Weekly readings – 22nd August 2020

What I wrote last week

I compared what is happening in Vietnam and New Zealand in the fight against Covid-19 and why it looks very bleak for America

I wrote a bit of analysis on Square, the owner of Cash App

Business

Instacart dominated the grocery delivery in the US

Second Measure on pandemic grocery spending
Source: Second Measure

A startup that promises to deliver groceries in less than 13 minutes in Turkey

An interview with the CEO of New York Times. He grew the subscriber base from the rock bottom of 22,000 in Q2 2013 to 6.5 million today

How Uber Turned a Promising Bikeshare Company Into Literal Garbage

Technology

Ben Evans on App Store and antitrust issues

A deep dive into iPhone 5C plastic cases

John Gruber on TikTok as a security threat

What I find interesting

The Canva Backlink Empire: How SEO, Outreach & Content Led To A $6B Valuation

To all Americans who are told all the nasty and misleading facts about Socialism & Communism whenever social benefits and safety nets are mentioned, please read this from your fellow American, who considers his move to Vietnam the best decision

Confessions of a Xinjiang Camp Teacher

A dazzling civilization flourished in Sudan nearly 5,000 years ago. Why was it forgotten?

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.

Book review: The Innovation Stack

Similar to the most recent books, this one came to me by chance when somebody I follow retweeted someone else who read it. I gave it a chance and I am glad I did. The book is penned by Jim McKelvey, the cofounder of Square. The book should be recommended by business schools and read by anyone who wishes to improve their competitiveness as a business or a company. It is a straightforward, easy-to-read, genuine and informative book. What I like the most about the book is the author’s genuineness. He doesn’t seem to try to immortalize entrepreneurs or make wild exaggerations. For instance, one of his main points is to copy what worked in the past. In my personal experience at business schools, I often listened to professors talk about “blue ocean” or “doing something unique”. I always find it hard to come across something that has never been done before. Perhaps, I am not smart enough. That’s why it’s refreshing to listen to a billionaire who admitted that he copied everything he could at Square.

Jim’s Innovation Stack simply refers to the process of companies trying to solve a problem which leads to two more problems and so on. By tackling each problem, successful entities come up with a unique mix of elements that only they can possess, elements that make them competitive. Any competitor that wants to copy an Innovation Stack has to somehow copy every single element of the Stack, not just one or a few. That makes a solid Innovation Stack defensible and difficult to emulate.

The same concept can also apply to individuals. For instance, speaking English may not give anyone a competitive advantage. However, combining English with other skills such as fluency in Latin and professional training in archaeology makes a person “more unique” and harder to compete.

There are other gems in the book that I believe will be useful to readers. If you are looking for a short quality read over this weekend, give it a try. It’s worth it.

“BEFORE stalking got such a bad reputation, I was pretty good at it. My target was always the same: some famous businessperson. Entrepreneurship was not taught in school at the time,* so I had to invent a way to get instruction. My technique was simple: I would wait until some famous entrepreneur came to St. Louis to give a speech. After the speech I would catch the speaker as he or she left the stage and offer a ride to the airport.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“A couple of ratios help illuminate the crime scene. Credit card vendors were making 0.04¢ on every dollar ($0.3 billion / $788 billion) they processed from their large merchants. Now compare this to 1.8¢ on the dollar, the profit they were making on small merchants ($2.4 billion / $130 billion). Their profit margin from small businesses was forty-five times higher than from billion-dollar corporations. I rechecked my math three times before that number sunk in. Small businesses pay forty-five times more than the giants do. We had identified a big problem and a good reason to start a company.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

The problem with solving one problem is that it usually creates a new problem that requires a new solution with its own new problems. This problem-solution-problem chain continues until eventually one of two things happens: either you fail to solve a problem and die, or you succeed in solving all the problems with a collection of both interlocking and independent innovation. This successful collection is what I call an Innovation Stack

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“But this book’s subject is the exploration of the unknown; so, as a consolation prize for readers expecting between five and seven bulleted steps to success, I will now tell you the universal formula for success in any existing industry. This formula works from building bridges to selling soap. This formula has worked for millennia and it will give you the ability to succeed in any known field of endeavor. Even better, you have been practicing the fundamental skill it requires since before you were born, and are almost certainly a master.

Ready?

Copy what everyone else does.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“In 1973, Braniff cut its fare between Dallas and Houston to $13, half of what Southwest charged. The Dallas–Houston run was Southwest’s primary source of profit—competing at that rate, even with its Innovation Stack and greater cost efficiency, would be disastrous. Braniff’s pricing attack violated US antitrust law, but the executives hoped to drive Southwest out of business before Herb could take them to court. Winning in court wouldn’t matter if Southwest was dead, so Herb needed a fast solution. He and his team devised a plan by looking at their customers.

Southwest knew that most of the passengers on the Dallas–Houston route were businesspeople. These businesspeople flew Southwest primarily for the convenience of multiple flights, easy changes, open seating, and on-time performance. Braniff could set any price it wanted, but it could not replicate the other effects of Southwest’s Innovation Stack. These business fliers were not choosing Southwest simply because of the low price, a price their employers reimbursed them for anyway. So Southwest offered fliers the option of paying only $13, or they could pay the full fare of $26 and get a complimentary bottle of Chivas Regal scotch, Crown Royal whiskey, or Smirnoff vodka. Most of the passengers stayed with Southwest and chose to pay the full fare and get the booze. Southwest managed to outsell Braniff at twice the price, and for the length of that promotion became the largest liquor distributor in Texas.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“Disruption has become nearly as threadbare a concept as entrepreneurship. The two words could be roommates at rehab. When Clayton Christensen first popularized the disruption concept back in 1997, the idea was novel and interesting. But what Christensen originally called disruptive innovation has now been shortened to just disruption and the oversimplification is profound. Two decades later, disruption has become the high-fructose corn syrup of business, an overused ingredient sprayed on pitches and injected into keynotes in the hope of disguising the familiar taste of conformity.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“IS DISRUPTION BAD? Not by itself. But disruption has also never been the focus of good entrepreneurs. The entrepreneurs profiled in this book set out to build and not to destroy. To focus on disruption is to look over one’s shoulder into the past. But if you are trying to solve a perfect problem or expand a market, shouldn’t you study that industry? No, you look at your customers, or I should say your potential customers, for they do not even know your product or service is possible.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

But now that you have read this book you have lost something as well. You can no longer look at a problem and say, “Nothing can be done.” You can’t even say, “I can’t do it because I am lacking (fill in your excuse du jour).” You can only say either, “I’m not going to do anything” or “I am going to solve this problem.” Because we have seen how world-changing entrepreneurs had few if any qualifications when they began their journeys. 

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

Comparing Enterprise SaaS Companies’ Metrics

Interested in how enterprise SaaS companies whose some or all of their revenue come from subscriptions, I set out to collect data from the companies that I know offer subscriptions to enterprise customers. Please be aware that this is my personal research stemming from intellectual curiosity only. They are not meant to be anything more than that.

  • Data is collected from the latest year in the companies’ latest annual reports to ensure that seasonality factor is removed
  • The metrics include subscription gross margin (subscription gross profit/subscription revenue), overall gross margin, Sales & Marketing expense as % of revenue, R&D as % of revenue, SG&A as % of revenue and net dollar expansion rate (or retention rate)
  • If there is a difference between subscription gross margin and overall gross margin, it’s because those companies also generate revenue from other sources such as hardware or professional services
  • Much as I tried to keep the figures accurate, do use them at your discretion

Subscription Gross Margin

Median: 82%/ Mean: 80%

Gross Margin

Median: 72%/ Mean: 71%

Sales & Marketing Expense as % of Revenue

Median: 44%/ Mean: 42%

R&D as % of Revenue

Median: 22% / Mean: 22%

SG&A as % of Revenue

Median: 15% / Mean: 15%

Operating Income (Loss) as % of Revenue

Median: -14%/ Mean: -10%

Dollar Expansion Rate

Median: 115% / Mean: 115%