Square’s IPO- are payments really that hard?

Square’s public market debut has put a focus how hard the payments business is, even for one of the apparent leaders. Is great design and user experience going to be enough to create and maintain a revolution, or is it just that, a beautiful product that ultimately struggles to be an amazing business?

What’s so new here?
One of the payment back end capabilities that was revolutionary behind Square was the extension of the merchant aggregation model for credit card acceptance from the internet (which Paypal has used so well) to the real world through an elegant point of sale solution. Innovating in one point of the chain the small merchant counter top (in this case beautiful design for the card payments themselves, combined with a new approach to credit card acceptance for merchants) is certainly interesting, but often ignores the other changes that are happening in the broader ecosystem- ubiquitous smart mobile devices are likely to have a very big impact on credit cards, as my colleague Jon Collins pointed out recently.

Small businesses don’t stick around
The businesses Square deals with themselves go out of business very fast. Smaller businesses tend to go out of business with depressing frequency. It’s quite likely that even with perfect retention at the operating level, enough of the small businesses that Square services will go out of business in a given year to create what would look like a churn problem.

What services complement payments?
Square, like others in the payments space, has experimented with a variety of other related services. Part of the challenge here is that payments are typically the end of chain, and unless you have a loyalty type program based on purchases, it’s not been clear how a payments player is well positioned to deliver upstream services- it’s more likely that payments might complement another service than vice versa. There are more and more examples of good loyalty programs with embedded mobile commerce as part of the offer, but these are usually account based systems, which tend to make less sense for smaller businesses with infrequent purchasers. More basically- many embedded mobile commerce and account based payments take the card out of the equation- most of this is in experiment mode, but it is happening, and clearly works well for small start ups like, say, Uber.

Larger businesses can get better deals
Square is calling out the Starbucks deal as a separate line item in their financials, which makes sense, especially if it was “a disaster,” as some have characterized it. Perhaps more generally relevant is the challenge that as customers get larger they can typically start to negotiate better credit card deals with providers, so many of Square’s customers will either stay small, or grow out of being customers, without that necessarily creating larger Square customers. Square is certainly not the only SaaS business with this challenge. Many of the advantages of SaaS on the user side are based around flexibility, and typically per unit costs are relatively high because of that. Once a business has a predictable base load of usage of resource x, the CFO is going to start looking harder and harder at those line items, and often a fixed investment, or new business terms with the provider, will start to make sense.

SaaS economics (or not?)
With payments, especially charged the way Square does, you only get paid when people actually use you- it’s worse than regular SaaS. There are a number of great resources for SaaS business model economics on the web (see for example Jeff Bussgang’s work here). Those businesses typically work or don’t work based on how much a customer costs to acquire, and then how long they remain a paying customer. The problem for Square is that they only get paid when a customer actually uses the service (i.e. to accept payments). This is perhaps partially mitigated by their market leadership, which likely translates into better customer acquisition metrics, indeed they say half their customers “find them.”

Is it all doom and gloom? There are some good signs, an increasing number of medium sized businesses are using Square, and the company is definitely still innovating with newer products (including IFTTT integration), and offerings like Square Capital (micro loans to businesses based on Square understand their business history, rather than traditional credit scoring techniques) are definitely interesting, as they use data from usage of the service to provide value, rather than attempting to sell something else. Perhaps the biggest question mark is how long we will be using credit cards for, and if that changes will Square be positioned to be part a newer way of paying?