News that Starbucks would allow customers to “Pay with Square” (and invest $25m in Square and have its CEO Howard Shultz sit on Square’s board) made waves last week.
This is of course a nice deal for Square. This allows Square entry into 7000+ Starbucks stores and bestows credibility in “mainstream” retailing – something that Square likely needs as it grows up.
But what about Starbucks? What is it getting in return? Starbucks customers with a phone (smart ones) can already pay for their $5 coffees and lattes using an app that is connected to a pre-paid or pre-loaded Starbucks “debit” card. So what is Starbucks’ Square attraction and what is its hoped-for payoff?
For that, let us try to dig a bit deeper and look at the
Merchant –> Consumer –> Transaction
value chain (payment processors should ideally be part of that but that market is sufficiently involved that it likely requires its own analysis).
First, let us visit the distant past. A past in which, when a merchant wanted to let customers pay with a credit card, they would have had to sign up for a moderately expensive card swipe machine and pay the payment processor a hefty fee to process transactions.
So if they merchants were selling goods “on the go” and/or if they were not very happy with the 4%+ swipe processing fee, then credit cards were just not an option for them – and they had to live with the potential loss of customers (ex: sometimes, if I don’t have cash and have to pay for an expensive cab ride, I wait until I find a cab that takes credit cards. so, in theory, the non-card cabs lost out on revenue and assuming they were still incurring “fixed” costs, took a daily or shift profit hit).
With a flat 2.75% swipe processing fee and a very handy and convenient (free) device that plugs into a smartphone or iPad headphone socket, Square took some segments by storm and upped the ante. Paypal came out with a triangular (!) device offering similar functionality:
but for now it appears that Square retains an early mover advantage. As of April this year, it was processing $5B in transactions on an annualized basis (up 25% from the previous month) and that volume is on its way up.
Clearly, this is more of a merchant-targeted system and creates value directly for them (and indirectly for consumers). It increases the size of the “pie” in terms of the number of credit card accepting merchants. But note that this innovation still requires a physical credit card and a physical device to process the credit card swipe.
NFC Payments enable cell phones with NFC technology (a chip) to pay for transactions with simple wave (in most cases) near a store’s NFC reader. On the back-end, you first have to tie your credit card data (any card, if you use Google Wallet – with the exception of AmEx) to an app on your phone.
[Why no AmEx? Because when a customer waves a phone today in a store,
...the in-store Wallet transactions are still handled by Google's original partner MasterCard via a PayPass account. So what that means is there's a possibility that not all purchase information is passed along to the credit card actually paying for the transaction. ]
Still, the good news for consumers is that this is one step closer to a much more secure, card-less, “contact-less” purchasing experience.
[If you set up your phone with a security passcode, Google Wallet's (the most popular NFC payment currently, though many banks and other coalitions are jumping into the game) PIN provides the 2nd level of authentication. Further, if you lose your phone with Google Wallet on it, you can actually disable the app remotely. So its probably more secure than having a credit card (caveat: credit cards don't run on battery power, unlike phones - so if your phone dies…).]
The bad news though is that while NFC payments create value for consumers, cell phone carriers now enter the ecosystem and want to capture a part of that value. It is not clear if Google shares any revenue with the carriers (but is Google even making anything off of its Wallet app? I wasn’t able to find anything that indicates Google is in fact generating revenue from its Wallet…so its probably a long-term play to control, sorry, manage consumers’ mobile payment experience so it can figure out revenue opportunities in the future). So many of them have blocked Google Wallet and have instead banded together to create ISIS – a digital “wallet” – that uses NFC:
And presumably ISIS and Google Wallet will duke it out for mindshare and marketshare. But note that from a merchant perspective, value creation is indirect. In fact, NFC technology might actually raise their costs because every store must acquire NFC compatible technology in order to process payments. Still, Visa is mandating that by 2013 every merchant be able to handle NFC payments, so one way or another, merchants’ “To NFC or Not To NFC” question will be settled soon.
Here is where it gets interesting. While the first two players above require some combination of hardware and/or other equipment, this third scenario changes the game because Bar Code / QR apps don’t require any new chips in phones or new merchant equipment (since almost all merchants already use bar code scanners for checkouts).
The way it works is that phones display bar/QR codes, merchants scan them, goods are paid for and customers are on their way.
This is where PayPal comes in with its app:
Starbucks has a similar app:
And now Square has jumped into the fray with a customer-facing app called “Pay with Square”. I suspect that Square did this or had to do this, precisely because of the low barriers to entry here (since just about anyone can write an app to display a scannable bar code, as long as the back-end payment infrastructure is in place). Square is acting quickly so it can become the “early mover” and establish itself, before someone else comes in, gains market share and signs up 95% of the free-standing merchants out there.
Given all of this, what makes Square unique and why Starbucks’ interest in square?
The answer seems to lie in Square’s ability to shape (and understand) consumer behavior – beyond what Starbucks was doing with its app or what PayPal was doing with its app.
After a user downloads the Square app and sets it up,
…Once you’re within 100 meters of the merchant, your tab will be automatically opened. Your name and photo will appear on the merchant’s register.
After you pick your goods or receive a service, you then walk up to the register and tell the cashier your name and your account is charged.
After you’ve made a purchase, or if you decide not to buy anything, your tab will automatically close as you move beyond 100 meters from the merchant’s store.
This tells us two things:
a. Square’s GPS-aware app sounds seamless and should work great in theory (though I can foresee many problems with this in practice…). And while any tech or social visionary will be blown away (like Starbucks was, apparently), its likely not ready for prime-time and for Starbucks, with tens of thousands of stores, unless the technology works the way the dial-tone on a land-line telephone works, it might be too big a risk to adopt it right away, “confuse” its upscale customers and otherwise impact their “affordable luxury” experience.
b. At the same time, keep in mind that Google Wallet (or ISIS) can easily replicate this (how difficult is it to add GPS-awareness to its Wallet app? Every smart phone these days is GPS-enabled and Google Maps and a plethora of other apps are GPS-aware already). For stores that sign up with Google on the back-end, customers can pay with the app exactly like with “Pay with Square” or if they have an NFC reader, thanks to Visa’s mandate, they can use their Google NFC-enabled Wallet app to pay. Google wins with both types of merchants.
That, meaning (a) and (b), explain this alliance in my opinion.
With this alliance, its CEO gets a seat on Square’s board. And that’s going to allow Starbucks to be very close to the “action” as Square strives to shape consumer behavior and understand how to make the consumer experience better. Lessons that Square learns in the process (both at Starbucks locations and elsewhere) can then be applied to make Starbucks’ customers experience faster, easier and more seamless. Cleverly, this also allows Starbucks to potentially blunt Google’s ever-expanding power in the mobile payment market (why would Starbucks want Google to capture consumer behavior data and monetize it via targeted, location-specific ads when it can do that by partnering with Square in the future and capturing more of the value created?).
Going into the future, that experience shaping should then help Starbucks differentiate itself against every other cafe and establishment offering $1.50 lattes and continue to maintain its premium pricing model.
Putting everything together and understanding what is at stake, $25m, a rounding error for Starbucks, is a small price to pay for a Square-side seat to the game being played out for customers’ wallets and minds.