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Find out the difference between customer financing and embedded financing and which is better for your business.
There’s a lot of confusion surrounding consumer financing and embedded financing. Many entrepreneurs use the two terms interchangeably to mean the same thing. But these are two distinct funding methods. Granted, it’s an excusable misunderstanding. After all, customer financing and embedded financing are two sides of the same coin — they both fall under the embedded finance banner.
So, what is the difference between embedded and customer financing, and which is the better option for your business and its customers? Let’s set the record straight.
Customer financing, also known as consumer/customer credit, is a funding method allowing buyers to purchase a product or service and pay for it over time instead of making a full payment upfront.
You can think of customer financing as an improvement on the old layaway system, where the buyer makes a small reserve payment on an item, and the seller holds on to it until the balance is paid off. The improvement is that, thanks to the magic of modern financing, the buyer gets the product right away but pays for it over time, usually in set installments.
Consumer financing is not a new concept in business. In 2021, the total consumer credit outstanding in the U.S. was approximately $4.3 trillion. Furthermore, point-of-sale financing is the fastest-growing type of unsecured personal lending.
Consumer credit is synonymous with the B2C retail space. But many B2B businesses also offer some form of consumer financing, mainly through vendor or trade credit. This is where a B2B business provides goods or services to its customers on short-term credit, typically under net-30 terms.
Customer financing generally takes the form of buy-now-pay-later (BNPL) solutions such as store credit, private label credit cards, point-of-sale financing, and hire purchase. Businesses offer these solutions in two main ways:
The business, or seller, sets up and runs the consumer credit system. Everything is done internally, from determining the financing terms and verifying customers' creditworthiness to tracking payments.
But managing consumer credit in-house is quite the enterprise. It often requires robust payment management systems and high levels of financial expertise. The upside is that the seller owns the credit program, meaning they can cash in on the interest/fees accrued on rendered credit.
However, most merchants do not charge their customers any interest or fees in order to encourage purchases. Again, this works best with in-house consumer financing.
In this case, the merchant outsources customer credit to a financial company rather than handling it in-house. The financial company works as an intermediary between the business and the customer. Customers still buy on credit, but the financial company pays for the purchases at checkout and collects the debt in installments.
The third party essentially takes over the lending responsibility from the business. It's a convenient arrangement for businesses wanting to offer customer credit without becoming debtors themselves. However, the intermediary charges a lending fee, usually passed on to the customer as interest or to the seller as retailer fee.
Klarna is a good example of a third-party customer financing provider. It offers a pay-in-four payment plan that allows online shoppers to break down purchases into four 2-week installments. Shoppers can pay for items using Klarna’s credit card, smartphone app, or browser extension integrated into selected checkouts. Instead of charging interest, Klarna makes money through retailer fees with every transaction. It does charge a small fee for late payments, though.
There are countless other BNPL service providers, including Afterpay, PayPal, Affirm, Sezzle, and ViaBill, with robust payment apps and web APIs that seamlessly integrate with any e-commerce checkout or POS system.
Most retailers and B2B companies offer customer financing to boost buyer conversions and sales. Splitting purchases into smaller periodic installments is an enticing proposition for many shoppers. The lack of an upfront payment encourages customers to buy in larger volumes and to even return for more.
The downside of consumer financing depends on whether it’s done in-house or through a third party. When handled in-house, the business incurs considerable investment costs to get the system up and running. And with a third-party BNPL provider, the merchant pays a retailer fee for each transaction. More worryingly, experts warn that BNPL payments tempt shoppers to spend more than they can afford, which could quickly lead to a debt crisis.
Embedded financing, or embedded funding, refers to integrating personal or commercial lending services in a non-financial company's offering. In other words, it's non-bank institutions offering business or personal loans.
Like customer financing, embedded funding is not a new concept. But it’s quickly becoming a go-to lending solution for both businesses and individuals. The global embedded lending market revenue totaled $4.7 billion in 2021 and could hit $32.5 billion in the next decade.
Like customer financing, businesses can manage embedded lending either in-house or through a third party. For most non-financial companies, partnering with a third party — in this case, a Business Lending as a Service (BLaaS) provider — is the more convenient, inexpensive, and safer way to offer embedded funding solutions.
The BLaaS partner helps the business integrate various lending solutions into its offering by handling the technicalities of developing, hosting, and managing the funding programs. This essentially makes the business a commercial lender without requiring any banking licenses, additional employees, or changes in the business model.
Popular funding solutions offered via embedded financing include:
Unsurprisingly, embedded funding is quickly taking root in the commercial finance industry. Rather than going to big banks and credit unions, entrepreneurs are increasingly opting for alternative loans due to better chances of approval, faster processes, and lenient requirements. Also, many B2B companies, including global brands Shopify, PayPal, Uber, and Amazon, are keen on funding their business customers.
The pros:
The cons:
The main difference between consumer financing and embedded lending is the purpose of funding. While consumer financing is primarily meant to increase or encourage sales, embedded funding is designed to empower entrepreneurs through access to much-needed business capital.
Embedded lending is a much more meaningful way of funding your business customers. Rather than limiting your offering to funding purchases, why not provide versatile solutions to solve your customers’ more pressing financial needs? Besides, uplifting your customers’ financial posture via embedded financing grows your business too.
Embedded funding is relatively complex, but its benefits to you and your customers far outweigh the simplicity of one-dimensional customer financing.
Admittedly, developing a business funding program may seem daunting, especially for entrepreneurs with limited skills and experience in the finance industry. That’s why Loanspark is here — to hold your hand in developing, launching, and managing the ideal funding program for your customers.
Loanspark is a BLaaS provider founded on the core values of simplicity, transparency, convenience, and mutual benefit. We bring all the expertise, fintech tools, and funding resources you’ll need to become a value-added lender in your business community. What’s more, you market the new funding program under your own brand through our co-brand offerings and vast referral network.
Offer your customers thoughtful and meaningful financial support with Loanspark and create a thriving ecosystem where businesses grow together. Contact us today to get started on embedded funding.
