Get to know Square, the owner of Cash App

How Square was founded and what it is today

Shortly before 2009, Jim McKelvey and Jack Dorsey were looking for a business idea to work on together. Jim was operating a glassblowing studio at the time. He had a customer come in ready to pay for an order. The customer had an American Express card, which the studio couldn’t accept. Jim lost the sale. He started to dig into the payment world and soon realized that there was a problem. The payment world is highly complicated with different credit card vendors and a myriad of rules and fees. To make its store accessible, a merchant had to work different credit card networks. Worse, in 2004, credit card vendors were making 45 times the amount of revenue on Small & Medium Sized merchants (SMB) as much as the revenue on large corporations.

Book Review: The Innovation Stack :: UXmatters
Figure 1 – Small and Medium Sized Merchants made up the majority of credit card vendors’ revenue in 2004. Source: uxmatters

The two co-founders of Square came up with an idea of a simple-to-use dongle that could read different credit cards, along with unprecedented transparency over fees to eliminate confusion for vendors. Their value proposition to customers was to simplify the process of working with different card vendors and to avoid the situation that some cards like Amex couldn’t be accepted. To lessen the fees for merchants, Square waived the per transaction fee and relied on the sale of their dongle, a small cut of interchange from transactions and likely a one-time fee to be able to use the dongle. That’s how the company started.

Fast forward to 2020, you can hardly recognize that Square company. It has grown leaps and bounds so that their offerings expanded to include a set of solutions for business and consumers. On the seller ecosystem side, Square offers software, hardware and financial services, namely:

  • Software: Online store, Square for different industries, Gift Card, Marketing, Dashboard
  • Hardware: different POS types
  • Financial services: managed payments, instant transfer, Square Card and Square Capital

On the Cash App side, the app can enable users to store & transfer funds to another person, spend via a debit card called Cash Card and invest in stocks, ETFs or Bitcoin.

Figure 2 – A simple way to look at Square business
Figure 3 – A more granular look at Square’s offerings. Source: Square

How does Square make money?

  • Transaction-based revenue: Square takes a small cut from every transaction from some services that they help facilitate through products and services
  • Subscriptions and fees: For some Square services, customers have to either subscribe or pay fees to be able to use them, including Square Capital, Instant Transfer, Cash Card, website & domain hosting and other
  • Hardware: Square also makes money from selling their hardware, including Stand, Register and Terminal, card swiping devices and chip readers
  • Bitcoine: allowing users to buy, sell and deposit Bitcoin, Square makes money in this segment by charging a fee for every transaction as well as raking in the difference in Bitcoin’s prices. For instance, the company might buy a Bitcoin at $9,950 and sell it at $10,000, netting $50 in revenue, on top of 1.7% in transaction fees
Figure 4 – Revenue breakdown from the Seller ecosystem. Source: Square
Figure 5 – Revenue breakdown from the Cash App ecosystem. Source: Square

Square has been growing very nicely in the last five years. The top line increased from $1.3 billion in 2015 to $4.7 billion in 2019, a CAGR of almost 38%. Meanwhile, the company went from losing money to the tune of $175 million in 2015 to making a modest operational income of $27 million in 2019.

In terms of segment revenue, transaction-based was the dominant source of revenue, making up 66% of Square’s revenue in 2019. On the other, Bitcoin was the fastest growing segment, growing at 211% YoY, followed by Subscription & Services.

Figure 6 – Square’s revenue by segment. Source: Square

Among Square’s segments, hardware is consistently the one that loses money. It’s the case of razor and blades. Square is willing to lose dozens of millions on hardware if that means they can make hundreds of millions of dollars in return from services. Meanwhile, Bitcoin’s gross margin is routinely at 2% while Square has made great improvements on the margin of Transaction-based and Subscriptions & Services.

Figure 7: Square’s Gross Margin. Source: Square

The growth of Cash App

Cash App has grown more important to Square over the years. The application was responsible for around 22-23% of the company’s revenue in Q2 2019, but the figure grew to 62% in Q2 2020, leaving the seller ecosystem only responsible for 38% of the total revenue. While the numbers for Cash App look impressive, most of the growth was attributed to the increase in Bitcoin revenue, even though Transaction-based and Subscription & Services also recorded nice growth. Additionally, Square increased the pile with a lower gross margin between Cash App and Seller ecosystems. If Cash App had 23% gross margin in Q2 2020, Seller notched 44%.

Figure 8 – Square’s Q2 2020 result. Source: Square

Over the years, Square has increased their marketing leverage. Sales & Marketing as % of revenue for Cash App decreased from 27% in Q2 2019 to 12% a year later. As a result, even though Cash App offers a lower gross margin than Seller, I suspect the increased marketing leverage enabled Square to turn a profit in Q2 2020. Whether this will persist as a routine in the future or whether it is mainly driven by Covid-19 remains to be seen.

Square defines “active transacting customers ” as those who have at least one cash inflow or outflow during a month. The base that had 1 million active transacting customers in Dec 2015 grew to 30 million in June 2020. Covid-19 helped accelerate the use of Cash App as these customers transacted 15 times per month or more on average every other day, up 50% from a year ago.

Figure 9 – Square’s Active Transacting Cash App Customers

At the end of FY 2019, over 50% of Cash App customers brought revenue to the company, a figure that was exceeded in Q2 2020 as the company reported an uplift. Revenue per customer, excluding bitcoin, was $45 on an annualized basis, compared to $30 in Q4 FY2019 and $15 in 2017.

Cause for concern

While Cash App seems to be going on the right track, Square does seem to have a problem at hand with the Seller ecosystem. In Q2 2020, Seller revenue decreased to $723 million from $870 million a year ago. In the meantime, Shopify’s revenue almost doubled in Q2 2020, compared to a year ago while offering essentially the same solutions and going after the same market as Square. Another competitor that had an impressive growth in the same quarter is Amazon. Their 3rd party segment’s revenue grew by 52% YoY. As I expect us to continue struggling with the pandemic in the months to come, what I have seen so far shows that Square may have a tough time competing to facilitate eCommerce with the likes of Amazon or Shopify. Other players include eBay, Google, Etsy, BigCommerce or Facebook.

It’s valuable indeed to help businesses manage their operations, but it’s not enough. The biggest worry of businesses is to generate revenue. As the pandemic fast-tracks eCommerce, revenue usually means website traffic. Amazon is the king of eCommerce in the US. Shopify partnered with Walmart, Facebook and Pinterest to bring traffic to their vendors. Meanwhile, I am not aware that Square has a similar capability to bring traffic to their customers. That’s a huge missing piece in their puzzle.

Another challenge that Square has to face for its Seller ecosystem is fulfillment. Walmart, Shopify and Amazon all have their fulfillment network. Even though Square already partnered with UPS, it’s not the same as owning that capability themselves, especially when the fulfillment demand scales up.

Cash App is also having to deal with a growing and fierce competition. Apple is pushing very hard to market Apple Pay, Apple Cash and Apple Card, whose basic utility is the same as that of Cash App and Cash Card. There is also Paypal/Venmo, Facebook with their own payment system and neobanks such as Point App. Although Cash App is in a pretty good shape, there is still a lot of work to do to stay competitive and fend off rivals. Having the ability to invest and trade Bitcoin is nice, but 1/ I don’t believe both features offer a high margin and 2/ they aren’t likely to keep consumers exclusive on Cash App. One can easily use Robinhood for trading and Apple services for other purposes.

Compared to their rival Shopify, Square has an advantage of having their feet in the consumer world as well. If they can manage to connect the consumer and seller side by offering consumer trend insights in real time to their sellers, that will be a great selling point to sellers. For Cash App customers, they need to find a way to keep customers active and use their services more. Recently, a new feature was added to let users access short-term loans of less than $200. However, the feature is a horizontal expansion and not everyone will be happy with a high interest loan. Cash App needs to get customers locked in by giving them more utility than the likes of Apple, Paypal and a host of other competitors.

In sum, Square is spinning a lot of disks at the same time. One can argue that catering to both the Seller and Cash App ecosystems spreads thin Square’s focus and resources, but to fend off fierce rivals on both sides, that is likely what Square has to do. As a fan of eCommerce and fintech, I am very interested in seeing what awaits Square in the future.

Disclaimer: I own Shopify and Amazon stocks in my personal portfolio.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.