The next frontier of embedded lending: Creating prosperity in emerging markets
Growth in SME segments, especially in emerging markets, for OEMs and global consumer brands, depends on these merchants’ access to liquidity. Today they lack access to financing due to a lack of distribution and credit scoring data. Embedded lending is perfectly suited to service “underbanked” merchants in retail and trade, if embedded in the sales process of OEMs and global consumer brands. By supplying this advanced form of trade financing to smaller enterprises, brands increase sales, boost economic development and ensure prosperity in emerging markets.
Small and medium-sized enterprises (SMEs) are the life blood of the global economy, providing employment opportunities and driving innovation, while making up ~50% of GDP in many economies. The magnitude of this segment is striking, as some markets like Indonesia showcase: 57mn micro-enterprises. Many of these micro-enterprises are in retail or act as suppliers to larger organizations. They represent the “long-tail” sales opportunity for industrial OEMs and manufacturers like Bosch, ABB or Knauf as well as consumer goods giants like Danone, Unilever and P&G.
SMEs in developing markets often struggle to secure the financing they need to grow and expand. The lending gap in B2B SME business is a global problem of $5tn in size according to IFC. Even in developed markets it is significant: in Europe about 30% of SME loans are declined by lenders, while emerging markets such as Egypt show rejection rates of around 92%. In these countries, smaller merchants are generally underbanked and often do not have a bank account at all: in Egypt, around 40% of the SME population operates without one. On the other hand, in the smartphone era, these SMEs, however small, have a phone with internet access, they are part of a community, and they have a strong drive to succeed.
Let’s consider what emerged in China: Lending services were embedded within smartphone apps such as Alibaba’s or WeChat which are used by vast numbers of vendors and suppliers. The data access allowed for better underwriting and the existing captive user base ensured broad access to loan distribution. Even in the US, consumer lending embedded within online shopping carts (BNPL), is being followed by business lending embedded in SaaS (Software-as-a-Service) accounting platforms. By embedding in applications with distribution power and underwriting data, lending businesses can scale at a rate which is governed by their ability to effectively underwrite.
As sophisticated, data driven lending begins to outperform traditional methods, one type of organization that holds the key to both distribution and underwriting data are brands with control over their distribution channels: Global OEMs and fast moving consumer goods brands. These organizations have been data driven for decades, from both the marketing and distribution side. They are tracking brands awareness, affinity, and prices sensitivity from advert to shelf space. In emerging markets and in the long-tail of smaller traders, their marketing and distribution is less advanced: They send their sales force from convenience store to convenience store or from trader to trader, track individual revenues and often build personal relationships with merchants. This is the optimal basis to distribute lending products and support underwriting in the markets with high potential, as cash constraints of merchants, limits growth of OEMs and brands. Therefore, we believe it’s time for large consumer goods brands to step into the credit gap together with embedded lending partners and boost their revenues in emerging markets.
What is Embedded B2B Lending?
In the B2B context, embedded lending means that lending services are integrated into the products or services offered by other non-financial businesses, such as marketplaces or platforms. This approach enables SMEs to access financing without having to go through a traditional bank loan application process, which can be time-consuming and often requires collateral. For embedded lenders, the efficiency arises from their on-the-ground knowledge about their SME clients, which is more granular, up-to-date, and tailored compared to a traditional bank. For example, if a sales manager delivers household goods to a merchant every week, they know their inventory (sight-check) and have a great data-point to deduce total revenues. Additionally, the interest rates offered can be subsidized by higher lifetime revenues with that merchant. This effect is substantial and sustainable, as the long-term client relationship allows embedded lenders to help SMEs build up a credit score, creating a positive flywheel of increased eligible loan amounts and growing revenues.
The embedded lending opportunity
At aperture.co we estimate the digital embedded lending to provide an annual $1.5bn opportunity in Europe and an opportunity around $5bn globally. This estimate is based on extrapolating the size of Bain’s research for the US market, which is focused on verticals primed to benefit from the opportunity: B2B online marketplaces, vertical SaaS-solutions or platforms that have SMEs as their supply side.
We believe that this is only the tip of the iceberg. If we can unlock the potential of embedded lending in trade financing, we can work towards closing the $5tn SME funding gap globally. IFC estimates that SME lending has growth potential of 140%. Behind this opportunity are astounding numbers about SMEs, which carry goods of global brands:
Benefits of embedded B2B lending across all the actors
We can define the typical benefits for all participants in the embedded lending value proposition.
The embedder, likely to be larger brands / manufacturers, vertical-SaaS, platforms, or B2B service providers. These facilitators benefit greatly from embedding lending into their business transactions: Higher sales, new customer segments, higher loyalty of customers and added revenues. The potential is very clearly proven by large vertical SaaS solutions like MindBody, who base their entire business model on cross-selling embedded finance incl. lending. Now, the use case is also proven in the emerging markets context through digital wholesaler. In Egypt, MaxAB offers financial services across lending and payments to strengthen their value proposition. The advantage of credit is so clear to brands, that they sometimes became the lender with in-house trade financing and payment target models.
The borrower: Often SMEs, who have less structured access to bank financing. This means, the key benefit is: They get access to liquidity to fiance inventory, which they would not have gotten from a bank. But embedded lending offers several additional benefits compared to traditional lending by being offered instantly at the point of need and priced based upon real-time risk analysis from accounts payable and historical trends.
The lender: If separated from the embedder, banks and other lenders can access new client segments with lower customer acquisition or processing costs. SMEs for example, in the embedded lending environment can directly prove their revenue data to lenders through the platform or marketplace, brokering the lending agreement. The decreased transaction cost will enable higher underwriting segments and improve profitability. Additionally, the decreased customer acquisition cost will increase profitability. Lastly, the partnership will increase digital underwriting competencies, valuable in the growing their online loan segment. We observe the underwriters behind a trade financing solution, to launch novel markets via embedded lending instead of direct loan sales. This is due to the additional data-points available in embedded lending, helping to build a first risk-model in a new market.
How this can secure the livelihood of merchants
Imagine running a small convenience store in low-income parts of Egypt. A small business operator will spend most of their day in the shop, selling everything from washing powder, to produce, to soft drinks. Every day, a different sales manager of one of the larger brands will come by and they will have a brief discussion on whether they need 2, 5 or 12 new items to stock the shelves. Offering choice attracts customers, but overstocking endangers the ability to supply necessities that month for their family. At the same time, consumer goods companies are coping with high distribution costs, low brand loyalty, fakes, and inconsistent inventory management. At the same time, regional super apps like MaxAB erode their margins, because digital wholesalers can run distribution more effectively.
Image Credits: MaxAB
The story is similar across emerging markets like Pakistan, Indonesia and elsewhere. To own the direct distribution channel, brands built digitized sales tools for their sales force and for their back-office management. They sometimes even manage to build sales partnerships with other brands to gain scale advantages. In comes the potential of FinTech:
By offering lending services to small retailers with an embedded lending partner to finance the inventory bought from the brands, they can enable their customers to grow and generate sustainable, added revenue. This opportunity is significant, with an estimated 2 billion people living in emerging markets that are underserved or excluded from formal financial services. The power of financing especially becomes clear in our examples of the smaller Egyptian trader. Imagine a household goods company offered them a trade financing solution.
Merchants’ sales are limited by the amount of stock they can buy at a time, because they are often active in underserved markets. Lack of availability and variety are a constant consumer pain point in low-income segments, typically serviced by micro- and small merchants. Its a very tangible issue: If the shop owner paid their electricity bill or rent on Monday, they might not have enough cash at hand to purchase inventory from the brand’s sales rep. Every month, owner-operators need to divide up their profits in a share used for living expenses and a share they can use to grow the business. On a total profit of 10% per month, they might consume 8%, allowing them to grow their business around 2%, by increasing their stock bought. This is slow — especially in markets with high inflation rates!
In cases where they can get inventory financing, they will be able to realize +50% significant growth within 1–2 months, more than enough to pay the financing cost. Because they gain a competitive advantage (higher choice and higher availability), this revenue increase is often sustainable. Their income changed dramatically and their living standards as well. In our example, even with a share of the profit going to interest, the sustainable growth can be 90% of the borrowed amount.
Case Study: Developing markets retailer financing
Our team launched an embedded finance pilot to capture the low-income segment in developing markets for a global consumer brand. The predominant channel in this segment are small convenience stores that are severely impeded in their growth due to a lack of financing. We interviewed these merchants and their end-customers to understand needs, potential points along the user journey to embed digital business models and identified a concrete need:
By financing their inventory, consumer goods brands can realize sales increases of up to 400% in the micro- and small-merchant segment and an avergage of 200% is achievable. The sales and profit increase of the smaller merchants directly translates into higher sales for the brand. While this direct sales increase is significant enough to justify launching a financing service, embedded lending offers further strategic advantages: In emerging markets, digital wholesaler platforms are taking market power from brands in this low margin market. By offering channel partners financing options, brands can retain channel control and thus protect margins. By launching a pilot within 3 months, the client team could prove the impact of the embedded lending project and define the necessary team to roll it out across the respective region. The cost-benefit analysis was striking. The sales increase was enabled by partnerships and only minimal adoptions in the sales systems and processes were necessary to distribute the onboarding to the financing solution. The entire project was steered by one consultant, enabling a new market to launch every 2–3 months.
Conclusion
The socio-economic benefits of micro-lending are proven, but difficult to implement due to credit underwriting and distribution challenges. Embedded B2B lending is a great solution that can help SMEs access the financing they need to grow and expand their businesses, while giving underwriters better data (revenue and stock levels) to assess credit risk. At the same time, brands are inclined to offer their on-the-ground sales teams as distribution channel because the gain in sales increase far outweighs the cost. Case studies across the digital wholesaler space prove the feasibility and value to brands, which need to retain their control on outlets, prices, and inventory decisions. We will support global brands in participating in this opportunity via three-month pilot projects and with dedicated team, safeguarding execution across markets. Lastly, we recommend to build an international team to work in sales enablement, extending and refining the proposition to further offers for small merchants, with services such as digital payments solutions. The path to value for emerging market development and sales growth is clear. Brands have all the building blocks to act.
