‘In biology, that’s called a symbiotic relationship’: Q2’s Ahon Sarkar on why the embedded finance model is a win-win-win (-win)
- Winning BaaS products are differentiated, scalable, and personalized to the individual -- not ‘the average person’
- The embedded finance model joins three experts -- the fintech, bank, and technology provider -- to work in unison and deliver the best of all worlds
The following was produced by Tearsheet Studios. We worked with Q2, a digital banking software company, to create a four part podcast series on the interplay between banks and fintechs.
The world of embedded finance, and Banking as a Service in particular, are made up of three pillars: banking, product, and platform. To make a truly good BaaS product, each one should be delivered by its own expert: the bank, the fintech, and the technology provider, respectively. When each entity gets to focus on what they’re best at, the fourth and central entity wins: the end-customer.
In this episode, Tearsheet's Zack Miller spoke with Ahon Sarkar, who currently serves as the GM of Q2’s Banking as a Service division.
Ahon Sarkar, Q2: My name is Ahon Sarkar, and I'm the general manager of Q2's Banking as a Service business.
We’ve reached a milestone in the financial industry as a whole, in which embedded finance products like banking, lending and now even crypto, are situated within ecosystems outside of traditional banking: in fintechs, technology companies, and brands. What would you say are the forces behind this wave of embedded finance?
Ahon Sarkar: I think it really comes down to three things. The first is that the capabilities are becoming democratized; all of these infrastructure providers are popping up and trying to take the underlying plumbing of banking and make it something that you can build on top of via API. As those capabilities become democratized, it makes it possible for people to embed finance products.
Then there's the economics -- the business model. As these providers have lowered the cost basis to offer products and created business models that align with the growth of their target customers, they've made it so fintechs, technology companies, and brands can target previously underserved customers. This made open blue ocean, so they can go after to try and provide a whole new set of consumers a bunch of value.
And the third thing, and I think this is really important when it comes to timing: if you rewind to 2008, and think of all those fintech companies who launched in one vertical -- whether it was wealth management, micro investing, or lending -- all of those companies who saw success and drove user growth are now trying to get engagement; they’re trying to drive stickiness and increased value.
If you think about software, it always starts off horizontal, to try and amortize the cost across as many services as possible; then it goes vertical, to try and solve for a specific part of the industry and differentiate itself; and then it goes personal, to think about, ‘How do I drive more customer value?'.
So you have all these fintech companies who launched in one vertical looking to go horizontal, combined with the capabilities to code via API, and a business model that gives a competitive advantage, made embedded finance the natural next turn.
The result of the growing widespread influence of embedded is a new approach to finance. Where before financial services were something that happened at the bank, today financial services and products are built into the everyday actions of our lives.
Ahon Sarkar: It's funny, I think we actually see a similar concept in other parts of our lives. A couple months ago I got back from South Africa, and one of the things I saw there was these wild animals, like giraffes and zebras, with these birds just sitting on top of them. And at first you wonder, ‘Why is a bird sitting on a giraffe?’ -- what a weird picture. But then you start to notice that these birds are actually helping the giraffes by eating some of the fleas or pests. And as a result, the giraffe is letting them sit on its back. In biology, that's called a symbiotic relationship.
The birds could go and find bugs or whatever they eat anywhere else, and the giraffes could go and deal with the stuff on their back themselves, but by working together, they're actually able to create a scenario where they're both getting additional value through the sum as opposed to the individual parts themselves.
In the embedded world, you have a bank helping out with operations, the regulatory components, the compliance and fraud components, etc., and you have a technology provider like Q2 who's facilitating the building of these types of products and the evolution of the technology over time. You have a world where every party can focus on what they're efficient at, so it becomes this symbiotic relationship that’s a win-win-win.
Much like the birds and giraffes, there’s a symbiotic relationship between fintechs, banks, and technology providers: each player brings their best strengths to the table, and together they’re able to drive better and more focused results that serve everybody’s needs.
Ahon Sarkar: The reason that people use online lenders as opposed to traditional lenders is the better experience, right? Fintechs are efficient at understanding their customers, at designing intuitive UI and UX that people love, and reimagining the way that things are done in a legacy manner. By focusing exclusively on that, it helps them design something that stands out, and helps the customer with more of their problems.
What about the bank? Well, these community banks that are located all across the country are really good at running bank operations, working within regulation and ensuring things are compliant, managing fraud to create profitable programs -- that's what they've built their whole shops around. The thing that they are less efficient at than the fintechs is building highly targeted products, because that hasn't been their focus. And so by partnering with the fintechs, they can grow their customer base, they can grow their deposit base, and they can focus on what they're really good at.
Then for us -- the technology layer in between -- this is our bread and butter. Q2 has been doing digital banking for 17 years, and so we focus exclusively on: ‘How do we make it simpler to build these products? And how do we create a world where finance becomes human centric, where products are built around people, and we consider the context that we have in people's lives?’ And so by not having to build the front end or do the operational components and focus exclusively on that technology and how to help our fintechs and banks scale, we can evolve technology, and we can improve capabilities.
We have a partner bank, MVB, that is a great example of this. Over the last couple of years, they have grown dramatically and become one of the top 50 banks by users, by partnering with companies like Credit Karma to launch these innovative services.
This is probably the first time there's been a biological analogy to embedded finance here on the podcast. So given the mutually beneficial nature of symbiosis, what does each player stand to gain from participating?
Ahon Sarkar: Well, we did biology last time, so let's do cloud computing this time. Go back to 2000, maybe 1995. If you wanted to launch a website, you needed to maintain a server farm, you probably needed to run air conditioning through so you didn't overheat it, you needed to have experts who knew how to build those kinds of things, then you needed front end experts, marketing, sales and all that kind of stuff. And what was the result? Only a few people could really build websites.
Well, once cloud computing became a thing, and suddenly you had companies that were exclusively dedicated to managing server farms and making it easy to build websites, more people could launch websites and make the experience better, because they didn't have to spend half their resources building the server farm.
Think AWS, for example, who initially got those services because they realized that during Christmas time they would need to ramp up their servers, but during January through October they weren't using all that free server space. They were able to monetize something that they had to build as a core competency that everybody wanted. And most importantly for people -- you, me, and everybody else can now access all of these websites and get direct consumer products that help us better understand the rest of the world, and we're better off for it.
The same thing is happening here. In a world where everyone can focus on what they're efficient at, every part of the ecosystem evolves faster, because the right experts are putting 100% of their dedicated attention to it.
As the fintech, the implication is that you don't have to pour resources into building out the operational or core functionality, or the back-end payment reconciliation; you can focus on acquisition, product design, customer relationships, growing the business, and expanding the product without necessarily having to become banking experts overnight.
As the bank, you get a totally new distribution channel that brings in users who wouldn't necessarily sign up for your product, while getting to continue building on your core competency.
And as a technology company like us, you get to bring these fintechs and banks together and build out plumbing that makes the system more fair, better targeted for underlying individuals, and opened up for all these new use cases.
Which means that finally, as the consumer, you're getting better targeted products that are aligned with what you actually need. If you think about it, what is the advantage that the fintechs or the technology companies have? Context. At the end of the day, people hire products to do a job. And the better someone understands you, the more likely they are to do that job well.
If this is such a win-win-win scenario, how come we don’t see a lot more banks, fintechs, and technology companies coming together in this way? What’s holding back more companies from taking the leap?
Ahon Sarkar: People often want to see someone else prove it out before they take the leap. One of the things we actually talked about at Tearsheet’s conference a couple of weeks ago is that adoption tends to happen in these concentric circles, where as people see an adjacent industry prove it out, they realize that there's potential for them to go do a similar thing.
The second is competing priorities. For all of these businesses, there are 100 things that they could do at a given time, and the important thing is going to be focusing. And so this may not be the thing that that company is focused on now.
To steal a page from Andreessen Horowitz’s book: Every company is going to become a fintech company over the next ten years in some way, shape, or form. Because at the end of the day, if you touch money -- meaning you have to store money, move money, accept money -- some aspect of your business is already a fintech business, and this evolution is going to change what's possible in that context.
For the entities that do take the leap and adopt an embedded finance model, various challenges exist. For one, launching standard embedded financial products like checking accounts or debit cards, which may be easy to do, and so will always be met by competition in the space.
Ahon Sarkar: You have to find some way to differentiate because offering the same standalone features that everyone else does without some kind of special sauce won't make you an appealing option. That's challenge number one.
The second main challenge is making sure that you're prepared for growth, and you're prepared for evolution and expansion. Because these kinds of things aren't just features. Banking is kind of a hub for a whole bunch of different financial products, and as you solve one problem for the customers, they're going to look to you to solve other problems within their financial lives.
Jack of all trades, or a master of none? An entity looking to provide a great BaaS product, and go at it alone, is faced with not only the challenges of differentiation and scale; but building a complete, vertically integrated stack with the responsibilities of the bank, the fintech, and the technology provider combined -- and being an expert in all three domains.
Ahon Sarkar: Focus is the thing that separates winners and losers. Your ability to focus on the area where you provide the most value, and win in that area is what is going to let you succeed.
In a world where you have to do the full stack in order to offer the service -- you probably won't. That's why prior to Banking as a Service providers like Q2, companies didn't really embed finance. By allowing them to only focus on what they're efficient at, it opens the door to even expand into these new businesses and solve more of your customers' problems, which lets you create more value.
Third and finally, it lets companies design products that are personalized to people. Historically, consumers have been a cost of deposits for banks. And it's not because banks don't care about consumers -- in fact, they do, and most banks pride themselves on that customer relationship. But most banks make their revenue through commercial lending or fee income, and what you pay consumers is a cost to facilitate that service. In this new paradigm, where you have a whole crop of fintechs that can focus on that consumer's problem and be human centric, I think that drives efficiency, not just for them in the bank and for us, but ultimately better products for people.
To wrap it up, I asked Ahon, what does the promise of embedded finance hold for the future? And what does this new era in financial services mean for the average person?
Ahon Sarkar: I'll tell you a quick story. In the late 1940s, the US government had a problem. A bunch of their pilots weren't able to keep control of their planes and the planes would crash. And so a bunch of scientists asked, ‘Why is this happening?’. And they realized that in 1926, when they built out those planes, they had gone and measured 500 or so people, figured out the average proportions across those people, and designed the cockpit for that average. And so the scientists now, 25 years later in 1950, thought, ‘Maybe the average has changed, and that's why the pilots aren't able to keep control.’ So they re-measured a bunch of people, and were going to go and adjust the cockpit size to adjust to the new average.
But there was this guy, Lieutenant Gilbert S. Daniels, who asked the question, ‘How many people are actually average?’ Right? So he went to over 1,000 people and measured out all of these pilots. And you know how many of those pilots were actually the same dimensions as the “average pilot?” Zero. Zero people were actually the exact dimensions of the average person. What did we learn there? Well, there's no such thing as an average pilot. If you've designed a cockpit to fit the average pilot, you actually designed it to fit nobody.
That is a perfect parallel for what is happening in financial services. People don't want financial services. They want to meet a goal, buy a house, send their kid to college, get a car that will get them to work -- and financial services are hired to do that job for that individual. But for every person, the context is different, and you need the ability to change the product based on who the person is.
Why do I tell you this story? Well, in this new world of embedded finance, you get a world in which consumers get products that are personalized to them -- designed for their attributes, and consider the context that that fintech or technology company has learned about them over the time that they’ve had that relationship.
Over time, I think what this will mean is more people will get access to fair financial services; financial services will stop being a one size fits all; and we'll end up with an economy that is better for the average person (even though the average person doesn't really exist).