Square Seems Obtuse?

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In a world where technology companies consistently receive absurd valuations and let everyone on earth down after their disgraceful IPOs, Square stands to either break the mold or continue the trend of disappointment after disappointment. Will it join the ranks of Facebook, Groupon, and Zynga -- or will Square be the first tech IPO in recent memory to not make everyone depressed?

Well, to be honest, one of my friends wrote me an e-mail the other day talking about how he interviewed with Square and didn't make the cut -- the nerd in me instantly asked "Square Enix"? Nope, Square, the company that allows merchants to accept credit cards through iPhones and iPads instead of expensive credit card technology infrastructure.

But is Square just another low-revenue company with rosy outlooks because it's a tech start-up, or is it actually the real deal?

I'll be the first to admit I don't know a whole lot about Square, but it certainly sounds like a cool idea. I started reading more about it and came across this Dealbook article that discusses Square's current position.

A quick read through this article will illuminate the fact that if Square plans to generate revenue with its current 2.75% commission, it will need to add larger retailers to its smorgasbord of clients. SBUX has already hopped on the bandwagon, but it's not clear that other key players will make the transition.

And I certainly don't blame them. I don't claim to be an expert in credit card technology or payment structures, but why would a company like Wal-Mart, for example, or TJ Maxx want to replace their existing credit card infrastructure with Square's technology? Even if the measure were cost-saving (and it's not, based on information I could find retailers usually lose 2.2-2.5% to the likes of Visa, MasterCard, and Discover), the implicit cost of transitioning to a new system (training, technology purchases, etc.) becomes very high across a large business.

Sure, it's awesome for me if I want to start a food truck and don't want to mess with traditional credit card processing, but for a company like Starbucks...why?

Also, the math provided by Nebo Djurdjevic in the Dealbook article isn't 100% clear to me. I understand where he's getting the $0.14, but the additional $0.27 to be paid to out to Visa, for example, seems absurd -- that's a 5.4% processing fee! All of the information I found online claims that all credit card companies but Amex hover around 2.4% for processing (Amex around 3.3%) -- where is this $0.27 coming from? Unless credit card processing fees are tiered to be higher for small purchases, the relationship between the processing fee and the payment should be linear -- so based on this math, wouldn't Square be in the red for every purchase, and not just in this example?

Anyway, the more important question to ask would be what other services can Square offer in its product suite to be the true drivers of revenue? What do you guys think? Does Square have real potential to revolutionize the way we pay, or is it going to end up as just another belly-up overhyped tech company?

Here's my basic, layperson problem with Square: there are always going to be people that carry cash and prefer to pay with it. Period. Woe be to those people when merchants start saying "Sorry we don't accept cash" instead of "Sorry, cash only". And if the vision of the company is to move toward a cashless society, well, that'll be awkward.

Thanks for reading.

 

Regarding the 27 cents, you can google Visa interchange rates and see exactly where it came from. They charge a variety of different fees based on the type of card used, but they all share a form of xx cents + x.x% of the transaction value. So for higher transaction values the fee will converge on the percentage, but for smaller transactions, the fixed cost becomes more important. Hence the reason square struggles to make money on small transactions.

 
Best Response

It's going to come down to providing marketing and buying pattern information to merchants. That is Square's value proposition. They may even expand the payment system as a loss leader for awhile until they reach a critical mass where they can start providing lots of real-time meaningful data on consumer behavior that can help merchants. Do Starbucks shoppers also tend to shop at Target? Do consumers shop at a lot of small retailers in one shopping trip, or do they spread it out? Is the first purchase of the day the biggest, or is the last? This kind of information can ultimately be valuable to merchants considering cross-promotions, marketing, joint-ventures, etc. I think this is where Square's true value actually lies. Obviously this is long term strategy and yet to be proven. I imagine, after FB and GRPN, Square will wait out the public capital markets until they are closer to implementing and monetizing their long term strategy.

 

Allow me to clarify a few things and introduce some points:

  1. Square is not the same as, say, Twitter (who is offering some intangible new technology). Square is introducing new technology to a relatively bread-and-butter application of processing credit card payments, which seems to have had a monopolistic stranglehold on itself, considering how little this has changed since the internet age began. As finance guys, you should be able to appreciate the concept of accepting fees to move money around!

  2. The flat fee of around 30 cents added to the percentage charge exist because of the physical element of this transaction (not as ethereal as sending an email on Gmail's servers!) and is a relic of this monopolistic industry. Look for it to change as Square becomes more powerful.

  3. I talked to a small business (haircutter), they said they pay 10% in credit card fees. TEN PERCENT!!! 5.4% would be a relief on the scale of thousands of dollars a month for this business. It is just plain ridiculous. Just like credit card interest rates. Hopefully the influx of technology into consumer payment-processing brings more competition and better rates for all. I know I would rather have a simple card with a fair rate than companies telling me how to spend my money(converting interest into miles, etc), countless glossy ads, and Alec Baldwin commercials.

How big can it be? Like I said, they're just processing payments (cheaply), something which has been around for decades...but it doesn't have to be novel to be revolutionary. Cheap flash-memory (what Apple uses today) MP3 players were around for years before the Ipod came around. Canonical, maker of Ubuntu, made a repository of safe software (read: App Store) before Apple did. And Apple sure as hell did not invent the cell phone. I think the key is for Square execs to not get Zuckerburg-esque dollar signs in their eyes, and for them to keep asking, "How can we make this better?".

-No comment-
 

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