In 2008, glass blower James McKelvey was unable to complete a $2,000 sale of his glassware because a customer could only pay by credit card. Frustrated, he discussed this with a friend, Jack Dorsey, the founder of Twitter. By the summer of 2009, Dorsey had prototyped a dongle and soon after, Square launched as a payments start-up targeting mainly the un-served micro-merchant space.
Fast forward to 2012. Square’s 2012 capital raise of $200 million implies a $3.25 billion valuation. Its valuation quadrupled between January and June 2011 and then doubled over the past year. This latest capital raise implies around 30x – 40x estimated revenue. In contrast, payment companies tend to be valued between 3x and 5x revenue multiples. What does this mean for the industry?
From a global payments market perspective, Square is a small player. Its $10 billion in payment processing volume annualized (announced on November 14th 2012), although independent of the payments processed by Starbucks, is inconspicuous compared with Vantiv’s $426 billion in 2011 or the $3.8 trillion processed by Visa. The top eight established players processed circa 98% of all transactions in 2011 in the U.S., exceeding $3 trillion.
What is noteworthy, however, is that Square has been able to sign up some million merchants since its launch less than two years ago. It is estimated that around eight million merchants were accepting credit cards in the U.S. before Square’s launch. While there may be some overlap, Square identified a new merchant class eligible for card acceptance and thus grew the size of the market itself rather than undercutting other payment competitors.
Square’s current valuation is based on more than its payment processing capabilities and growth. The current product could offer additional services to merchants, who could extract value from consumer data and improve margins by moving outside the debit and credit card networks.
By offering a simple and transparent pricing model, Square has successfully implemented disruptive technology to unlock demand in the micro-merchant payment space formerly not serviced by larger merchant acquirers. Additionally, Square is now targeting the core market with, among others, its Starbucks partnership.
Unsurprisingly, it is facing strong competition from both established players such as PayPal and young startups in both the U.S. and Europe such as LevelUp, iZettle and SumUp. This competition, while being good news for the customer, could be detrimental to the market because it drives the prices down: for example, LevelUp charges 0% transaction fee as compared with 2.75% charged by Square on the premise that it can make enough profit through loyalty and customer acquisition campaigns. However, the recent demise of Sail (Verifone’s Square competitor) eight months after its launch due to “razor-thin margins” demonstrates the difficulty of not only challenging Square on its home turf but also the complexity of breaking the micro-payments market.
Square has a number of things going for it: Twitter founder Dorsey is CEO, Keith Rabois, former CFO of PayPal, is COO and the company boasts a who’s who of VC funds as investors. The company has raised $342 million so far, a number significantly beyond PayPal’s raise of $197 million prior to its IPO.
Another strong advantage that Square has over its competitors is its unique PR and distribution network, notably through partnership with Starbucks, which is key to increasing its user base at a higher pace. This could significantly reduce marketing and merchant acquiring costs and at the same time, potentially give Square access to Starbucks’ 18,000 stores in 60 countries. Square took what many consider a ‘safe’ step into Canada, but why is it so slow to exploit this happy circumstance and make a global mark? Apart from the usual regional regulatory difficulties, the answer is simple: securing as large a volume as possible of transactions as possible in one market is more important and profitable than having an extensive geographical footprint but with small transaction volumes in each market. International forays, while impressive in the press, mean little until a critical and sustainable volume has been reached.
However, Square doesn’t have all the time in the world to fine-tune its leap across the pond. In Europe, even though iZettle has been hobbled by its services being cut by Visa due to conflicts over its card-user authentication process, others like Berlin-based SumUp have already picked up the baton. By the end of 2012, SumUp took its European business presence to 10 markets including two of Europe’s largest retail markets: the UK and Germany. Again, results and profits depend on how quickly SumUp is able to acquire merchants, but the backing it has received in the form of an eight figure series A round demonstrates investor confidence in the space and in SumUp. The same goes for PayPal and Inuit: because of their existing user base and in the case of PayPal a strong European presence, they could speed up their growth and emerge as some of Square’s strongest competitors.
Digitization of Payments
Technically, a payment is a set of data and metadata exchanged between a merchant and a consumer. It includes transaction details (product, amount, time, location) and information on the consumer (social ID, spending habits, past transactions) and the merchant (social ID, customer data, inventory data). Square is uniquely positioned to capture all this data. The receipts Square produces are a web page containing all the information relevant to the transaction. In fact, Square is essentially a big data company, able to leverage its aggregated sales and consumer and merchant data to generate insights into its own business as well as to trace spending patterns for consumers and merchants.
As society goes increasingly cashless, this data will prove to be more valuable than the primary payments services provided by such companies. It will help “close the loop” for offline transactions (tracking that purchase back to the originating source). Additionally, Square could utilize this data to create new businesses.
Square’s pricing reflects how it caters to merchants of all sizes: there’s a fixed fee of 2.75% per transaction or a fixed monthly fee of $275 per month. Square also provides analytics to small businesses, much in the same manner as Google Analytics. It also realized that anyone could be a merchant and adapted its onboarding process accordingly. It only takes three minutes to be accepted as a Square merchant. According to statements made by Keith Rabois, Square is also experimenting with social validation, leveraging data from Twitter and Yelp to validate merchants.
What’s more, Square Wallet allows payments to be authorized simply by saying your name. As is often said, Amazon, with its barcode scanning and image recognition app, has the best bricks-and-mortar network in the world: the stores of all the other retail outlets! A simplified, seamless in-store payment experience, as demonstrated by Apple and now Square, may be the answer to this trend.
Due to the way it is set up, Square is in a good position to benefit from a post-credit card payment landscape. With Square Register, Square Wallet, and now Square Directory, it has full control of the payment experience, with the credit card hidden in the back.
Square Directory is a web-based search engine that allows users to find new merchants based on location and the particular items they are looking for at the time. The service already has over 200,000 businesses listed in its directory. The combination of these Square services results in a customer-centric user experience. And, unlike other wallets, Square displays the location cards instead of the payment cards, in effect putting the credit card out of the view of the customer.
Alternative payments are not solely card-based and as such, eWallets can be funded by a variety of sources such as a bank account, pre-paid card or credit and debit cards. When the customer only sees the mobile payment layer, the underlying product matters less in the experience. This gives Square the flexibility to switch the payment means from a credit card to another solution, without disrupting the front-end payment for either the merchant or the customer.
Square payment volume has been growing rapidly. It took PayPal 18 months after launch to process $8 million a day, while Square achieved this in half the time. With an $8 billion annual payment volume, Square’s revenue could well be in the $250 million range. However, due to the nature of its business, it is estimated that around 60% of its revenue goes towards issuing banks and payment processing. With this in mind, it is likely that Square could hit $100 million in net revenue in 2013.
It is not yet certain that Square’s disruptive model will translate into a sustainable global business. But Square’s progress implies strong competition to established merchant acquirers and payment processors as well as PayPal and small European start-ups. It is up to credit card companies, PayPal, and the likes of iZettle to write a different future.
Geneva-based Yann Ranchere is finance director of Anthemis Group, a company focused on reinventing financial services for the 21st century.