The $3.6 Trillion Embedded Finance Opportunity
Is Embedded Finance the world's next platform shift?
Mike Massaro is the CEO of Flywire, a payments technology company fresh off a $120m Series E led by Goldman Sachs. Matt Harris is a Partner at Bain Capital Ventures and one of the smartest fintech VCs on the planet.
Both Mike and Matt have been on Rebank before, in episodes I highly recommend everyone check out.
In this conversation, we dig into the embedded finance opportunity and Bain Capital Ventures’ prediction that we’re at the beginning of a platform shift that will be as big as the Internet, Cloud and Mobile. The combination of Matt’s investor perspective and Mike’s insight at the helm of a leading payments company make this a fascinating discussion.
Full transcript:
Will Beeson:
Mike Massaro and Matt Harris, welcome to Rebank.
Mike Massaro:
Thanks for having us, Will.
Matt Harris:
Glad to be here.
Will Beeson:
Yeah. Well, it's fantastic to connect with both of you guys again. We have connected individually in the past. Mike, we did an amazing deep dive on Flywire and the space that you guys play in. And Matt, I guess it was probably last year at this point, I think we have what is still one of Rebank's best episodes, completely due to your skill as a thinker and communicator. Just one of the most ranging conversations around the state of fintech, what's interesting, who's doing what, and your very expert views into the future of the space.
Will Beeson:
So, I thought it would be fantastic to reconnect and kind of tie the themes, Matt, that you guys at Bain are tracking on a regular basis as you think forward with the practice of what Mike is doing at Flywire. And specifically, I think the topic that pulls all of this together is embedded finance. So, specifically in the case of Flywire, payments as a piece of customer interactions around travel, education, and healthcare. And Matt, in the case of some of your theses around the development of the broader fintech market, embedding initially payments, but I think over time also lending and insurance and other parts of financial services into, I think what you call the fourth platform after internet, cloud, and mobile. This kind of financial services infrastructure that ends up kind of horizontally sitting across all sorts of different industry verticals.
Will Beeson:
So, big topic. And we'll see if we can work through it with a bit of focus. Maybe to kick off, Matt, you can summarize that thesis of yours, the fourth platform.
Matt Harris:
Sure. I'd be happy to. And this involves a little bit of a history before we get to what we're seeing today. And the history quickly is that most of fintech, or what I call modern fintech, so, that's to say the last 10 years of financial technology, has been about taking products that are pretty well understood, a mortgage, cross border payment, small business insurance, and making them digital. Fintech basically had this core observation that the incumbents in financial services were quite analog, quite burdensome, often felt too comfortable, protected by their regulatory moats. And a set of entrepreneurs said, "You know what? We can make these products, and we can do it more elegantly in the digital form." And frankly, businesses and consumers responded to that. And a lot of these fintech 1.0 companies, many of which I invested in quite happily, took market share away from the incumbents.
Matt Harris:
But our view is that that phase of the financial technology revolution is coming to an end. The incumbents have now got the joke pretty squarely and understand that digital versions of their products are necessary. And frankly, the JP Morgan Chase app is pretty delightful. And so, that's not a great competitive framework at this point to launch digital versions of traditional products. And what we're seeing in terms of the next 10, perhaps 20 years of financial services is actually these products being subsumed in software. And so, companies that are trying to sell me renters insurance or sell me a bank account or sell merchant payments to a business or cross border payments to a business are not going to be met with receptive ears. What businesses and consumers, what end users more broadly in financial services are looking for is to buy payments, to buy loans, to buy insurance products through the software they use every day. And those software companies view financial products and financial services as an ingredient in the way that they build their business and the way that they construct their economic model and in the way that they build value propositions for their customers, whether they be businesses or consumers.
Matt Harris:
And so, more and more, we think that businesses and consumers will find and purchase and enjoy their financial products and financial services through the software they use to run their lives every day. And that will both create huge opportunity for software driven financial services companies and huge threats to both the incumbents and the 1.0 fintechs who have not yet moved beyond their product driven view of the world.
Will Beeson:
Yep. And Mike, perhaps this is a great time to bring you in to refresh everyone's memories as to what Flywire does and how it fits into this view of the future of fintech?
Mike Massaro:
Sure, happy to. Flywire's about a 500 person company, 12 offices globally. It's been going on for about 10 years now. One of the things that we've really noticed is that the combination of software and payments is very powerful. If you look at how we embed within detailed workflows and often use that software and the payment economics to build a very profitable business, while also delivering a lot of value to the end client or user. So, we've gotten really good over the years at building out solutions for vertical markets, making sure that we have been solving pain points, some of which have been overlooked for years.
Mike Massaro:
We're also big fans of sectors that are underserved, poorly executed maybe by incumbents, or have been neglected for years. And as Matt said, you used to have to string together software payments, financial services products to get a complete solution. And so, what we've gotten really great at is taking what is one set of payment technology with our own payment network that we own and control, and putting it on top of very targeted vertical software that allows us to go after very large markets. Flywire's found success in some of the largest consumer spending markets in the world, markets like education, healthcare, and travel. We're effectively taking legacy back and systems that our clients have had in place and extending them to the payer and providing better, more modern payment technology, things they would expect in their consumer worlds from other products that they may be using, but really delivering great functionality without having to kind of uproot and replace all these legacy backend systems.
Will Beeson:
And so, specifically, those three verticals that you mentioned, travel, education, and healthcare. Can you talk about what makes those specifically ripe for your sort of offering?
Mike Massaro:
Traditionally, these industries have not seen the level of digital engagement that markets like eCommerce have seen. These industries have used relatively dated technology, often requiring the finance and accounting teams to do quite a bit of manual work. And in a modern world that we're living in, pretty much all businesses are going through quite a transformation, looking for better solutions, maybe to automate backend systems. Ultimately, at Flywire, we like industries that traditionally aren't simple. They aren't just running a commodity payment transaction, that actually have a layer of engagement between the payer and the receiver that we can help facilitate through our targeted vertical software.
Mike Massaro:
For instance, if you've ever made a tuition payment for child, if you've ever tried to pay out of pocket healthcare expenses, we have four boys here in our household, so quite a number of medical expenses. Or if you've ever taken your family maybe on a family trip abroad, you've probably seen different types of payment experiences, some of which remind you of 10, 20 years ago, maybe trying to make a payment online. Others just are frustrating. You end up not knowing if your payment went through, not knowing if it was received, not getting proper payment confirmation or statuses back, sometimes paying too much for a transaction as well that you may be making.
Mike Massaro:
So, if you look at that and you look at within these industries, like education, look at payment plans, right? Oftentimes, people aren't paying in one payment to send their kid to a college. They are making multiple installments in a payment plan. You need software to really engage the payer to manage that payment plan digitally, to remind them to post those installments as well to the backend systems. When it comes to healthcare payments, it's different. You oftentimes are getting inundated with many, many invoices. You're not getting one consolidated balance. Oftentimes, you've made five or six different trips, or different family members have had different healthcare visits. And that's all coming at you very rapidly. And you're wondering, "Has my insurance been applied? Is this really what I owe?" And so, there's different challenges within that industry.
Mike Massaro:
And if you look at travel, you're obviously often dealing with people from different countries when you're running a travel business. And oftentimes, you're asking them to go and make an international bank wire, you know? You could be asking someone to physically have to go to their bank to follow a process they haven't followed before. Maybe they have to call a special line or get special approval, which may not be open in normal business working hours for a large transaction from their bank to go via bank wire. So, it's these uniquenesses within the industries that we focus on that truly matter. You cannot truly innovate in these industries. You cannot solve the complexities with a simple web form to capture a credit card. There's actually software that has to be built around these use cases. Deep integrations with backend infrastructure to truly deliver a great user experience.
Will Beeson:
So, Matt, I think that part of your view is that payments is kind of a leading indicator around a lot of fintech trends. And that's not just true now. I think it's been true over a number of decades. And now we're seeing some great examples of payments being the kind of leading use case for embedded finance. Can you just talk through some of the examples that you've seen in the market, whether they're portfolio companies of yours or otherwise, around people who are approaching this concept well, whether it's payments or a different financial service embedded in their offering?
Matt Harris:
Yes. And I first want to confirm that innovation in financial services does tend to start in payments. And we can see that quite clearly going back 30 years with the advent of first data, payments was, if you think about all the financial services, the first to move outside of the traditional incumbents. Many banks have come to the conclusion that payments is both a technology business and a scale dependent business. And as such, very hard to compete on a bank by bank basis. And so, nearly half of all market share in US payments are conducted by non banks. And in fact, over half if you count the joint ventures between Wells Fargo and Bank of America, which are really run by First Data / Fiserv.
Matt Harris:
So, payments was the first traditional banking activity to be first sort of attacked. And then, lately dominated by non-banks. And the reasons there are relatively clear. I mentioned the use of technology and the requirements for scale. But in addition, relative to lending or insurance, it's the least risk intensive activity. Obviously there is risk in payments, there's fraud risk for sure. There is bankruptcy risk as a merchant acquirer or an issuer credit risk more broadly. But relative to lending or insurance, it is less risk intensive and relatedly less regulatory complex and requires less of a balance sheet. So, we can understand why, when innovation happens in financial services, it happens in payments first. But I think it's no less inevitable across the other facets of financial services.
Matt Harris:
And clearly, as it relates to embedded financial services, we have seen it in payments first initially on the merchant's side with companies like Shopify and Mindbody. We think that we see a category of software businesses that we generically call practice management software companies that tend to be highly verticalized. So, if you look in every industry serving, again broadly defined merchants, not just retailers, but any company that needs to take payments from its generally speaking consumers, there are dozens of software players, whether it be a florist or a lawn care professional or a yoga studio or an eCommerce merchant. There are software platforms, dozens of them serving each of those verticals and micro-verticals.
Matt Harris:
In aggregate, we estimate there are upwards of 14,000 software companies that serve broadly defined merchants. And what those software platforms have learned is that, because they in effect run these businesses, they are the practice management systems where the business owners make all their decisions, manage their payroll, manage their inventory, manage their CRM, and often host the interface between the business and their customers, including billing and invoicing, it's a very logical insertion point for integrated payments, where the software platform can help the underlying merchants take payments from their consumer or business customers.
Matt Harris:
So, this started eight, nine years ago. Really the innovator here was a company called Mercury Payments, who realized that there was a channel to offer merchant payments through what they called ISVs, independent software vendors. Mercury was bought by Worldpay. Well, first by Vantiv, then now Worldpay, actually now FIS. And so, that endeavor by Mercury really opened everyone's eyes to the fact that, not only could payments be sold, cross-sold on a referral basis by software companies. But actually, payments could be integrated into the software experience. And by doing so, create new economics and create new user experiences. And so, fast forward to today. The latest report is that 10% of all US cart volume goes through software companies on an integrated basis up from 8% six months ago. And that portion of US payments volume is growing at double the market growth rate.
Matt Harris:
We and others estimate that 40% of US merchant payments volume will go through software companies sort of within 10 years. So, that revolution, that aspect of the revolution is well underway for obvious economic and value proposition reasons. We've invested in some of these software companies on the merchant side, and also in the enablement layer. These software companies, if they're going to become payments companies, which they have every economic incentive to do. If you look at Shopify, which if you go visit Shopify, you would say, "This is a great software company." If you look at their P&L, you would say, "This is a payments company." It's a majority payments company by revenue. And payments is growing faster than the rest of the business.
Matt Harris:
So, that as an example, along with many others, I think the software industry overall recognizes the economic opportunity. But it's not without its challenges. So, we've invested in a company like Finix, who exist to help software companies take advantage of the payments opportunity in front of them. The other embedded payments opportunity is on the issuing side. And here we've seen this primarily in B2B, where companies that focus on procurement or sourcing or accounts payable automation have all recognized that they have an opportunity to help their broadly defined accounts payable oriented customer base make payments, not just manage workflows and data around which vendors do you work with and which invoices are ready to pay, etc. But also go ahead and execute those payments by creating virtual commercial credit cards and using bank rails to move into the payments execution side of commercial payments of B2B payments.
Matt Harris:
We have a company called AvidXchange. It's one of the pioneers in this space. But there are others. And again, verticals matter a lot in this regard. And enterprise clients are very different than small business clients. So, we feel that there are many lanes to operate in by size of business, by type of business, by geography. The US is very different than Europe is very different than Asia. So, we see huge opportunities merely within payments both on the merchant side and the issuing side.
Will Beeson:
This kind of makes me think of ... I think I ready somewhere you writing 20 years ago when you started investing in fintech, you were kind of the only person doing it and actually the term fintech didn't even exist. Fast forward to today and even investors who don't think they're investing in fintech, who think they're investing in an eCommerce platform, like Shopify, or fintech investors, because every company is becoming a fintech company. And I think AvidXchange, you had also suggested at one point that when you invested in the company, it was a software company. And now, 80% of their revenues are related to payments. So, just the transformation of existing companies by picking up on some of these trends is phenomenal.
Will Beeson:
Mike, switching gears quickly and thinking about Flywire, do you already or do you intend to ... I don't want to say extend the offering. But rather, embed it even more deeply? Like, power platforms who are in turn supporting the types of industries and the types of customers that you guys currently service?
Mike Massaro:
Yeah. So, what we're able to do is take the software that we have. And again, it's consistent payment technology, storing a card, it's setting up a payment plan, it's doing a payout, you know? Or a settlement in a given country out of a different currency than what maybe the payment came in from. All of that kind of horizontal capabilities is kind of what powers the network and our own kind of banking infrastructure and card processing and alternative payment infrastructure. So, I think what's fascinating for us is that we have this long path to continue executing within our vertical markets. And in addition to just executing in certain geographies in our vertical markets, we actually have taken our businesses effectively global, right? So, we've got clients in 32 countries, right?
Mike Massaro:
So, we actually have an opportunity by focusing on those verticals to say, "Hey, we can actually help effectively every educational institution around the world who has a very similar problem, but has a very different nuance in their country as to how the money has to move or how the payment has to be collected." We can actually help automate kind of the global market for these industries, which is very, very fascinating. We're already also enabling other use cases within those industries, right?
Mike Massaro:
So, I'll give you an example inside education. If you look at education, 80% of the volume of money going into a given institution comes through tuition payment. But actually, 80% of the transaction volume actually isn't the tuition payment, right? So, it's a very large ticket transaction. But our clients actually want to automate all the AR happening, right? So, if for instance, you're organizing an alumni event or you're having a special fundraiser of some sort, those are all things that actually the money has to flow into the university. And how it's traditionally worked on those campuses is they'd have different solutions, right? You'd have different departments actually bringing up different providers. And what happens is, fundamentally, you've got a finance department who needs to know where all the money's coming in from. And you've got a compliance and risk standard that says, "Hey, we need to make sure we're storing credit cards in the right way and it's a secure way and everything flows to the overall financial systems at that university."
Mike Massaro:
Hospitals are very similar, right? You have very diverse infrastructure. You may have a major hospital system. But then you may have smaller doctors' offices all around that fit under that umbrella. And so, what we've found with our technology is we can focus on kind of more that enterprise use case, going after 80% of the volume. But then through partnership in our payment tech, we can actually enable other providers who may have a more targeted solution within that given vertical market.
Mike Massaro:
So, it's definitely something we're doing. We're doing it right now, in that example where people are trying to set up one time storefronts or ways in which they can collect certain types of payments on campus. We're also doing it for admissions, as a good example. There's a lot of admissions platforms. There's probably 10, 20 different admissions platforms for applying for school, all of which have a problem of capturing payments and integrating payments well into that flow. And so, you can stop short of getting into student application software, which is a whole industry and mass point within itself, a whole subindustry. But you can still enable those vendors and still help our end client kind of solve what their end goal is, which is streamlining that admissions process.
Mike Massaro:
Same thing happens in travel, right? There's so many different booking platforms, as an example, being used in travel, right? Where the travel suppliers ... You may go on an African safari when COVID all ends. And that safari company may be using a bookings platform. But the payment has traditionally flown outside of that bookings platform through the bank wire system or through a separate card acquiror relationship. And there's money flowing all to and from that supplier, right? The consumer has to pay. If they went through a travel agent, that travel agent may be getting a commission as part of that booking, right? So, all of that use case is extremely complex.
Mike Massaro:
So, for us, we'll go direct to market, where we see a fit within our existing software that we own. And when we see a use case that's big enough, large enough, we'll definitely go there directly. But there's frankly so much opportunity in the sub sectors that Matt mentioned, that we're also looking for where can we partner? Where can we enable other companies who have that specialty? And definitely add value to the industries that we serve.
Will Beeson:
So, specifically there, I mean, if we pick up the travel example, is it you have a sales team who's going to tour operators and selling your solution? Or are you going to Booking.com and working with them to add Flywire on the backend within their platform?
Mike Massaro:
Something like a Booking.com or a TripAdvisor who is processing what is a traditional card payment through their interface, they're likely to go to more of a large scale commodity credit card acquirer or processor, right? They're really probably negotiating what is a relatively transaction store a card, capture a card, run the card. And so, their user experience actually isn't that complex. So, they're much more likely to end up at a Fiserv or an FIS Worldpay or an Adyen or someone to that effect, right? Even someone like a Stripe. The use cases that we like are ones that ... An example would be an adventure luxury travel experience, a heli skiing trip, an African safari, a destination experience company. And there's literally hundreds of those and thousands probably globally across all the countries that have high experience based travel.
Mike Massaro:
And again, they're using different products to automate their business, right? They're using something to manage the contact of who the traveler is, who the travel agencies are, how a quote goes out, how they can figure their sub-suppliers within their safari, who's going to actually pick you up from the airport, how are you going to fly from one airport to another within Africa. All of that stuff gets parked kind of in software that gets built up into your overall trip experience. And then, what they have traditionally done is just left the payment to be 'offline.' And so, that's really where we're putting our time and effort. How do we help that supplier digitize, right? Because you've got a large, complex transaction. You've got a global payer community.
Mike Massaro:
And in addition to that, those bookings platforms for us are great partner opportunities, right? Because they may service 50 or 100 of those travel experience companies. And again, we can get kind of distribution and scale through those integrations in enabling those platforms to do more. But yet, we don't have to go and own and build all of the bookings software, right? We won't want to have to effectively build end to end software. I always like to say, we want to own enough of the software to solve the payment problem. But it doesn't mean we're going to go into building software that doesn't fit directly related to how the payment and the money goes.
Will Beeson:
Picking up another quote from Matt, this is great, we could do an entire podcast just pulling on gems from Matt over time. So, existing software relationships are data rich, which leads to smarter cross sell, prequalification, and massive risk reduction. And where my mind goes in reading this, and then thinking about Flywire or payments companies in general, you're sitting right at the heart of the transaction. I mean, this is why the payments business has been so attractive for so long. And the data that's originated through that transaction. This actually leads me to an episode we did not too long ago with the CEO of PayU, around their potential vision of basically becoming a free payments processing company and monetizing through the data that's originated around the payment for consumer credit for other types of lending and for other financial services. Mike, specific to Flywire, do you have any plans, whether it's shorter term or longer term of using that payments experience as an entry point into other financial services?
Mike Massaro:
Yeah, for us obviously we see a ton of growth in relation to just getting the payments digitized still. We're still at a very ... Even after eight to 10 years, we're still at a relatively early innings for the global digitization of payments within the industries that we serve. But you're exactly right. We're touching some of the most critical larger sectors of payments. If you look at who's using our technology, it's seven of the eight Ivy Leagues use Flywire technology for tuition. It's entire educational systems, they have multiple campuses. 30% of US hospitals touch on Flywire technology in healthcare. So, it's very widely distributed. And so, that data that you're getting, not only spending habits, but what a user is either doing or where they're going, right? Is a fascinating part of that. Look at the application process. We see effectively a person applying to higher ed, all the way through application into where they study. And then, also potentially in post grad. And so, that data is massive.
Mike Massaro:
To Matt's point, there's additional services that you then have an opportunity to add on to. But we believe they have to be applicable, right? We don't believe you can turn it into a Groupon where you're trying to sell everyone anything. It'd have to be targeted, right? But within our sectors, if you look at the international student as a sub sector for us, you have a massive issue around credit. You have people crossing borders who oftentimes can't use the banking services that easily that existing populations can use in the country that they're studying from. They have different demands. And oftentimes, when they go and get employed afterwards as well, they then have different needs, right? They may be living in yet a third country, studied in another, and have family in yet a third, right?
Mike Massaro:
So, those are pretty unique experiences. And if you've helped those consumers and your brand is aware to those consumers, I think you have an opportunity to provide additional value add to them over time. But I think you have to do it in a way that isn't me too, and isn't trying to just push products. And we're fortunate to have a very strong business in driving that value equation between the payer and client, the receiver of money. And yet, at the same time, have the ability to add additional capabilities over time. So, for us it's more of a longer term thing. There's a lot of short term opportunity to keep growing. But we're effectively building up this set of very unique data of a global consumer base across our industries, which is again a huge asset, I think, for future growth.
Will Beeson:
Matt, so if we zoom out a little bit, kind of picking up on that point, do you have views on what other sorts of financial services you expect to be embedded and where any specific opportunities might lie?
Matt Harris:
We're already starting to see the embedded financial services movement move beyond payment into credit. And Mike gave us some good examples of this. Perhaps the largest single example of this is Square Capital. Square obviously famous for offering merchant acquiring services to small merchants. But really, the way customers experience square is as a software company. And in fact, as a classic practice management software company. They run their payroll, their inventory, scheduling, everything on Square, and obviously payments as well. And as such, Square put itself in an incredibly advantaged position to be a lender to its customers.
Matt Harris:
Lending, after all, is about customer acquisition. It's about kind of unfair advantages in terms of underwriting and positive selection. And then it's about monitoring and servicing loans. And Square has deep advantages over other small business lenders across that full continuum of the value chain of lending. They obviously are intimately related to each of their customers already. They know in advance, not only who's credit worthy, but they have zero fraud costs, fraud risks, because they know that each of their customers is in fact an actual small business with revenue flowing through it. They know the quality of that revenue. They know the propensity to want to take a loan. And so, their marketing can be very narrowly targeted on a pre-approved basis and integrated into the product that their customers are using every day.
Matt Harris:
And similarly, they're servicing and monitoring. They know the ongoing credit health of each of the customers on a daily basis and can react much more quickly than, not only a traditional small business lender, but even an online fintech 1.0 small business lender who has no similar insight into the very nuanced health of its customer base. So, Square Capital really points the way to where innovation in credit will happen, which is to say, as mentioned, with those software companies that have that intimate data rich relationship with their business customers or their consumer customers and can leverage that unfair data advantage and that ongoing connectivity to both have lower cost of customer acquisition, meaningfully lower credit losses at the time of underwriting, and then much better user experiences on the servicing and monitoring end, and ongoing credit loss management.
Matt Harris:
So, we see this happening across small business software platforms now. Toast in the restaurant space launched a lending product. And we think this will be quite common that these practice management solutions will move beyond payments to also offer loans. Shopify now offers loans to its merchant customer base, etc. So, this is very clearly the next wave. Point of sale lending is, many could argue, the sort of granddaddy of embedded financial services. It is positioning a loan offering in the middle of a commerce experience. So, when you go to buy a Peloton, you are not looking for a loan that day. You happen to experience a firm in the way of making a commerce transaction. And that integration that a firm has done into a point of sale system provides for at least neutral and arguably positive, they have experienced positive selection, because one of the inherent issues with lending is that when someone waves their hand and shouts, "I need money," that's not a great time to give them money. There's actually an inherent adverse selection in marketing loans to people.
Matt Harris:
But there's not an adverse selection in marketing incredibly expensive fitness equipment to people. People who believe in the first instance that they can afford a Peloton, even if they then go on to take a loan to pay for the Peloton, are the kind of customers you want. And even more so, for instance, the home improvement vertical, where a consumer who owns their own home who has decided to improve it is actually a prima facie great credit risk. And so, the point of sale lending space is an early progenitor of embedded lending and has had disproportionately good credit results throughout its history, depending on the category. I think cosmetic surgery and jewelry not so much. But categories like fitness and like home improvement have had extraordinary results and will continue to do so.
Matt Harris:
And so, we see companies building embedded point of sale lending capability for software platforms. So, that platforms that serve contractors, like Jobber or Housecall Pro, etc., should be able through APIs to offer embedded point of sale lending as a service to their customers, just the same way that they offer payments to their customers. So, we're seeing it happen in lending. It's happening here, there, versus across the waterfront. But we believe that revolution will be nearly as complete as the embedded payments movement when it reaches full flower. Banks will always be in the picture, we believe, as the regulated entities and as the balance sheet providers. But there will be robust intermediaries that bring bank capital to where loans need to be made, which is both for consumers and for businesses increasingly in software.
Will Beeson:
Matt, to the extent you have insight into this, it's one thing for the software companies to decide that they're going to offer embedded lending. It's another thing for the balance sheet provider to, one, understand what they're talking about. Two, realize that it's a good idea, get it through risk committees, and build whatever connectivity monitoring systems they would need in order to actually deliver that. How developed is the balance sheet provider side of this market right now? And is that not an issue to launching these embedded credit products? Or is it a throttle on innovation?
Matt Harris:
It's a throttle now. And I think it'll be an ongoing throttle. I've made no secret of the fact that lending is not my favorite category for venture investing. And the reason is that the dependence on third party balance sheets is not a solvable problem because crises in the economy are inevitable. And when they happen, they tend to constrain access to capital. At the very least, they increase the cost of capital. And more generally, they often choke off access to capital. And so, for non-bank lenders, that's a basic Sword of Damocles hanging over your head, where once a decade at least, you're going to lose your fuel. So, I continue to think that's an issue.
Matt Harris:
But I think the solution is not to create non-bank lenders, who then have to go build their balance sheet brick by brick with wholesale sources of capital that inevitably dry up. It's rather to build conduits between the software companies who are able to manufacture these loan assets on one hand, and the forward thinking banks on the other hand, who understand ... at least have a glimmer of an understanding of embedded financial services and who are eager to get to positively selected borrowers and not negatively selected borrowers. And there are banks like this.
Matt Harris:
Actually, a company that managed to do this quite well is GreenSky. GreenSky is fintech 1.0. But they have a platform of sorts that contractors can use to finance their customers point of sale loans. And GreenSky didn't build a balance sheet. They realized that banks, like Fifth Third and Regions and others understand FICO Score based loans, they understand point of sale loans and home improvement loans. They just have no effective channel for originating them. And so, I think in my experience, where the product itself is actually relatively traditional, and by traditional, I mean it is underwritten using a FICO Score, for instance, it is either securitized by an asset like a home or a car that is well understood, or it is for a use of proceeds that is well understood like home improvement.
Matt Harris:
So, where you have these traditional loans that are just being originated and underwritten in new and clearly better ways, we have seen banks on a more durable basis, on a primary basis say that they're interested in those assets, not as a wholesale lender, lending to another lender, but rather as the direct lender on these platforms. So, that's where we see the next five to 10 years at least, capital being relatively abundant for these platforms. And then, I think over time there may be appetite for novel forms of lending, truly novel.
Matt Harris:
Like, I think in this supply chain finance area, we see companies like Avid and others, who have access to lots and lots of buyer and seller transactional data have an opportunity to intermediate credit risk in truly secured ways, secured not by assets and collateral, but secured by data sources that are new to the world and deeply integrated into how businesses transact with each other. Tradeshift and C2FO and other examples of this, Taulia for instance. I think over time, even though those are relatively esoteric loan types, I think the incredible performance of these assets over time will attract durable bank capital on a primary basis. But for the time being, the bulk of the embedded lending activity will be in more traditional categories. I would say Goldman Sachs and their willingness to make revolving credit card loans through Apple, rather than direct through customers they acquire themselves is an example of embedded lending, and not a coincidence that it's happening in credit card lending, which again is a 40 year old form of lending that people understand quite well.
Will Beeson:
Personally, I'm very interested to see what comes out of the SoFi acquisition of Galileo, the processing platform. We connected with Clay Wilkes, the founder and CEO of Galileo recently, who talked a little bit about the vision of effectively delivering SoFi's lending products and balance sheet through Galileo and therefore, via API to all of the neo banks and fin techs who use Galileo's platform in what could potentially be a very powerful development. To wrap up, Matt, perhaps you can help us understand the scale of this opportunity as you see it. I think you've done the math and compared what the internet platforms represented in terms of value creation, and what you expect this fourth platform, embedded finance, to potentially represent?
Matt Harris:
Yes. Well, to us, what jumped out was just the market sizes at work here. So, if you combine payments and lending and insurance, in aggregate, either on a revenue basis or even more acutely on a profit basis, they are more than an order of magnitude larger than the entire software industry. On a revenue basis, they're 12 times as big. And on a profit basis, they're nearly 20 times as big. And as we've seen, the consequence of this is that when you start to incorporate payments, lending, and insurance in your business model, they don't just become 10% of revenue, they become more than half of revenue. We've seen this with Shopify. Obviously we see this at Square. We've seen this at Mindbody. We've seen this at AvidXchange. And so, it's not actually the frosting, it's the cake. And that has enormous implications.
Matt Harris:
It means that this is no longer optional, because if you're a software company, your competitors are going to be doing this. And the latitude they will then have on pricing, pricing of things like merchant acquiring, but pricing of software is actually a threat to you. They can, although people rarely do, but they can give away the software for free to make money on the embedded financial service, or at the very least, have a highly concessionary negotiating posture on price vis a vis their customers and what were formerly your customers.
Matt Harris:
So, the very size of these markets means a couple of things. One, it means that this is not an optional activity that you can do at the margin for a little more ARPU, average revenue per user. This is actually a critical business initiative that you're probably already too late in addressing. And the second thing is just the value creation. We looked at the last 30 years of venture backed companies. And collectively, they've created three trillion dollars worth of value, which has been incredible for our industry, the venture industry, and incredible for the founders and employees, and ultimately public shareholders who place their faith in technology as a value creation engine.
Matt Harris:
But if you assume that 40% of US payments and say 20% of lending and 20% of insurance over the next couple of decades move from being delivered by traditional incumbents, or even technology based insurgents in traditional ways to being served on an embedded basis, and then you apply modest revenue multiples to those streams, it dwarfs the last three decades of technology innovation, including Facebook, Amazon, Apple, any company you might name. So, both the revenue and profit opportunity and the market cap opportunity are larger than anything we've seen in the prior platform shifts across internet, cloud, and mobile.
Matt Harris:
So, first, I feel confident that I'll probably have a job for a little while, that the fintech thing is not here today, gone tomorrow. But also, challenged by the idea that everything I've come to believe, everything I've observed in the past two decades of working with fintech, which is to say all you have to be is smarter than the bank, smarter than the insurance carrier. It's the equivalent of just being faster than your camping mate, rather than faster than the bear. That logic is out the window. You actually have to provide products on an embedded basis if you want to win. And so, it's been both exhilarating and exciting and confidence building for those of us in fintech investing who believe this is the future. But also challenging and forced us to think in new ways about the coming decades, verus the ones we've already lived through.
Will Beeson:
Well, it is amazing. And I'm sure, Matt, that 20 years ago when you started fintech investing, certainly ... I don't know, what? Maybe seven years ago, when I feel like I kind of first really dug into fintech. Mike, it sounds like a bit longer for you and Flywire. I was as bullish as anyone, right? But if you had told me there was potentially another 20, 30 year green space in front of us here, I think I would have been surprised. But it's clear that this is only the beginning. It's clear that this is opening up. If Flywire has built a billion dollar plus business, just raised $120 million series E round, I think led by Goldman, which we didn't even have time to get into today, after eight years, but this is just the beginning, then wow. This is going to be an exciting ride.
Will Beeson:
Guys, thank you so much for making time to connect today. Fascinating discussion, amazing topic. I'm sure we will continue to explore it in the future. Matt Harris and Mike Massaro, thank you very much for joining us today.
Mike Massaro:
Thanks Will.
Matt Harris:
It's been great to be here.
