Square Inc. is a favorite punching bag of the payments industry. With the Wall Street Journal reporting that Square lost roughly $100 million in 2013 and has engaged in acquisition talks with tech giants, critics have more ammunition with which to disparage the payment innovator. However, Square is not without resources and leverage among a significant class of merchants, and payment experts warn against making predictions of Square's imminent demise.
On April 21, 2014, the WSJ cited anonymous sources who said Square processed over $20 billion in transactions in 2013 and realized approximately $550 million in revenue from that volume. However, said sources stated the $100 million deficit last year had expanded over 2012 losses, and the startup had burned through over half of the $340 million in venture capital it has attained since its founding in 2009.
In the same article, the WSJ's sources claimed Square had approached Google Inc., Apple Inc. and PayPal Inc. about purchasing the San Francisco-based payment firm founded by social media pioneer Jack Dorsey. An April 21, 2014, Forbes opinion piece also said Square had "secret" acquisition talks with Visa Inc., which has a sizable investment in Square. But a Square spokesman denied these claims.
Using the same statement that has circulated in other media outlets, the Square spokesman told The Green Sheet that "We are not, nor have we ever been in acquisition talks with Google, and while we appreciate that Square may be an attractive target for some companies, we have never seriously considered selling to anyone or been in any talks to do so." A change in FANF If the numbers cited above are accurate and Square is far from even balancing its books, Visa's decision to change the ground rules on its Fixed Acquirer Network Fee (FANF) means Square's balance sheet will apparently skew further into the red.
In mid April, Visa circulated a bulletin among acquirers that reportedly said the FANF fee schedule would be officially modified on April 1, 2015, so that many micro-merchants using aggregators like Square and PayPal to process electronic payments would be individually assessed the fee, which will apparently raise costs for aggregators.
FANF was implemented two years ago to offset costs incurred by Visa for the dual debit card routing mandate of the Durbin Amendment to the Dodd-Frank Act. FANF obligates payment service providers to charge merchants an additional monthly fee based on their electronic payment volume. For traditional ISOs, that meant assessing the complicated FANF on all merchants in their portfolios.
However, FANF did not apply in the same way to aggregators, who pool small and micro-merchants into large merchant accounts controlled by the aggregators themselves. Instead, Visa charged the aggregators a lump sum of no more than $40,000 per month in FANF fees, based on the overall volume of payments from those merchants, and not merchant by merchant.
The change in FANF means the majority of individual merchants in those aggregated accounts will be assessed the fee based on a complicated calculation of card-present and card-not-present transactions processed by each merchant. The micro-merchants that process no more than $200 per month will apparently be the only aggregated merchants exempt from FANF.
For Square, the upshot of this change is that an unknown but substantial amount of its merchants will be assessed the fee individually, which will likely add up to more than the $40,000 cap now in place.
Ken Musante, President of Eureka Payments LLC, stated that "with a stroke of a pen [by Visa], Square's costs have increased dramatically." He said Square's main advantage and market differentiator is the simplicity of its marketing and charging merchants one flat fee. But the new FANF schedule might force Square to increase its fees on merchants. "If they raise rates, and they raise rates by a flat percentage, that keeps the simplicity but does not necessarily put the increase in revenue in line with the increase in costs," he said.
If the published reports about Square's processing versus its revenue are to be believed, FANF will only exasperate its attempts to achieve profitability. "It seems difficult for them to just be able to grow their way out; even if they get to a point where their margin is profitable, it's still not where they want to be," Musante said.
A popular thread on the GS Online MLS Forum zeros in on the vulnerabilities of Square's business model and its inability to gain profitability from its pool of low-volume/low-transaction merchants. But Musante cautions against underestimating Square. "I see them as a very formidable competitor," he said. "They have access to a lot of capital – number one. Number two, they're one of the few that has both consumers and merchants using their product, and money has been put into them at a $5 billion valuation. So regardless of whether they are making money, if that company is really worth $5 billion, they have created an enormous amount of wealth."
Aite Group LLC Analyst Nathalie Reinelt also reminded the payments industry that the acquisition talk surrounding Square is based on rumor and unnamed sources, and that Square has publicly denied the claims. However, in speculating about what type of business would benefit from purchasing Square, Reinelt turned to potential suitors coming from Silicon Valley rather than traditional payments.
"[I]t would make more sense for it to come from the tech sector," she said. "Their product, culture and user experience-centric payments philosophy is more in line with Silicon Valley, and that partnership would make more sense.
Traditional acquirers already have small merchants covered, so there wouldn't be much in it for them to offer a large enough sum to make it attractive for Square to sell, whereas tech companies are notorious for having deep pockets."
Furthermore, Reinelt believes Square would be a better fit for Amazon or PayPal than Google Inc. or Facebook. "Google and Facebook use so much data for marketing, and payments is not their core focus, which could make merchants and consumers a bit leery," she said. "Amazon and PayPal are merchant-focused payment companies, which makes them a much better match."
Reinelt sees the intriguing possibilities of a Square-Amazon match, "considering Amazon has reportedly entertained the notion of taking their digital wallet into the brick-and-mortar space via their Kindle tablets."
For that reason, "Square's business model would fit in nicely with that initiative, albeit they would have to address the fact that the Square Stand is an iPad versus a Kindle," she added.
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