Great Idea, Bad Business. The Square Problem.
By: Shaan Fye, Managing Partner
Square, a company started by one of the founders of Twitter, Jack Dorsey, recently has run into a problem in business — losing money. Square is a company designed around democratizing the tight margin business of payment processing. Square’s business relies upon an adapter for iPhones and iPads, allowing customers to swipe their credit cards. These payments are processed by Square, charging sellers a fee of 2.75%. The concept is brilliant, as lower-volume vendors such as farmers at a market can now have access to the credit card market. The company has received much praise for this since its inception in 2011, and in terms of adoption, the company’s reader and software for iOS have spread like wildfire. By measure of helping low volume vendors and sellers, it is wildly successful. There are significant underlying issues however, and Square will have to solve for them if this business is to continue.
Ironically, the issue that is holding Square back from achieving success is what their business is based around. Money has been a significant problem for Square since its inception. Seventy or Eighty percent of Square’s transaction fees go towards repaying the credit card companies, quickly eliminating most of the revenue that could be profit. To put this in perspective, a $100 dollar transaction nets Square only about 55 cents to run their entire business. This generates challenges to break even, much less make money. These thin margins mean that gross revenue doesn’t translate into profit. In other words, scaling doesn’t help, as it does with many other businesses. In fact, Square reported a 100 million dollar loss in 2013, according to a report by the Wall Street Journal. Sources say that in about 9 months, Square will have to dig into its “cushion fund,” money set aside to keep the company afloat. The Venture Capital funding Square has received since its inception has been in the hundreds of millions, but it is all running out.
What are Square’s options? Already, rumors have been swirling that Square is seeking a larger company such as Google to buy them out, giving Square more time to monetize its business and products. This larger safety net may provide an ample enough trampoline to bounce the company to profitability. Another option is taking on more debt, something Square has already done. Goldman Sachs and other major banks provided a 100 million dollar line of credit to Square, giving the company more time. However, the mounting losses, growing as Square grows, will easily consume this credit in less than a year if current trends continue. Square was also considering going public this year, offering an IPO to potential investors, but halted the idea when concerns over mounting losses grew.
Square’s main problem is basic in theory, but incredibly hard to execute, especially for a payment processing company. The conundrum they face is that the higher revenue they have, which will be easy to grow, as the concept is beautiful and practical, the more that Square loses. Losses will exponentially increase as Square doles out more and more money to credit card companies while bringing less back to the bank. Monetization is the key, and unfortunately for consumers and small business owners, will be very hard to do. The possibility that a great idea such as this will fail because of lack of profit will fail is significant if Square doesn’t come up with something. This leaves one remaining question.
Should we, the taxpayers, the consumers, the business owners, actually be supporting this company? While any thought of government support of a unprofitable company immediately alienates free-market ideologists, this may be worth looking into. Is Square offering something beneficial enough that the taxpayers propping it up will be in the best interest of the country? If you ask small business owners, most will agree that Square democratizes the playing field, allowing a fruit vendor to take credit cards while still not drowning in fees. It is an interesting thought experiment that has no clear answer, at least to me. I obviously am not qualified to give a definitive answer, but I feel that Square’s product does provide a public service, and I think that is worth considering. Please feel free to comment and make sure you answer the poll.
Shaan Fye is the Managing Partner of the Atlas Business Journal