Square Puck

Matt Harris —  November 24, 2012 — 21 Comments

Replica of first hockey puck ever used (it actually was square-ish)

Square Puck:  sounds dangerous, right?  I think it is.

There’s a famous/trite expression, commonly cited in the venture business, about how you want to skate to where the puck is going, not to where it is right now.  As I watch the payments industry grapple to deal with the phenomenon of Square’s micro-merchant processing business, I’m reminded of this truism, and increasingly convinced that all the incumbents are skating in the wrong direction.  This doesn’t mean that Square will achieve the kind of world domination that their valuation implies, but it does mean that lots of other folks are wasting vast resources and time pursuing the wrong goals.

In just the last week, Bank of America announced a micro-merchant offering, and TSYS bought ProPay, a vertically focused Square clone.  In the past year, we’ve seen a steady drumbeat of product announcements from Verifone, Intuit, PayPal, NCR, WorldPay* and PayAnywhere*, all directly focused on competing with Square’s dongle-based merchant payments service.  Meanwhile, in the investment community, there is a lot of self-satisfied sniggering about Square’s business model, in which it is assumed that given pricing and risk, Square loses money on every swipe.  Their recent move to undercut Starbuck’s already razor thin processing costs, even though they aren’t the low cost provider, reinforces this view … there’s no way that is profitable business for Square.  If Square is entirely dependent on merchant processing revenues, they are not only overvalued, they are in fact worthless … that business will never produce meaningful cash or be strategic to anyone.

But that’s irrelevant, as it is increasingly obvious that the merchant side of Square’s business is somewhere they had to start, but nowhere near where they plan to land.  At the end of the day, Square is a consumer-facing company; that is their DNA, their culture and their IP.  The entire merchant processing effort is a loss leader, a necessary evil on the way to building up sufficient retail coverage to make their mobile app useful to consumers.  It’s not too different from what LevelUp is doing, but Square’s approach, both in terms of pricing and design, is far more elegant and nuanced, probably because they control their own payments infrastructure and LevelUp outsources to Braintree.   All of the incumbent merchant processing and terminal infrastructure players who are freaking out about this and building direct rivals are totally missing the point, and are lunging to compete in a segment that will ultimately have a negative profit pool.

Typically in this blog, and more generally in life, I avoid making explicit recommendations and predictions.  I’ve just been humbled too many times by the world’s unpredictability.  But I’m going to make an exception in this case.

The recommendation is that Verifone should swallow their pride and do a comprehensive business development deal with Square, where they enable their entire existing merchant base to accept Pay With Square in exchange for essentially taking over Square’s merchant processing hardware business.  Given Verifone’s bluster and defensiveness regarding Square, I think this is unlikely, but it would be a master stroke.  Square doesn’t think hardware is strategic and is increasingly just trying to build their merchant base (see:  Starbucks deal) and they are only messing with Verifone as an accidental byproduct of their initial go to market strategy.  Square would do this deal if Verifone could convince them that they would take good care of their customers.

The prediction is that in six to twelve months, the conventional wisdom on Square will have changed to reflect the growing reality that Square isn’t primarily a merchant acquirer, but instead a mobile wallet provider.  Pay With Square, just like Google Wallet, PayPal and the other wallet providers, creates a unified merchant-facing cardholder application, which aggregates the user’s existing payment accounts behind the scenes, and layers on offers and enhanced information.

At that point, someone (probably not Verifone, unfortunately for them; my bet is Heartland or Global Payments, with Chase Paymentech as a long shot) will do the business development deal I describe above and PayPal, Verifone, BAMS,TSYS et al will be left holding their dongles.  The whole merchant processing community will then lurch toward some kind of cardholder side functionality, directly or through partnerships, and an unbelievable amount of time will be wasted essentially recreating the current Visa/MC merchant-issuer network in a Balkanized and therefore useless way.  Discover will get bought by Google for $35B and Amex stock will go up 30%.

Unfortunately, by that point, the puck will have moved again, and Square will have abandoned the mobile wallet play in favor of their actual ultimate goal, which is to become a new tender type, disintermediating payment cards altogether.  He shoots…he scores!

*For the record, I think WorldPay and PayAnywhere, with their focus on the SMB segment vs. the true micro-merchant segment, have it right.  NB:  my firm is an investor in WorldPay.

21 responses to Square Puck

  1. Very insightful…..but I always thought Square will get acquired by First data or any other big fish and it is a matter of time….but that does not seem to be happening in a near future…. Any views ?

    • i think first data is extremely unlikely … Square may have a higher current equity value than first data, given how much debt is piled on top of that company. the traditional players can’t pay the $7-10B that Square’s investors will now require. it’s basically down to the four horseman (Apple, Google, Facebook & Amazon), in that order i think.

  2. this is well thought out and an extremely good prediction!

  3. Great post! Simplifying credit card payments is just the tip of the iceberg for Square. Verifone and other similar companies, probably find it difficult to accept that a card-less future might exist. Classic symptoms of the Innovator’s Dilemma!

  4. you’re an idiot

    square processes on chase paymentech so your assertion that “Square’s approach, both in terms of pricing and design, is far more elegant and nuanced, probably because they control their own payments infrastructure ” is completely wrong. They don’t control anything except the relationship with the merchant. Verifone is much larger than Square and not losing business to them.

    Stop talking about things that you know nothing about.

    • this sentence was not as detailed as it should have been. in relation to levelup (which is the context of the point), they control a lot more of the payment infrastructure, including the merchant relationship, the gateway, the hardware, the POS software, etc. agreed, they are not end to end; as you seem to know well, few players in the payments ecosystem are.

  5. “their actual ultimate goal, which is to become a new tender type”

    What does that mean exactly? Instead of using a credit card, I would pay for things with a Square App?

    This prediction seems to be addressing a problem I don’t have. I been paying for things with a MasterCard, Visa, and American Express cards my entire adult life. It is simple. It works at every store on the planet and every website on the Internet.

    I don’t wear skinny hipster jeans, so carrying a wallet is not a problem. I have to carry it anyways to hold my drivers license, insurance card, club key, door key, etc.

    • i agree that the primary pain point here is the merchant’s pain, not the cardholders. the current card associations and the related economic model costs retailers 2-3% of each transaction, and if Square is able to get ACH funding as a mechanism (like PayPal), they can dramatically reduce these costs. on the cardholder (consumer) side, the user experience of Pay With Square is pretty awesome, but it certainly won’t be enough to get everyone. for the record, i’m just predicting that this is where Square is headed, not that it will all work!

  6. Hmm, I hadn’t thought of it that way, as I have ONLY seen Square and other ‘solutions’ being used by brownies, boy scouts, and one-man scuba shops. And few enough of those to make it remarkable.

    I get the mobile wallet thing but have never seen it as solving an important problem for me. And my highly unscientific survey of my circle shows nobody else using this ‘solution’ either. (The reason I am fairly sure that nobody I know is using one is that I’d certainly have gotten a tech support call by now!)

    So maybe I’m living in a bubble out here. Or maybe some other people are.


  7. i work for a small financial institution. square and stripe (web-based UI but no hardware) make it so easy to accept debit cards for account activation and loan payments. i tried to get our credit card processor on board but they had monthly and annual fees plus multiple UI’s and different fees for different cards. right now we process cards with stripe offline but eventually can connect it directly to our system. frictionless systems grab marketshare. if they can stay ahead of fraud then square will evolve into micro and larger ticket payments ahead of paypal.

    • the flip side of that ease of use argument is that square and stripe, as aggregators, bear all of the risk for their underlying merchants. currently the card associations are allowing all sorts of experimentation and growth in the aggregator sector, but it remains a real challenge, at least to me. i’m more bullish on braintree, which can do aggregation but can also go whole hog and issue a MID for each merchant, which is more logical in most cases (my view).

  8. I really, really liked this commentary and think you are dead on regarding just about all of it.

    My only problem (and this could be a failure of vision on my part) is that I just don’t see how anyone — Square included — is going to create a tender type in place of the Visa/MC network. And I don’t mean the pipes. I mean the underwriting of millions of merchants, the relationships with each and every bank (it’s still gotta be banks at some point, right? Maybe not, I guess) and the relationships with each card/phone holder. Anyway, it seems like a VAST undertaking. Especially when you’ve got a perfectly good set up currently in place (that costs maintenance costs). Maybe ACH is it, but there’s a reason merchants generally don’t take ACH and it’s the fraud question and dispute resolution on ACH isn’t anywhere near as user friendly as the cards.

    Other question: Assume I’m wrong and that Square can and does create a new tender type. They won’t really abandon the mobile wallet for the tender type, will they? Instead the mobile wallet will be the customer GUI for the new tender type (ie, they just change it from routing to Visa/MC to SquareNet or whatever).

    Here’s my prediction, which like you, I’m generally loathe to make. You are correct: merchant processing is loss leader to get to mobile wallet (I agree, even in its early form, the experience is great). But Square never gets to its own network and it continues to run on Visa/MC rails. So they’ll make tiny amounts/lose on merchant side, but make big $$ (though not enough to justify their valuation) on reaching customers with advertising, coupon push, sales data etc.

    PS, I actually do think Verifone/Ingenico has a need to worry. Why buy their box when I can buy an ipad with POS/Square in one (which can be continually updated in much more effective ways than Verifone’s box?

    • i now wish you wrote the post, and i was just commenting, this is very smart. i don’t disagree with you regarding odds of success, and where Square might stall out over time, i just think they will continue to dream big. i agree that the mobile wallet will become synonymous with the tender type: Pay With Square. i think they will source funds from ACH/bank accounts, either preloaded by consumers or post-paid where they are comfortable with the risk. it will only be accepted at merchants who accept the current Pay With Square wallet, currently a bunch of micro-merchants and Starbucks, but growing quickly. it’s basically the PayPal playbook executed IRL, with many of the same people leading it, most notably Keith Rabois.

      i also agree that the merchant hw guys have to worry, but i think more about Revel/Shopkeep/POSLavu than about Square.

      • 1) Thanks for the response! You did the heavy lifting here, I’m just lobbing rocks at things. I really did think your post was quite good.

        2) Good point on Square continuing to dream big. They will. And luckily for them, they’ve convinced investors to give them enough cash at a massive valuation that they can…..

        3) I really think POS (including the inventory management etc that comes with the best ones) is a big part of Square’s strategy to keep merchants sticky. Historically POS’s been clunky. If Square (or Google or whomever) can apply their Silicon Valley design/ease-of-use principals to POS and make it an ipad/phone app (updatable at will), they’re going to make life a whole lot easier for merchants who will stick with them (and thus accelerate the wallet adoption).

        4) Maybe someone like Dwolla will really figure out a new payments system via ACH or whatever and when combined with Square (I think there’s some VC overlap there; not sure) create something that obviates Visa/MC. It just seems so damn hard to get the network effects right in a world with a pretty decent currently existing system.

        4) Sorry for rambling. Last point. I was very excited for the Square/Starbucks thing, but at least now, it looks like they are going with a QR code. It’s too bad, because I think one of the real value adds of Square is not taking your phone out of your pocket. Maybe that woulda required too much of an upgrade to — there it is again — Starbucks POS system.

        But as with all this stuff, what do I know? These guys aren’t dummies, so all of the above thoughts may have been worked around already! I just wish some of the fawning interviews I see with Dorsey, etc would at least ask SOME of these questions.

        Thanks again for the post and taking the time to respond to my comment!

        • My #3 is probably redundant/obvious with the last sentence of your response, which I somehow didn’t see until I posted mine!!

  9. Interesting post Matt. Now you’re talking about where Dwalla thinks all of this is going: ACH.

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