Strategic Conclusions Traditional Acquirers Can Draw from Square

Navigator Edition: March 2016
By: Marc Abbey and Brooke Ybarra

Square has been a controversial player in the merchant acquiring business since its launch, a player that has attracted much criticism from more traditional acquirers. Though some of this skepticism is well founded, much is not, and the acquiring industry should not fail to absorb the strategic lessons that Square’s rise has made evident. The critique of Square by its competitors has been frequent and wide ranging and has tended to focus around its targeting of micro-merchants and its operating losses. Square’s recent IPO price failed to meet expectations initially, and many observers in the acquiring industry felt this outcome was somewhat validating of what they see as shortcomings in the Square model. The jury is still out as to the validity or relevance of competitors’ criticisms but focusing only on the fragilities of the Square model misses critical, larger points.

It should be said that Square’s share price is up nearly 25% since the public offering (as of this writing, the second week of March), and the company has a public valuation of almost $3.5 billion. The company’s volume grew 50% over the past year to nearly $36 billion, and its revenue, adjusting for Starbucks, grew 64%. 39% of its volume is now from merchants with annual volume greater than $125,000 per year (see Figure 1). The company is projecting 2016 as its breakeven year, and some equity analysts project a mid-year turning point in earnings. In private research First Annapolis has completed or has seen from other research companies and consulting firms, Square consistently scores highly favorable relative to traditional acquirers on customer satisfaction, likelihood to recommend, likelihood to ‘renew,’ and similar measures. Square reported a net promoter score of 70 on its recent earnings call. Acquirers should not disregard this sort of performance lightly.

Figure 1: Square Portfolio Growth, 2014 to 2015

Figure-1_-Square-Portfolio-Growth-2014-to-2015Source: Square 2015 10-K, Q4 2015 earnings release, and S-1.

In a sense, Square has taken competitive concepts that are commonplace in other industries and applied them to the acquiring business freshly. We see four enduring lessons:

  1. Advertising: Square has been the beneficiary of quantities of highly favorable and free publicity through the press’s fascination with the company and its CEO, but it also spent $58 million on advertising in 2015, nearly 13% of adjusted net revenue. By contrast, we estimate the industry average for acquiring is less than 2% of net revenue (see Figure 2). Much of the advertising that exists in acquiring is targeted to the sales channel, for example the merchant-level sales person or the software developer and dealer, rather than to the end-user, the merchant. For most acquirers, advertising is simply not a factor in their sales and marketing dynamics. For Square, on the other hand, developing a recognizable brand through advertising is likely a core contributor to its sales performance. 50% of Square’s leads result from merchants contacting the company directly without any form of outbound sales.
  2. Buying Behavior: Square’s performance has resulted despite the near complete absence of a traditional sales organization and traditional lead sources. To a large degree, Square’s growth results from a segmentation strategy based on buying behavior or consumer-style “pull-based” distribution, standard in many industries but not all that common among acquirers, who typically leverage “push-based” distribution. The company recognized there are parts of the market that will buy largely through self-discovery and self-enrollment, albeit with an offer specifically appropriate for merchants with such buying behavior.
  3. Business Process Innovation: When Square’s mobile reader was released, it was not the first mobile point-of-sale product and within a few quarters, it was largely copied across the industry. Within a year, mobile readers were practically ubiquitous. However, the company’s self-enrollment, expedited enrollment, and deferred underwriting business processes, though no longer exclusive to Square, still have not been matched by the strong majority of acquirers. The Square Capital product itself was a rather late-to-market cash advance product. We’d argue much more than the product, per se, the business processes Square has used to originate such loans resulted in the company originating $400 million in 2015, just a little over two years after launching the product. Square has introduced an offering called Instant Deposit in which it will settle a transaction to a merchant in near real time using original credit transactions to a card, for a 100 basis point fee. 58,000 merchants used this service in the last five months of 2015. It is the business process and not original credit transactions, per se, that is the innovation in this case. Though product lifecycles have proven relatively narrow, the lifecycles of Square’s business process-based competitive advantages have been longer lived.
  4. Branding: Acquiring is famously a business of weak brands. In past First Annapolis research, as many as 50% of small merchants could not identify their acquirers successfully. Many of the large players in the industry explicitly pursue a strategy of leveraging the brands of partners and keeping their own brands deep in the background. The group of acquirers who have strong acquiring-level brands (as opposed to, for example, strong bank brands – Chase, Bank of America – that connote very little about acquiring, per se) is a very exclusive club; Cielo in Brazil, Moneris in Canada, and a few others. Square built a brand which is generally highly recognized and associated with very favorable attributes, in the research First Annapolis has completed and seen from others. Square built this brand rapidly and with a media savvy that we tend not to associate with acquirers, and make no mistake, it is a competitive weapon.

Figure 2: Advertising Expense as a Percent of Net Revenue

(Square vs. Acquiring Industry)

Figure-2_-Advertising-Expense-as-a-Percent-of-Net-Revenue--Square-vs-Acquiring-Industry-Source: Square 2015 10-K and First Annapolis Consulting research.

Our purpose, with these observations, is not to portray Square as a company all others should emulate, and time will tell how Square’s strengths balance its vulnerabilities. Rather, our purpose is to point out that defining strategy and competition in acquiring in traditional ways has a risk that we think Square has made apparent by competing in ways that acquirers have not.

For more information, please contact Marc Abbey, Managing Partner,; or Brooke Ybarra, Senior Manager, Both specialize in Merchant Acquiring.

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