Square’s $5 Billion Gamble To Change The Commerce World

“And how will you be paying for these?”

This is a question that some of us may remember being asked when buying groceries, clothes, or other goods and services. The marketplace has become congested with numerous ways for someone to pay for things. There’s the time-honored tradition of using cash, or perhaps by writing a check. Let’s not forget about the money order or using a debit or credit card. Now, mainstream adoption of the Internet and smartphones has opened the doors for the likes of PayPal, Square, Stripe, Google, Amazon, Shopify, Isis, and Dwolla, among a plethora of others.

And it’s more than a fad: mobile payments have become mainstream. In 2013, Gartner estimated that year’s worldwide mobile payment transactions would hit $235.4 billion. It also projected a 38 percent jump in 2014 to $325 billion. So it’s understandable that everyone wants in on the action. But finding out ways to pay shouldn’t be complicated, so how do you stand out from the noise?

Although there are a multitude of payment choices, one in particular seeks to redefine the commerce world. Many are all about getting you through the experience…enabling the transaction, if you will. But buying something is more than just the payment — it’s about an experience. In my view, Square is looking to bring that to the forefront and promote itself as something more unique to the entire commercial ecosystem. This company has been valued at nearly $5 billion and as such could be an example of the future of digital payments, especially in an industry long dominated by PayPal.

What follows is a tale about where Square came from and an analysis of its sustainability along its bumpy road to create a new paradigm in the purchasing world. Even amid all the criticism, I believe that Square has established the foundation to effect change in how we view paying — it’s re-established the human connection between merchants and consumers.

Square, the Payment Platform

Five years ago, Jim McKelvey and Jack Dorsey started a company to try and revolutionize the way people thought about shopping. This business became Square and the premise was that it would be possible for anyone, merchant, retailer, independent contractor, or consumer, to exchange money easily.

“We went through the whole payments process and worked on designing a brand-new (person-to-person) payment system,” says Dorsey in an interview with GigaOm founder Om Malik in 2009. That statement is quite telling about how Square has evolved in its relatively short lifetime. For many tech companies now, to survive and scale, it’s necessary to form a platform.

And a platform isn’t just something that exists simply because you announced it. As TechCrunch‘s Alex Wilhelm stated recently:

Companies that have a platform are different from platform companies. The former tend to offer a platform in a specific product sense, while the latter are broader and tend to build hardware, operating systems and software on top of their stacks.

Granted Wilhelm was speaking more about more companies like Google and Apple, but the general principle, at least in my view still holds. The notion that a company can survive in the current technological age by being solely focused on one tool, as opposed to understanding its ecosystem is flawed. At first glance, Square was viewed to be a competitor to PayPal and Intuit. So it would be fathomable to believe that there was no hope for the company — how could it compete against a behemoth the size of PayPal, which processed $180 billion in 2013?

Simple: focus on the larger purpose of what merchants and consumers want in commerce. Instead of focusing on how payments would be processed, Square decided to examine the entire chain, including tools that merchants needed and the behaviors of consumers. Granted not everything has gone the way it had hoped: it has encountered setbacks including sunsetting its Square Wallet application, and also received quite a bit of criticism over its Starbucks deal, and its overall stability. Recently, there was a lot of talk about it contemplating a sale to Google, Visa, MasterCard, and other companies.

Is this “Unicorn” in trouble? Square denies that any exit talks are taking place, or have, but it would be a shame, in my opinion, to see this billion-dollar valued company lose its independence.

For many years, when companies wanted to handle online payments, PayPal was the leader. But while it has certainly been used by many merchants, it still failed to look at the bigger picture, until it was too late. PayPal’s role on top of the payment space started to slip, but it wasn’t because of Square. Rather it was the arrival of new payment startups. PayPal’s focus shifted away from its ecosystem and lost out on a key audience: developers. The company has repeatedly acknowledged this strategic flaw and has begun righting its ship, especially with the launch of a new Braintree SDK and integration of its developer team with Braintree’s. PayPal is certainly keeping an eye on its rivals but doesn’t seem worried. Former PayPal president David Marcus said that he welcomed the competition, at least under his watch.

But while there’s some sense of comfort in Marcus’ perspective, it puts PayPal in an interesting situation. As Eventbrite CEO and co-founder Kevin Hartz once said: “PayPal has been on a very strong growth trajectory, but it’s facing a period of disruption ahead…We just haven’t seen a lot of innovation that’s needed for them to continue their leadership.” And Hartz has some interest in seeing the eBay-owned company succeed — he’s an investor in the company, and also in Square. But he also has credibility when it comes to disruption — Eventbrite has done very well in challenging long-time incumbents like Ticketmaster.

Now you might be thinking that much of what Square has done is something that PayPal has already accomplished. But the thing is that while PayPal has been able to integrate itself into multiple facets of the commerce world seemingly, what is it that gave Square the fuel to come in and take away some of PayPal’s market share? Was it because the eBay-owned company didn’t innovate fast enough? Or was it because it couldn’t strike such a big enough deal as Square did with Starbucks? Perhaps it was the lack of developer support?

Square is by no means perfect and it can do better. However, in my view, it was more about at least three key themes that helped the company stand out. Namely, it needed to:

1. Make commerce simple.
2. Bring back the “people experience”.
3. Appeal to merchants, developers, consumers, and the enterprise.

Not all of these themes have been accomplished, but it appears that the Dorsey-led company is making moves in that direction.

Think Differently About Money

The world of payments has been rather convoluted for all. No matter whether you’re a merchant, consumer, or developer, there’s some angst that you deal with. There’s no doubt that when accepting payment online or through an app, there are plenty of procedures, policies, and systems in place to ensure that everything goes smoothly.

Simplicity is the name of the game. Ribbon, Stripe, and other services are bringing it to both brands and consumers. Lessen the hurdles between the payor and payee and the level of satisfaction increases. This includes things like how payments are made, the interface, and of course, how much the processing fee will be. There’s been some comparison of Dorsey’s company being akin to Apple. Some speculate that he could take the helm at the company that created the iPhone and iPad.

Square’s endeavors seem to focus on simplicity, including its sleek hardware design, straightforward apps, and simple processing fee of 2.75 percent. Compounding its efforts is the fact that it needed to deal with a mobile world. Until now, hardly any payment company has broken the smartphone barrier — how could a consumer or merchant handle transactions from their mobile device? PayPal didn’t have a very intuitive app for users to do this (honestly, before the major update to its app, when was the last time you made a payment to someone or a business?) And Google Wallet doesn’t appear to have received a lot of traction. There are certainly a lot more services out there like Venmo (now owned by PayPal), but it seems that Square seeks to position itself as being a service for all businesses.

The Apple-esque school of design also comes into play with Square’s hardware. Its now-familiar card reader is small and easy to use. In an era of smartphone technology, Square was one of the earliest adopters to recognize that a card reader integrated with a mobile device (especially one that’s on your person nearly every waking moment and has also replaced your computer) could be a significant discovery. Other card readers from Intuit and PayPal are certainly useful but just don’t seem to have the necessary appeal. Square has gone through multiple iterations of its device and continuously made improvements to process payments faster, putting the focus on end users.

Another thing that stands out about Square is that it was one of the first payment companies to focus on mobile-first. Yes, PayPal, Intuit, and others allow users to make payments through smartphones, but Dorsey and his team opted to build for mobile, not the desktop. And it was probably a great strategic move too: a Bain & Company study of 25,000 consumers revealed that many are already shopping on their mobile devices. What’s more, 3 to 7 percent of consumers used their phones to buy coffee, books, or other physical goods, highlighting the available opportunity for in-store mobile payments.

Humanizing the Commerce Experience

While I’m fascinated by the route PayPal is taking to be the de facto payment service of the Internet, I must say that Square’s focus on customer service is probably better. By this I mean that Square makes it simple for merchants to use so that the focus is placed on renewing the bond a business has with the people buying their product.

I had an opportunity to speak with a Square merchant, Red Chair Salon, a boutique hair styling store in San Francisco. During our interview, I was told by its owner Kristin Maddox that the introduction of more technical features like the Square Stand and the ability to sign receipts using their fingers keeps her customers more engaged in what her salon is doing. She came across the company after noticing that her business was getting charged exorbitant fees through the use of traditional credit card terminals. Her partner introduced Square to her and she immediately checked it out, calling it “serendipitous”. After getting a tutorial, her stylists found out how clean the experience was, the level of support was provided, and how easy for them and their clients to use, and quickly realized that it would wind up saving the saloon at least $400 per month.

“It makes it much easier for us,” says Maddox. She explains that pre-Square, the salon had to grudgingly accept credit cards, knowing that some like American Express had much higher transaction rates. But after becoming a Square merchant, the company is now free of the pressure of worrying about how the customer will pay and can embrace putting forth a better overall experience. What’s more, later in our interview, Maddox raised an interesting point…being a stylist, she may need to be in the field working at weddings and other events — simply having a cash register on hand isn’t possible. Square’s card reader lets people manage payments wherever they are.

Part of the experience also goes back to Square leveraging Apple’s design influence. The point is that if a merchant’s employees are constantly having to figure out the complex Point of Sale (PoS) system, there’s less focus being placed on establishing a rapport with customers. And the external aesthetics of a product matter — Maddox shared that the reason why Red Chair Salon chose Square was because it looked better than what Intuit and PayPal offered.

Emblematic of how antiquated existing payment technology support is, Maddox told us about her frustration before Square. After taking over the business, she tried to get her account set up with the incumbent payment processing provider. The provider said that it would take five minutes to get everything set up, but she wound up being on the phone for over an hour. The amount of downtime worrying about whether the account was set up or if a terminal would be delivered caused unnecessary stress. Maddox says that things got better once Square became part of her business.

Probably put succinctly, a Square spokesperson gave this perspective: “Keep in mind who you’re building for. That’s something that we always do.”

Square’s Slow Advances

Square came onto the field with much promise, seeking to help revolutionize the way we accept payments by credit cards quickly and seamlessly. It was one of the first to popularize portable card readers. Soon after, it followed through with other advancements like Square Wallet, Square Register, Square Stand, Square Cash, and recently, Square Capital.

But except for the last two releases, it seems that the company experienced a perhaps sluggish momentum shift — not necessarily by anything done internally, but possibly from external forces like the industry, merchant resistance, etc. Square set out to create a new paradigm in the marketplace and entered the industry as a media darling and these forces could have impacted people’s ability to transcend the boring process that is of accepting payment transactions.

The company raised $440.5 million in funding, and landed a lucrative deal with Apple and another big one with Starbucks and Whole Foods, while also receiving a strategic investment from Visa. Much of those achievements helped to validate its very existence, and Square made considerable headwinds into redefining the industry paradigm.

Disrupting an industry as complex as payments certainly isn’t an easy one. For Square, while there was much promise in the beginning, it hasn’t necessarily been a smooth ride. The company has been plagued by much criticism, especially from regulators, competition, reaching merchants who are pretty reliant on old tech, and more. Once a hallmark deal for the company, there have been reports suggesting that the Starbucks deal didn’t have the needed impact and possibly caused coffee retailer CEO Howard Schultz to step down from his position on Square’s board (although he did remain three months beyond his contract).

External factors such as public perception about mobile payments could also shed some light on the adoption rate of Square and its competition’s technology. Bain & Company says that no matter what service is chosen, consumers’ primary concerns include security, privacy, and convenience. Moreover, the public expects banks to provide their digital wallet, opting to trust their financial institutions more than third parties like PayPal or Square — which makes sense since banks are probably more skilled at providing the necessary security and workflow within the payment space (but not the speed of innovation), but they’re refusing to enter the space, citing “the unclear business case and a highly fragmented market with no standard yet.”

This point is proven with the introduction of Visa into the picture. The credit card provider made an undisclosed investment in Square back in April 2011, but at the same time, it’s putting forth an effort to create its entity to compete with the Dorsey-led company. Fast forward to July 16, 2014, and now Visa has made another attempt, this time with Visa Checkout, a program to help consumers pay for goods and services using their mobile or PC devices with only a couple of clicks. So while financial institutions may appear to be backing Square, they’re also looking to put a stop to it with their inventions. But will their plan work?

Some analysts may also point to Square’s forecast as a sign that it’s going downhill. Fortune stated that early reports indicated the company was losing money on every transaction, but later reports showed that things weren’t necessarily that much in disarray. In fact:

Internal e-mails show that gross margins on transactions — the amount of profit left after paying card processors, payment networks and other intermediaries — are a relatively healthy 34%. On a $100 transaction, the company takes a cut of about $3, which it records as revenue and from which it earns about $1 in gross profit. According to the internal e-mails, company is processing about $30 billion in transactions annually, which would put its gross profit at an annual rate of about $300 million.

Investors are also starting to grow skeptical about the payment space. TechCrunch reported that over the past three quarters, the number of venture-backed payment companies has declined, “tumbling from 59 startups in the third quarter of 2013 to just 41 companies in the second quarter of 2014.”

Could the marketplace already be getting crowded? Is Square realizing this and is it moving slower than most people expect? Maybe Khosla Ventures’ Benjamin Ling can shine some light on the issue…in the same TechCrunch article, he’s quoted as saying:

Payments are a massive industry with a lot of room for innovation, but it is very hard to break through because not only do you have to get consumers, you also need merchants and often times…third parties like associations behind you to be successful. Consumers want trust and ubiquity in payments. Merchants want to know there are large numbers of consumers. For a startup none of these is usually true. The chicken and egg problem in payments is one of the hardest to break through.

As Fortune puts it, Square is in a transition, but it seems that the company is moving slowly while in the fast lane. That being said, it has been recently trying to shock some life into itself, first with the release of Square Cash, its peer-to-peer payment service, a la Venmo, and then withSquare Capital where it gives advance loans to merchants in exchange for a cut of the business’s proceeds until the debt is paid off. Would you call this a pivot? Does this raise any eyebrows from people who could speculate that it essentially characterizes Square as being a predatory lender?

Pundits are positing that with Square Capital, it’s Square’s time to shine …it needs to find something that’ll help get its mojo back.

Fierce Competition

Square isn’t alone in its pursuit of users. Joining it are the likes of Stripe, Google Wallet, and eventually Amazon. Each one is eager to process more payments than the other. Let’s face it, amid talk about the “commerce graph”, the “payment graph”, or anything else remotely buzzwordy, the bottom line is that these companies are looking to get your money, no matter whether you’re a merchant or a customer.

The marketplace is quite crowded with a multitude of different options to handle the role of commerce. And I’ll be the first to admit that Square isn’t in a position to be the best possible solution for everyone. Stripe has a huge advantage in helping developers and companies integrate payments into apps and services. The same can be said for PayPal, especially when you want to scale to the enterprise and have a sound trust policy. Balanced is worthwhile when you are looking to establish a marketplace, but this is not a consumer-facing service…it’s more behind the scenes.

Square is probably best in a situation where you have freelancers, independent contractors, small businesses, brick-and-mortar retailers, and individuals. In this regard, it’s put into direct competition with Google Wallet, Intuit, and others in the space.

Incumbent financial providers are certainly noticing this disruption. For merchants, they would need to either buy or rent credit card terminals, which could be pretty expensive. Dealing with the equipment, the fees, and having to get all the necessary technology installed is an unnecessary hassle so Square, Google Wallet, and Intuit help to put merchants at ease — they can use the devices that they’re already accustomed to using.

Risk vs. Reward

Overall, Square is looking to redefine what commerce means and if you look at the overall picture, the tools are there to help merchants and businesses streamline their interface and get better adapted to the 21st century. With its card reader, Square users can accept payments anywhere they are. The simplicity of the process is carried over to its Point of Sale system, Square Stand and the customer service experience continues through receipts a customer receives, thanks to Feedback. Let’s not also forget about Square Order, which lets you order ahead and pick it up — but maybe expanding to actual delivery thanks to a reported acquisition of Caviar.

Beyond business-to-consumer, Square recognizes that individual needs must also be met, so it’s facilitating commerce through Square Cash, its response to Venmo. And since the Internet allows commerce to take place beyond being face-to-face, there’s also Square Marketplace, a storefront for any merchant to sell their wares to anyone easily without having to necessarily build their e-commerce site.

Yes, a lot of the above sounds very similar to what is currently offered by PayPal and that’s where the risk comes into play. Square has a vision of redefining the commerce space and is executing much of the same, but it’s hoping that a streamlined approach and a different philosophy will aid it in growing its market share. The next true test is whether Square can generate adoption from developers — it began opening up its API in December 2013 but it’s for merchants and allows for the retrieval of activity reports for processed payments, refunds, and deposits, and only for a single account. Will it ever allow developers to accept payments through their apps? It has to complete the puzzle.

Square is inching closer to becoming a public company, potentially joining the ranks of Visa and other payment providers. But what could make things unique is the fact that Square would be probably the first tech payment provider to do so with a supposed Unicorn-level valuation. Of course, we have to believe the skeptics who think that the company is also going the wrong way and the rumored postponement of the IPO is a sign of bad things to come.

Is Square’s gamble paying off? The company certainly has its detractors, offering criticism against it for various reasons. Is Square worth $5 billion? Take a look at this great insight into Square’s financial position to help paint a better picture. Does it have the necessary capabilities to take on big processors and financial institutions like Visa? Mastercard? Bank of America? Time obviously will be the deciding factor and it seems that while the company has ushered in a platform of tools for merchants and individuals to use, numerous factors are weighing it down to slow its pace. But customers appear to like what they’re seeing — as Maddox tells me: “This company is here for the small businesses and myself.”

Image credits: Commerce lumascape via LUMA Partners, e-commerce infographic via TouchMedia Ads, mobile payment study graphs via Bain & Company, photo of Red Chair Salon via The Red Chair Salon, image of Jack Dorsey's vision of Square via Forbes tweet, image of Starbucks' CEO Howard Schultz and Square CEO Jack Dorsey via Bub.blicio.us, and venture investment graphs via Crunchbase.