How Square is Building a Two-Market Platform One Market at a Time

The incumbents in the payment market have historically focused on the transactions themselves: how to process them faster, make them more secure, and convenient.  The incumbents include the card issuers, acquirers, credit card associations (Visa, MasterCard, etc.), POS manufacturers, companies such as PayPal, and related service providers.  Beyond the services offered by companies such as Catalina Marketing, there hasn’t been a lot of innovation around the purchase experience or the data that is generated during the transaction (location, item-level purchase data, an individual’s purchase history, etc.).  And while there has been progress in improving card issuers’ “online billing” sites, those sites are still terrible at presenting information and making that information useful.

It’s conventional wisdom that PayPal is best positioned to lead the next cycle of innovation in payments but I’m skeptical of this.  Following its acquisition by eBay, PayPal’s culture of innovation was subsumed by the far more measured innovation ethic at eBay.  At PlaceVine we are users of PayPal’s APIs – including the recurring billing features – and the experience has been exasperating at best.  Other developers I have spoken with have found the APIs similarly frustrating.  While PayPal has the huge benefit of a large installed base of customers and recently announced its new global payments platform, PayPal X (“X” was also the name of Elon Musk’s payments company which merged with Peter Thiel’s Confinity (PayPal was its flagship brand) to become PayPal), there is opportunity for upstarts with fresh approaches unburdened by legacy platforms and business models.

It is notoriously difficult for payment platforms to achieve ubiquity (how many other PayPal’s do you know of?) but one company is taking an interesting approach to payments: Square.  While Square – the payments company launched by twitter-creator Jack Dorsey – has received a lot of recent buzz, it’s not all hype.  Square enables anyone with an iPhone, iPod Touch, or Blackberry to accept credit card payments via a dongle that plugs into the device’s headphone jack.  The service also bundles in a merchant account that doesn’t require monthly fees (Square’s initial plan will be to make money on transaction fees).

I imagine the dongle will only be one of many ways Square will accept payments (here is a demo of Square running on Apple’s new Linea Pro iPod Touch POS from Infinite Peripherals), but the strategy to focus first on accepting credit cards is a smart one.  The company is making a number of solid strategic moves.

The credit card business is a two-market platform (aka two-sided market) as it requires cardholders (to buy things) and merchants (to accept holders’ payments).  PlaceVine is another example of a two-market platform as it requires both content producers and marketers in order for the platform to create value.  Diners Club was the first charge card company and they started off by mailing a thousand or so cards to affluent New Yorkers while convincing a group of restaurants to accept them.  Simultaneously building a two-market platform is a classic chicken-and-egg problem and it takes brute force and (usually) a lot of capital to get both markets onto the platform.

Square wants to “design” the purchase process and we can assume they would like for people to eventually pay with Square (instead of paying with Amex, MC, etc.).  But it’s too expensive (and slow) for them to try and acquire  payers directly (as Diner’s Club did with cardholders).  So, instead they are focusing on under-served merchants (which will also be expensive to acquire, but less so) and leveraging the enormous installed base of credit cards in the hands of payers.  In other words, Square doesn’t need to build the payer side of the platform in order for Square to be useful.  Payers can buy from Square merchants using credit cards at first and Square can roll out a service for payers later on.  Assuming that Square can gain traction among merchants, Square can begin to short-circuit the major costs and challenges of simultaneously building a two-market platform.  How will they do this?  Receipts!

As Dorsey mentioned, receipts offer a huge opportunity for innovation.  Currently, receipts are just little pieces of paper without a whole lot of use.  However, when a payer buys something from a Square merchant, the payer can have the receipt emailed to her.  This feedback loop is critical because the receipt is a perfect touch point to expose the customer to what can be done with this data via Square.  The greater the number of Square merchants, the more receipts, the more services that will be built on top of this data, and thus the more frequently customers will be exposed to Square (this process will take years to gain critical mass, but it’s important).  If customers come to value the payment process provided by Square merchants, payer demand could be a positive factor in helping accelerate adoption among merchants.  The next step will then be to design payment capabilities for the payers (the other “market” in the two-market platform) so that they can ditch their credit cards and begin using Square to buy things.

Removing Friction Points to Gain Merchant Acceptance
So, Square is removing as many friction points as possible in order to build this two-market payment platform.  Leveraging the installed base of credit cards is one move.  The other is providing “free” merchant accounts and dongles to a category of merchants that have been under-served by incumbent technology and service providers.  By making it inexpensive (assuming the transaction-based fee structure is competitive) and easy for merchants to use Square, the company can focus on gaining traction from traditionally under-served merchants without rocking the boats of competitors focused on high-end POS deployments.

Focusing on Design, Social, and Open Systems
Creating a robust and ubiquitous payment utility is an enormous challenge, but Square is being built by a team that understands the benefits of simplicity, the social graph, and open systems.  The incumbents do not have this in their DNA.  Square is a classic disruptive technology but is unique in that it: 1) satisfies a need in the market that older POS technology could not fulfill (at least at Square’s launch; now there are competitors); and 2) as a software utility with (future) open APIs, it has the potential to move upmarket and take share from incumbent POS providers (ie those focused on major retailers) that may have initially discounted Square for its downmarket focus (again, the Apple Linea Pro/Square demo is a good example of where this could go).  #2 is especially powerful because developers will be looking to build on the most flexible and open platform.  When Foursquare begins building payments functionality in so that it can tie FS ads/check-ins to actual purchases (*the* local ad category killer IMO), what API will it implement?  It won’t be PayPal’s (and it’s not just because Crowley and Dorsey have invested in each others’ startups).

To the three people who have read this far, I can only apologize – this was too long!  More to come on this topic, but that’s all for now.