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Most fintechs serving small and medium-sized businesses (SMBs) started life by doing one thing well, catering to an underserved market that big banks and incumbents were failing. But to scale and achieve profitability, they’re increasingly finding the need to build on their core product and expand their offerings. The result is a generation of fintechs broadening their feature sets and a market-wide convergence towards the idea of becoming a ‘one-stop-shop’ central financial operating system for SMBs.
This trend will intensify in 2023 as economic pressure intensifies. However, as financial service and technology providers battle it out for market dominance, their SMB customers are ultimately (and counter-productively) the ones that will feel the pain.
Convergence has dominated SMB fintech in recent years
Fintechs serving SMBs learn early that acquiring customers is expensive compared to what those customers spend. Their prospects go through the same lengthy consideration and assessment process as larger businesses, which makes the sales process high touch and expensive, and yet they only end up spending relatively small amounts. Effectively, small businesses buy like businesses, but spend like consumers. On top of that, each small business customer is more expensive to acquire than the last as a fintech further penetrates its market.
To compensate, SMB fintech providers are left needing to increase their average revenue per user by expanding their products and services. To do this, many have turned to fintech’s most popular money maker: lending. Every SMB platform, from Intuit to Paypal and even Uber, offers a form of lending product now.
At the same time, incumbent banks looking to increase engagement are also expanding their services to incorporate cash flow analytics and invoice payment, for example. The extra data that this generates enables them to make better product recommendations and to lend more confidently. In turn, this encourages customers to spend more with them and increases their own revenue.
These moves have led to massive convergence in the financial services ecosystem towards this idea of creating a central business operating system and offering a holistic financial services solution.
This convergence has created a hyper-competitive environment where financial service providers are encroaching on each other’s territories as they seek to occupy a larger share of SMBs’ attention and wallet.
Convergence will intensify in 2023
The trend of convergence will only deepen in a recessionary environment. As businesses spend less, financial service providers will see revenues decline. Churn will become a serious issue as small businesses cut spending or close down. At the same time, small businesses facing the economic risks will expect more from their financial service providers, for the same cost. As Anish Bhatt, VP of Product at corporate card provider Jeeves put it recently in an interview with Codat: businesses are “consolidating suppliers” and “picking fintechs that offer banking in a box”.
This cyclical dynamic will intensify convergence as SMB platforms look to diversify their revenues by expanding into new areas.
Convergence creates frenemy tension
As providers continue offering additional features that bring fresh revenue streams, access to data will come to dominate competitive dynamics. Platforms will need to find the right balance of supporting their own product build as well as enabling partnerships via open API ecosystems.
Shopify, Intuit and Amazon, for example, are building out their own lending and payment businesses. Despite this, they still maintain and depend on deep and complex payment, lending and data partnerships, structured as part of their integrations and app stores.
These partnerships are vital for fintech providers to truly become central business operating systems. For any business to ship new features, whether lending, cash flow analytics or anything else, incorporating, syncing and extracting data from other systems is critical. Accounting platforms for instance will need close relationships with banks to ensure their clients can automatically reconcile banking data into their accounting platforms and in return, banks will expect that their SMB clients can integrate their accounting data into their products when required, such as to apply for a loan.
As the market continues to evolve, overlaps will become more frequent and platforms will be faced with dilemmas as partnerships come into conflict with internal product success metrics.
It creates a catch-22 for platforms serving SMBs. These providers need to integrate and pass data to each other in order to create slick digital experiences and be compatible with the vast number of tools a typical business uses, but still compete at the same time.
Providers that choose to withhold access to their API ecosystems and their SMB client’s data – with a view to protecting their most valuable competitive differentiators – will only end up limiting the utility of their own features, which in turn harms SMBs.
This dynamic is filling the industry with ‘frenemies’ and nurturing an uneasy tension between them.
Small businesses will pay the price
The uneasy tension between fintech ‘frenemies’ will result in two possible outcomes.
In the first scenario, fintech providers acknowledge that competition and collaboration are required in equal measure for a thriving industry, and most find productive ways to work side by side. Platforms massively extend their value via integrations: an SMB fintech provider with hundreds of apps and integrations is far more valuable than one with a great core product but zero connectivity. Although in the short term, providers may sacrifice a percentage growth point or two by enabling competing offerings, in the long term this is without doubt the best possible dynamic for small businesses; they’ll have access to a landscape of secure, reliable and slick digital services.
The other, less desirable outcome is that succumbing to a misguided sense of self preservation, a significant number of SMB providers decide to withhold access to their API ecosystems. Whilst protecting a perceived competitive differentiator, this action will simultaneously restrict the utility of their own platform, damage the services available to SMBs and ultimately lead to reciprocal action from the rest of the market. It will also likely act as a trigger for some form of regulatory intervention.
The potential domino effect will make life difficult for financial service and technology providers and crucially, reduce the quality of services and products on offer to SMBs – at a time when they need them more than ever.
Fintech platforms must accept that inter-system data flow is key to a flourishing industry, and must prioritise partnerships, even if they seem to reduce competitive advantage in the short term. Without cooperation and good faith, fintech convergence will leave small businesses facing a landscape of substandard, unreliable and unsafe services, at a time when support from financial technology is more crucial than ever to their survival.
About the author: Peter Lord, CEO & Co-Founder at Codat
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