Square Converts Underbanked Small Businesses

Cash-Based Small Businesses are the Bane of Banking Industry

Small businesses can use banks for loans, deposits and payment processing services. The vast majority of those small businesses use banks for their cash and check processing, but as cash based businesses, they haven’t accepted credit cards from their customers. Bank card issuers and processors have always been at a loss for a successful strategy to convert those oh-so-20th century cash and check payments to cards.

Welcome Square

Payments analysts greeted the arrival of Square with intense curiosity and more than a smidgeon of skepticism.  Would a start-up be able to distribute free card readers to any merchant, charge transaction fees small merchants would tolerate AND be able to make money while absorbing a seemingly bottomless exposure to risk?

The answer to all of those questions appears to be yes. Processing more than $11 million in credit card transactions a day, Square has tapped a brand new market by allowing a million small merchants to switch their preferred transaction type from cash to card. That growth from 0 to 1 million merchants happened by word of mouth by a company that cannot afford mass market advertising campaigns.

Square’s Main Competitor: Cash

While many industry analysts contextualize Square in relation to VISA, showing how Square’s daily processing volume is .44% of VISA’s U.S. daily volume, we would posit that comparison to the world’s second largest card network is a false comparison.

For instance, in the most recent quarter, VISA attributed its transaction volume growth to the larger monthly volumes of its customers. Its growth is among its current customers while Square is bringing new small businesses into the card-centric economy.

While much of the cash-to-card market conversion has already occurred, small merchants and their seemingly intractable preference for cash has remained the bane of the credit card industry since 1958.

Most of the nation’s 27.8 million businesses have no employees and altogether, these 21.7 million businesses account for only 3.4% of business receipts. Depending on their industry, these sole proprietorships and the 3.6 million micro businesses with 1-4 employees are the new business development sweet spot for Square and its competitors.

Market Opportunity of Square is 5.1 million small, cash-based businesses

Our analysis shows that the market potential for Square is the 5.1 million businesses (in specific niche industries) that either have no employees or have no more than 4 employees. These industries are either mobile (caterers, mobile food venders, specialty contractors) or craftsman businesses selling to consumers with a price point above $40.

Altogether, these 5.1 million businesses employ 6.3 million employees and each of those employees, equipped with a smart phone, is a potential user of Square’s payment processing services.

We are not including franchises in our market sizing because while these armies of plumbers and moving men are prime consumers of hand-held POS terminals, they need robust accounting features for their head offices that the Mom and/or Pop Square customers just don’t need.

Conservative Estimate: $116.5 billion in transactions is Square’s Market Opportunity

These nonemployee and microbusinesses have a combined revenue of $233 billion. If only ½ of their revenue switched from cash and checks to credit cards, that would represent new credit card business of $116.5 billion. At the moment, Square is processing $402 million (annualized). That means there is small business revenue of $116 billion that is fair game for new card payment technologies.

That’s a big piece of payment business to bring back into the banks.

Square’s CEO, Jack Dorsey, attributes the success of Square to the power of design and straight forward simplicity in creating a trustworthy brand for the one million small merchants processing credit card transactions using the Square plug-in to their smart phones. To that simplicity, we would add transparency, corporate responsiveness to consumer demand and elegant technology.

Almost Zero Cost-of-sales + Evangelical Word-of-Mouth + Huge Retail Distribution System = Goooooooooal

With a cost-of-sales that is the price of a card swipe widget and a web page, Square has offered small businesses a flat fee structure (2.75% of all transactions), next day payout and the ability for any small merchant to accept a full suite of U.S. credit cards.

By early 2011, investors were pounding on Square’s door to add their millions to its early funding of $10 million. Series C investors had added $103 million in funding which is allowing Square to add features to its core product, build relationships with retailers (if you can wait for Square to mail you a card reader, the plug-in is free. If you need it right now, you can pick it up at one of 9,000 retail stores including Target, Wal-Mart, Apple stores. At a retailer, the readers cost $10 and come with a $10 coupon that is instantly credited when the merchant account is set up).

Low cost of sales, a rapidly expanding card reader distribution network, easy to set up processing and a flat fee structure combined with that $116 billion in potential new business make Square a thrillingly obvious (easy to say now!) winner.

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