In this episode, Ron and Jonathan discuss embedded finance, embedded fintech, and for which companies Q2 Innovation Studio and Q2 Banking as a Service make the most sense.
Watch the full episode here.
Ron Shevlin:
Hi, and welcome to Tapping into the Potential of Embedded Finance, sponsored by Q2. I'm your host, Ron Shevlin, Director of Research at Cornerstone Advisors and senior contributor at Forbes, where I write the Fintech Snark Tank blog. My guest today is Jonathan Price, Executive Vice President of Emerging Businesses at Q2. Prior to joining Q2 in early 2018, Jonathan held senior IT management positions at BMO capital markets and did stints at Citibank and Goldman Sachs before that. Jonathan, Welcome. Thanks for joining me today.
Jonathan Price:
Thank you very much. Thank you for having me.
Ron Shevlin:
Great. Let's start by talking about what Q2 is doing in the embedded finance and embedded fintech space. Company recently introduced its Innovation Studio, and let me just ask you to talk a little bit about that. What is it and what is it designed to do?
Jonathan Price:
Yeah, so really the premise of Innovation Studio for us dates back to when Hank Seale founded this company, which wasn't so much about how do we distribute software to banks and credit unions. It was really about how do we empower them with technology to make them more competitive and democratize financial services beyond just the top banks. And as the company has been built over the years and our digital banking and digital lending platforms have evolved, one of the things we started to realize is that we can't do everything for all our customers, and so we developed an SDK, software development kit, back in 2017 that originally was opened up just to our customers. Allows them to extend their capabilities, customize certain things with their own experiences. In about 2019, we started to realize that there was an opportunity to open that SDK app and expose our APIs to third parties, not just to our customers, and that's what really spawned the formality of Q2 Innovation Studio.
And today Q2 Innovation Studio is a model that we have that is allowing third parties to access our digital banking rails and embed applications or develop on top of our digital banking platform. And then there are multiple models under Innovation Studio. I'm sure we'll talk about some, but Q2 Marketplace is one we've mentioned publicly. Our Accelerator program is one that's more for a B2B fintech, whereas marketplace is B2C, where you're actually targeting the end user of the FI directly, but happy to go into those. As helpful for this conversation.
Ron Shevlin:
Yeah, well, let's actually do that. Let's start with the Accelerator. What exactly is the Accelerator, accelerating?
Jonathan Price:
Well, really what it's accelerating for this partner ecosystem is speed to a very large channel. When you think about the digital banking channel they're accessing, we have over 19 million retail end users on the platform, and between one and two million small businesses that are customers of our banks, and when you're a relatively small or even a larger fintech, that's building a business targeting financial institutions, or even just their end users in a direct model, they have challenges as they're building their business, right? They have resource constraints on the technology side, they have go-to-market constraints around the cost of building a sales force, and we feel like we're helping them on both sides of that equation, because with a single integration, they can distribute their application to all of our FIs. We have north of 450 financial institutions that are on the digital banking platform.
And so for a fintech that wants to access a very large channel like that, it's very cost-effective to be able to do that with a single integration. We're finding our customers are often building these things in a matter of a few weeks and then has access to obviously a huge channel, and so we think we're solving a technology problem, where we're easily enabling them to access our digital banking rail through our SDK. We're also solving a business challenge because when you think about the cost it takes to stand up a sales organization to sell into what is a highly fragmented market, you know 10,000ish financial institutions across banks and credit unions. It's a very tough thing, and it's a highly regulated market. The banks and credit unions tend to purchase from known vendors. They like to have established relationships, and so this is an easier, more cost-effective way for these partners to access that channel.
Ron Shevlin:
So, I know for fintechs like Glia and Finn AI are both utilizing the Partner Accelerator you have. Take us through, from their perspective, how do they work with this? What benefits are they getting? How does it work from their perspective?
Jonathan Price:
So in those two cases, and we have over a dozen others that are already live or in the process of going to production with Accelerator specifically, they're taking advantage of the APIs and our platform to be able to quickly roll out their solution to as many banks and credit unions as possible. The game here is lower cost and friction for them, and speed to market, and so we've seen both of those firms you mentioned, have early success. We're sharing pipelines, we're talking about specific opportunities, we're leveraging data and Q2 SMART and other tools we have, to understand the propensity of certain financial institutions and users to buy their applications, so we're really working with them to figure out who are the right FIs to pair them up with, and then ultimately to help them distribute their product as broadly within our customer base. So it's a win-win for — sorry, go ahead.
Ron Shevlin:
No, no. I was gonna say, it's not just a sales aspect, there's a technology integration aspect to the Accelerator then, correct?
Jonathan Price:
Absolutely. When you think about the experience, and it varies by application, from a simple SSO to a deeper, more ingrained native experience, but the reality is when you think about that value prop of having their applications embedded very rapidly in the digital banking experience, that's a huge saving for them because otherwise, these firms, Glia, Finn AI and all our other partners, are going bank by bank, doing custom projects, that have cost for the FI and costs for these firms to go build those integrations, work with a variety of different partners to make those integrations work, and we're kind of serving that up to our base and to these partners off the shelf.
Ron Shevlin:
Now, another key element of the Innovation Studio is the Marketplace. It sounds to me like that could be a little bit of overlap with the Accelerator. What is the Marketplace doing from the fintech's perspective?
Jonathan Price:
It's a good question, and we need to be very clear in the market on the difference. From a Marketplace perspective, the model is shifting. In Accelerator, Finn and Glia as you mentioned, they're really selling to the FI, and the FI is making the decision to offer that product up to all of their end users, and the cost is born by the FI. In marketplace, what we're really doing is bringing a set of direct-to-consumer or direct-to-small business apps through a shopping cart experience that's interior to digital banking.
We can think about some of the names that are live in the marketplace today, like TransferWise now known as Wise, AutoBooks. They've built an integration where it's not the FI. The FI makes a decision they want to surface the app, but they are instantly provisioning the app when an end user, be it a small business or a retail end user like you or I, goes through a shopping cart experience inside digital banking, and decides to purchase that application. So the difference is really that you're putting the purchase decision in the hands of the banks end user, or the credit unions end user instead of the FI themselves.
Ron Shevlin:
And so from the FI's perspective, the financial institution's perspective, how do they work with the Marketplace? Can they just sort of choose whichever services they want? How do they pay for it? What's the mechanism by which they interact with the Marketplace?
Jonathan Price:
As Q2 digital banking customers, they set up the Marketplace for free, and our belief is that we are going to be an open marketplace and a platform where we are attempting to be Switzerland. We do not want to choose the right vendor for the right FI. We're trying to give them options in a given segment. So if you think about a world of, let's just say, small business finance and accounting apps, we have a few vendors and we're going to have more over time, but we're allowing the FI to choose which of those apps they want to offer to their end users. The end user will only see the apps that the FI chooses, but yes, for the FI themselves, they get to choose which apps they're showing to their end users, and there is no cost to the FI to doing this.
In fact, one of the beauty of this model for the FI is we're kind of flipping it on its head where, when we strike a revenue arrangement with these third-party partners, after we cover our fixed costs, we're actually sharing 50% of our revenue back with the FI. So, back to Hank's mission out of the gate that I started with in your first question, the Marketplace model really becomes a revenue generation engine for the FI, which really is a new paradigm for when you think about what already exists in our industry, in terms of marketplaces in the bank-tech landscape.
Ron Shevlin:
You mentioned AutoBooks, and that's really from a small business tool. From a consumer perspective, what type of capabilities are available in the Marketplace today? And as you look forward, what are you sort of recruiting and where do you intend to grow?
Jonathan Price:
We have personal finance apps. There's an app in there called Hurdlr. I talked about international payments with TransferWise, Experian for credit monitoring. What we think is the right way to address this for the financial institutions and ultimately their end users, is to get deep in certain segments that are highly adjacent to their customer's financial journeys. I'll tell a quick story, one of the things that we put in front of our board of directors to sell them on the business case to invest in this organization, is that the average small business in the United States spends $200,000 a year on 20 disparate apps, to run the business around a bank. So these are apps for the treasurer or the CFO of a small business, that allow you to manage payables and receivables or accounting and finance or invoicing, or even CRM on the front end.
And our vision is that doesn't need to be unintegrated and dis-aggregated from the digital banking experience, the FI can participate in the distribution of those functions, and they should, and when you think about the benefit to the end user, that treasurer controller, when they're running their business to have that all integrated, to have it from a single place of purchase, as opposed to the security and management friction with 20 disparate apps, we really think we're solving a pain point there for the end user, and then on the FI side, all of the benefits I talked about about a revenue center and more stickiness and engagement. One of the existential threats we see in traditional banks and credit unions right now is all of the pressures that fintechs and even large banks that are trying to unbundle some of the regional community offerings.
At the end of the day, this embedded FinTech direction, where we're powering the banks and credit unions to have more of these third-party apps, is all about bringing that back into their channel, and that example of the small business data I talked about is pretty compelling, because there's so much around the financial journey that the bank and credit union does not participate in today.
Ron Shevlin:
Yeah. I think you got that small business data point from a report I wrote, so thanks a lot for bringing that in, Jonathan, and I appreciate that.
Jonathan Price:
I appreciate the insights.
Ron Shevlin:
What I also find intriguing about this, and perhaps a challenge, is I think there's still a lot of mindset among a lot of financial institution executives that these revenue opportunities are small potatoes, small things. Do they get that this is really about embedding themselves better into their customers and their members' financial lives, by offering wider range of services? Do you get any pushback from that, or do you feel like they're getting it and are moving in that direction?
Jonathan Price:
I think so. For us, it's pretty aspirational and part of Hank's vision to really drive revenue back to the FI and change the paradigm of our relationship with them. We've seen very few of our early adopters, or even now we're up now, we're sort of near call it a hundred financial institutions that are participating in Accelerator and Marketplace. Very few of them are talking about the revenue benefits right now. What they're talking about is, how do I get more stickiness with my customers? How do I get more engaged? How do I bring them and solve more of the pain points that they're feeling from my financial institution? There's very little talk right now around the revenue element of this.
I do believe that at scale, if you start thinking about a single FI doing a dozen of these apps, or a couple dozen of these apps and getting somewhere between, let's say 1 and 5% penetration within their base, the math will be meaningful, And that can be very notable revenue stream for the financial institution. But I just think right now we're selling them on a vision and they're feeling the need to get more competitive around solutions like this, and so there's much more of a focus on what you said, which is what are the strategic reasons we need to be going down paths like Marketplace, like Accelerator.
I had an interesting conversation with the COO of about a $10 billion bank last week, and what he told me is they're very fintech forward. They really want to have aggressive relationships with a bunch of fintechs to bring new products to their end user, but they said the problem is they have 17 disparate projects with these 17 fintechs to go figure out the integration strategy, and the timeline, and the economics, and the negotiation around that, how they're going to surface things to customers. They want to abstract that effort from themselves, and this model of Marketplace and Accelerator, if we do our job in bringing a broad array of applications to them, they eliminate all that friction. All of that happens more seamlessly, and the time to value is so much quicker with these two models that I think that's what they're focused on.
Ron Shevlin:
Yeah. I agree. There's certainly an efficiency aspect from a partnership, but I will say this, Jonathan, I think while today you might not be seeing a lot of focus on the revenue side of it, my colleague, Steve Williams is coining this term that we're in a revenue recession in banking, and I think that's going to persist for a while, so I think we're going to see a lot more focus on the revenue side, especially from a non-interest income perspective, and I think the firms that are looking at this Marketplace as a strategic opportunity are going to really benefit from the revenue side. So, listen, we've talked a lot about the embedded fintech side of the coin here. Let's talk a little bit about the embedded finance side, and I make that distinction to think about it in terms of non-financial brands getting into the financial services space. Are there particular industry segments that you think this makes more sense for than others?
Jonathan Price:
Y ah. I think any brand in America, be it, and I want to strip out neobanks from this, because I agree with you. Sort of the neobanks space and the way they're bringing banking to their end users is a little different, but I do think it's worth talking about non-neobank fintechs, and then every other brand, because I do think at the end of the day, this is about companies that have large well-known brands that have loyal customers, because if you have those two things, you have a recipe for embedding finance and creating a few things that are advantageous to these brands. So, stepping back to answer your first question, I do think areas like telecom, consumer retail, insurance, are some obvious areas that it makes sense given the size of those customer bases and the loyalty to those brands, that embedded finance would be a very obvious strategic direction they could go.
But at the end of the day, I think it's more about how loyal and how engaged are their users and are there new ways they want to interact with them? Because that's what we're seeing with our large customers is they're really wanting to drive a different level of engagement, create new monetization opportunities, and ultimately these types of programs give them a lot of data on those customers, and with that data, they can be better at targeting their own users with their current products, or be more effective in deciding how they want to use these new type products in financial services. So, hopefully that gives you a little bit of color of the spaces that we're seeing it in. And again, the non-neobank fintech, places like insurance telecom, consumer retail brands that are embedding payments or lending or banking at the point of sale, all sorts of things like that are use cases we think will proliferate over the next couple of years.
Ron Shevlin:
Yeah. I'm actually amazed to see how broad the interest is in this. Even companies like Gerber, which makes baby food, and we think, what would that have to do with financial services? But the reality is that their customer base tends to be young adults, young parents who want to save up for their newborn's college education, so there's opportunities to sell them savings accounts and 529 plans. I think it's important to though recognize that these brands don't really want to become financial services firms. They want to provide financial products, and so they obviously are partnering with some financial institution in the back end for this. From your perspective, Jonathan, is there really an opportunity for a lot of financial institutions to be in this game? Or is it really going to evolve to where there's just a handful of banks who are focusing on this as a strategy?
Jonathan Price:
It's an important question. One of the things we've seen within the customer base of Q2 is there's definitely a desire. Banks and credit unions see that they need to play in this market in some way, and some are doing it with the embedded fintech conversation we've talked about, some are doing it with embedded finance and actually standing up their own digital initiatives and creating a revenue stream in a strategic engagement that way. I've talked to a lot of banks that want to become white-label banks of record, and that's their decision on how they want to play in the space, but it's more challenging than you'd think. Operationally, this isn't something that a bank can do successfully at the side of their desk, and so they have to set up an org around it, invest heavily in the process and the difference. We've seen the existing bank of record universe in the United States.
I talk to certainly our bank of records all the time, and one of the things that has matured within them is they've built an entire org. It's just a separate part of the bank than their traditional bank. And it's growing as they white-label more and more larger brands. The demands, the regulatory burden, the awareness is just out there. So, to go back to your question, I think it will be more than a handful, because I think banks and credit unions recognize the need to play in this space, and white labeling behind them is a way to do that. I just think that they need to be aware of the burden and the investment and the commitment it takes, so I think it's a list of maybe it's 10 to 20 over time, that are really prominent, but I think it'll be more than a handful, but I don't think it's going to be hundreds.
I don't even think it's going to be that many dozens. I think there's going to be folks that figure out a model around this, that commit to it, and that are able to do it at scale because at the end of the day, that's one of the things that differentiates BaaS providers ourselves, is, you can bank smaller fintechs, smaller brands, but as soon as you get into the large tier one space, call it an excess of a million users, the burden on both the technology provider and the financial institution is a different ball game altogether, and so I think that limits how broad that universe of white-labeled banks could be, but I do think, already, we're seeing more than a handful, there's at least 10 to 12 well-known banks in the fintech landscape that are white-labeled financial institutions as a core business.
Ron Shevlin:
Yeah. I'm glad you brought up the provider side of the equation because it's getting pretty crowded in the banking as a service provider space. What distinguishes the various providers in the market?
Jonathan Price:
There's a bunch of criteria that I think customers and prospects look at when thinking about BaaS providers. Number one, I think is size and who the vendors are serving, because as I mentioned a minute ago, when you think about banking, the Acorns, Credit Karma, it's the big sort of multi-million end users, customers that we're targeting and other BaaS vendors are targeting. It's just a different level of expectation, of scalability, of security. The demands are so intensive that few platforms actually operate and are proven to be able to do that at scale, and so I think that's one of the big things that any prospect that wants to enter this space is going to look at when evaluating technology vendors. When you think about the tech stack, a lot of what players in the space are doing are plugging middleware into legacy cores, as opposed to a real-time cloud-based core that's standing up real-time accounts and allowing for these customers to innovate rapidly, and if you're plugging into a legacy core, there are limitations around the pace at which you can innovate.
So, broad-bucket tech stack. Banks, you talked about banks in the last question. One of the things that I think is obvious, is there are many vendors in the space that really work with one, maybe two banks, but others, like us and others in the space have a stable of white-label banks, and there are advantages and disadvantages to both models. Others in the space actually have a charter and are their own bank, as well as the vendor to the BaaS customer, so there's all different models around the banks dynamic. One of the things that's changing right in front of us right now, especially in the tier one space, is the broader service model, and that's something that all customers are going to evaluate.
So will your vendors be doing fraud monitoring, dispute tracking? How are they thinking about all the things related to fraud and dispute? How are they thinking about program management? Operationally, this is a big burden, especially as we move out to the brand segment. Folks that haven't operated in financial services in any way, shape or form, program management is a key piece that they're going to look at their vendors for. The level of operational engagement, who does what day-to-day. Those are the types of things, and the last thing I'll mention is the economic model is something that everyone that's looking at the space would evaluate their vendors around, and I think people have chosen to go down the path of taking a fixed subscription software fee, and for that, they get a whole bunch of services, and other vendors are trying to pivot on a model that's growing with their customers.
One of the things I see a lot in our business is on the digital banking side, we have a subscription software model. We take a bank or credit union live, they're paying a subscription fee, but we're taking, 50,000, 100,00 users live on day one. In a BaaS business, we're going live with no users and no cards issued, and so the customers are often looking at us to grow with them. They don't want to pay huge minimums out of the gate because they're making a bet on us, on themselves, on their ability to convert that ecosystem of customers they have to financial services users, and they're willing to share in the economics as they grow, but not necessarily willing to pay for it upfront, and that's an evolving dynamic in our space right now.
Ron Shevlin:
Yeah. I think it's an important point too, that it's really about helping them grow the business as much as it is being a technology provider.
Jonathan Price:
Absolutely.
Ron Shevlin:
Jonathan, listen, I wish we had a lot more time, but we are out of time on this session. So, appreciate everybody. Thank you for Jonathan Price, Executive Vice President of Emerging Businesses at Q2. Thanks for joining us today on Tapping into the Potential of Embedded Finance and everybody, I hope you'll join us for the next episode. Thanks.
Jonathan Price:
Thanks Ron. Appreciate your time.