Fintech data wars risk harming small businesses

Most fintechs serving small and medium-sized enterprises (SMEs) started life doing one thing well, catering to an underserved market that big banks and incumbents failed. But to scale and achieve profitability, they are increasingly finding the need to build on their core product and expand their offerings. The result is a generation of fintechs expanding their feature sets and a market-wide convergence towards the idea of ​​becoming a “one-stop-shop” central financial operating system for SMEs.

This trend will intensify in 2023 as the economic pressure increases. But as financial services and technology providers battle for market dominance, their SME customers are ultimately (and counterproductively) the ones who will feel the pain.

Convergence has dominated SME fintech in recent years

Fintechs serving SMBs are learning early that acquiring customers is expensive compared to what those customers spend. Their prospects go through the same lengthy assessment and evaluation process as larger businesses, making the sales process highly involved and expensive, and yet they end up spending relatively small amounts. Small businesses effectively 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, SME fintech providers must increase their average revenue per user by expanding their products and services. To do this, many have turned to fintech’s most popular moneymaker: lending. Every SMB platform, from Intuit to Paypal and even Uber, now offers some form of lending product.

At the same time, incumbent banks looking to increase engagement are also expanding their services to include cash flow analysis and invoice payment, for example. The additional data this generates enables them to make better product recommendations and 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 solution for financial services.

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 greater share of SMBs’ attention and wallets.

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 revenue decline. Churn will become a serious problem when small businesses cut expenses or go out of business. At the same time, small businesses facing financial risks will expect more from their financial service providers, at the same cost. As Anish Bhatt, VP of Product at corporate card provider Jeeves recently put it in an interview with Codat: businesses are “consolidating providers” and “picking fintechs that offer banking services in a box”.

This cyclical dynamic will intensify convergence as SMB platforms look to diversify their revenue by expanding into new areas.

Convergence creates frenemy tension

As vendors continue to offer additional features that provide new revenue streams, access to data will dominate the competitive dynamic. Platforms must find the right balance between supporting their own product building as well as enabling partnerships via open API ecosystems.

Shopify, Intuit and Amazon, for example, are building their own lending and payment businesses. Despite this, they maintain and continue to rely on deep and complex payment, lending and data partnerships, structured as part of their integrations and app stores.

These partnerships are essential for fintech providers to truly become central business operating systems. For any business to deliver new functions, whether it’s lending, cash flow analysis or something else, incorporating, synchronizing and extracting data from other systems is critical. For example, accounting platforms will need close relationships with banks to ensure that their customers can automatically reconcile bank data to their accounting platforms, and in return banks will expect their SME customers to be able to integrate their accounting data into their products when needed, for example to apply for a loan.

As the market continues to evolve, overlaps will become more frequent and platforms will be faced with dilemmas when partnerships conflict with internal product success metrics.

That creates a catch-22 for platforms serving SMBs. These providers must integrate and transfer data to each other to create smart digital experiences and be compatible with the large number of tools a typical business uses, but still compete at the same time.

Vendors that choose to withhold access to their API ecosystems and SMB client data – with the aim of protecting their most valuable competitive differentiators – will only end up limiting the usefulness of their own capabilities, which in turn hurts SMBs.

This dynamic fills the industry with “frenemies” and feeds 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 recognize 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 SME fintech provider with hundreds of apps and integrations is far more valuable than one with a great core product but zero connectivity. While in the short term providers may sacrifice a percentage point of growth or two by enabling competing offers, in the long term this is arguably the best possible dynamic for small businesses; they will have access to a landscape of secure, reliable and smart digital services.

The other, less desirable outcome is that a significant number of SMB vendors decide to withhold access to their API ecosystems after succumbing to a misguided sense of self-preservation. While protecting a perceived competitive differentiator, this action will simultaneously limit the utility of their own platform, harm the services available to SMEs and ultimately lead to reciprocal action from the rest of the market. It is also likely to act as a trigger for some form of regulatory intervention.

The potential domino effect will make life difficult for financial services and technology providers, decisively reducing the quality of services and products offered to SMEs – at a time when they need them more than ever.

Fintech platforms must accept that data flow between systems is key to a thriving industry, and must prioritize partnerships, even if they appear to reduce competitive advantage in the short term. Without collaboration and good faith, fintech convergence will leave small businesses facing a landscape of substandard, unreliable and insecure services, at a time when fintech support is more critical than ever to their survival.

About the author: Peter Lord, CEO and co-founder of Codat