Back into the past! What automotive banks can teach us about Embedded Finance .
By: Sebastian Scheib
Tags: VC, Embedded Finance, Fintech, Banking

Perhaps the biggest trend that is currently sweeping the FinTech universe is Embedded Finance or the Verticalization of FinTech. This is about non-financial service (software) companies, e.g. Shopify or Uber, offering their customers financial products. Shopify offers loans to its retailers or Uber provides its drivers not only with an app to reach (end) customers but also with a current account. They often do so by using so-called banking as a service providers, which provide the underlying technology and regulatory services.

The reasons for embedding financial services are obvious: On the one hand, companies strive to offer their customers the best possible experience and therefore want to control the entire customer journey. On the other hand, companies want to increase the customer lifetime value (CLV) of their customers by (a) tapping into new revenue pools offered by financial products and (b) making the customer relationship last longer as the product becomes stickier through financial products.

“Every Company Will Be a FinTech Company”, Angela Strange of a16z

This trend is now celebrated in start-up circles as the best thing since sliced bread, but it is completely ignored that this trend is decades old. Original equipment manufacturers (OEM) with their automotive banks, a.k.a. captives like VW Financial Services, probably initiated this trend in the 1950s and are now major players. Now, I do not want to belittle the current embedded finance trend, but rather illuminate what today’s players can perhaps learn from their “parents”.

What role do automotive banks play?

Automotive banks can be seen as the forerunner of today’s embedded finance movement. They were founded primarily with the goal of selling a larger number of existing products, namely cars. To achieve this, OEMs realized early on that one of the problems for car sales men is the fact that buying a car is an important (financial) decision in the life of the customer, which makes convincing customers quite tedious. In response, OEMs have come to the conclusion that if traditional banks are not willing to provide financing to help their customers in buying a car, they will have to do it themselves.

Especially in the early stages, when cars have not yet spread to a wider population, many banks were suspicious of this new trend. However, over time, car financing has proven to be a relatively low-risk business, even for traditional banks (mainly because of the collateral).

Evolution of automotive banks and common ground to embedded finance

To this day, one of the main goals for automotive banks, besides generating profits, is to support their own sales force. This does not necessarily mean that automotive banks themselves offer their own financing solutions to achieve these goals, but that a wide variety of business models are suitable for this purpose. These business models can be categorized into different evolutionary stages and are very similar to the evolutionary stages of the embedded finance players: (1) Pure Reselling, (2) White Labelling, and (3) Fully-fledged Autobank. I will give you now an overview over the different stages and will outline how these stages are similar to the evolution stages in embedded finance.

Pure Reselling

The “simplest” model usually involves OEMs referring their customers to one or more financing partners. This model requires little effort from the OEMs and still solves the customer’s problem. The clear disadvantage, of course, is that you give up some control over the customer journey and run the risk of offering a bad experience to your customers.

In today’s tech world, this model is similar to Shopify’s former practice of referring customers to banks for financing. The revenue model for automotive banks and embedded finance players is quite similar: Whenever they refer a customer, they receive some type of kickback from their financial partner.

White Labelling

The next evolutionary step is a white label version where everything in the brand is branded by the OEM or its respective automotive bank. A strong player in this market is Banco Santander, which acts as a white label bank for various OEMs and thus remains virtually invisible to the end customer. This has the advantage for the OEM that it retains control of the customer journey to a large extent.

This stage is in the current discussion about embedded finance the most frequently discussed. In the tech world, companies often use so-called Banking-as-a-Service players, which mainly operate in the background, as a technological as well as regulatory platform to offer financial products to their customers. For example Toast, a unicorn in the restaurant management space, offers its customers loans which are issued by WebBank.

As in the pure reselling stage we can observe that both software companies and OEMs operate quite similar. However, the next stage will show that many OEMs with their automotive banks integrate financial products even deeper in their value chain.

Fully-fledged automotive bank

This last step usually involves the offering of proprietary financial products. For automotive banks, this means that, at least on the customer side, everything is supplied from a single source. In these cases, it even happens that the automotive bank has its own banking license (e.g. VW Financial Services) and thus takes over many regulatory tasks itself. This means that OEMs actually have their own fully-fledged banks with limited need to engage with third-party banks.

In the tech world, this stage can only be seen in rare cases. Very few players such as Amazons apply for their own banking license, because this step requires enormous financial and human resources. Therefore, in the embedded finance field, with the exception of very large companies, we will probably see this option less frequently.

Even though the evolutionary stages of embedded finance players and automotive banks are very similar, both parties (so far) are still acting with a different objective. As described above, automotive banks mainly want to support their sales operations and generate a profit with their financial products. Embedded finance players have a more holistic approach as they not only care to sell financial products to generate additional profit, but also to give the customer a better experience that should make hin stick around for longer.

However, it is slowly becoming apparent that automotive banks and embedded finance are converging in terms of objectives. Because, in the meantime, automotive banks are beginning to also aim to in increase the lifetime value of their end customers.

What can both sides learn from each other?

In my view, automotive banks can learn two things from today’s embedded finance players. One is the original objective. Because why shouldn’t automotive banks not only focus on profit generation and sales support, but also on the CLV of the end customer? Tech players use financial products mainly to keep the customer longer with their own brand and to generate additional sales with them (automotive banks do also the second, to be fair). The same makes sense for automotive banks, because a loan might also offer the possibility to create incentives to buy the next car of the same brand (= prolongation of the customer relationship). Or the additional data points that can be created by a financial product can be used to offer additional products (e.g. suitable digital services). All this requires a tighter integration into the parents’s, the OEM, value chain.

Focus of automotive banks. Source: Roland Berger, New Captive Finance

The other point that automotive banks could take with them is aimed at the technological side. Under certain circumstances, it may make sense to outsource parts of your own IT infrastructure or regulatory affairs to Banking-as-a-Service (BaaS) players. In the tech world, it is not unusual that even large players such as Walmart or Uber outsource parts of their (financial) infrastructure to BaaS providers such as Green Dot. Admittedly, outsourcing your own IT only makes sense if you don’t see financial products as the core of your business. From a bird’s eye view, this may make sense for an OEM in general, but automotive banks (even though they belong to OEMs) probably see it differently, as they are often allowed to act very independently and therefore see IT as a core area.

Embedded finance players can also take a lot from automotive banks. For example, technology companies could also use embedded financial products to create incentives for clients to buy their products (= sales support). A good example of this is probably Apple. With its new credit card it guarantees its customers a discount on the purchase of Apple products. Another point where tech players can learn from automotive banks is certainly the organization. Nowadays, automotive banks are an integral part of the value chain of OEMs. For example, about 70% of all privately used cars in Germany are partially or even completely financed. While it is clear that financial services are becoming more and more attractive for tech players, we are still a long way from these dimensions.

What challenges does this pose for traditional banks?

Probably the biggest disadvantage for traditional banks is that embedded finance players (but also automotive banks) can offer their customers financial products directly where a need arises. A loan is never an end in itself: I only get a car loan because I want to buy a car or I only need a construction loan if I want to build or buy property. Furthermore, non-financial services players have the advantage that their customer acquisition costs for their core products are often significantly lower than those of banks. Therefore, these financial products can be offered at lower prices than traditional banks.

These are only two examples and if you think this logic through to the end, you may not need banks at all or only from an infrastructure or balance sheet perspective. It is easy to see that the problems that arise are very diverse and that banks have to find solutions. For this reason alone, things never get boring in the financial services industry!