Square, the ultimate bank industry disruptor

Companies need to constantly to adapt

Successful companies can often be grouped into businesses, that either have the capability to generate demand while the other group of companies exactly targets and fulfill people’s needs, in fact, they provide solutions for specific problems. Of course, it depends on the life cycle of a company and some companies even combine attributes of both groups at the same time.

When Nokia, decades ago introduced the Short Messages Services on their handsets, most of the people did not immediately recognize the usefulness of that application. After all, at the early stage, people saw a Nokia handy as a wireless telephone, it was about speaking – not writing.

Well, today, writing Messages via WhatsApp, i-Messages, etc. got incredibly important. In fact, I use my smartphone as often to write Messages as I use it to speak.

Clearly, demand has been created, people got more accustomed to wireless phones. I’m not gonna cover here the decline of Nokia in detail, but clearly, after entering a new stage, this company did not find a way to target and fulfill people’s expectations. Device buyer saw their handset as a convenience product and wanted to use it for internet access, as a kind of fashion device, etc. Nokia did not recognize and react to changing consumer trends which would have provided a huge opportunity but instead continued producing “cheap” handsets instead of making the leap to becoming a global smartphone leader.

We all know the story, Apple and Samsung became the undisputed giants in that sector. They had figured out, how to fulfill consumer needs.

It’s ironic, to some extent, that Nokia’s slogan “connecting people” has literally been fulfilled by another company: Facebook. Its ecosystem consisting of several properties such as Facebook Messenger, Instagram, and WhatsApp allows people not only to connect but also to use the platforms for business. The company became also an e-commerce player with Facebook Shop. When you look at the company’s history, you see, that Facebook initially created a need and is now capitalizing on it by providing solutions to specific desires. Facebook’s ability to solve problems was particularly interesting to see during the COVID-19 pandemic. With billions of people stuck at home and the huge challenges of small businesses to stay afloat, they immediately realized the problems, they reacted and launched Facebook Shop together with Shopify.

That’s not to say, that Facebook does not have huge problems and that it does address them all perfectly. Facebook has to some extent very rightfully been criticized and boycotted for allowing people to use their platforms for false news, hate speeches, etc. But still, Facebook is a very good example for a company, that successfully created demand and is then capitalizing on that, on its huge reach and unprecedented market position to adapt to customer needs and target specific expectations and provide solutions to business challenges … and of course make a lot of money on that way.

These are things, Nokia screwed terribly decades ago.

So, societies, industries, and companies alike are constantly changing and adapting. They have to. This provides huge opportunities for some and initiates the downfall of others.

Now, with that having said, let’s have a look at a relatively banking industry player, that is set to shuffle cards.

Square – the mobile payment and fintech industry transformer

Square’s history goes back to 2009, starting as a mobile payment company with a very strong focus on small businesses in the US. 

Jack Dorsey (who is also co-founder of the social media platform Twitter) had the inspiration for the first product resp. solution when a friend of his – a small entrepreneur – was not able to complete a product sale because he could not accept credit cards.

For small start-ups or small businesses in general like coffee houses, imbiss restaurants, etc. offering payments by credit card to their customer is a major cost factor, in fact, one of the greatest challenges facing small business owners is/was processing credit card payments. It’s not rare, that bank institute refuses small companies, it seems there is too much paper work and risk involved to make it an appealing business relationship for them.

Clients expect convenience when it comes to payments methods. We want to have the choice to pay by cash or check, credit card, bank transfer, etc. But who wants to buy a product and then hear from the seller: “I don’t take American Express. Don’t you have a Visa card?’ Or “I don’t take any credit cards, could you please pay in cash.”

Well, even if a small business has the ability to take different credit cards, these are all cost factors for a small company, adding to the complexity, biting into profit margins.

So, the first solution Square provided was figuring out how to easily and conveniently accept credit card payments at the point of sale without being hammered by prohibitively expensive merchant services fees.

The solution was just brilliant: they invented the Square Reader, a square-shaped card reader which could be connected to a smartphone or tablet and through which you can swipe a credit card.

Together with the according software, small businesses were put into a position to easily accept all kinds of payments (Visa, Mastercard, American Express, etc.), including contactless.

Square makes it possible for anyone, whether an individual or small business, to take payments via credit card. These readers have no moving parts and are so inexpensive to manufacture that Square can give them away. Anyone can sign up for the service and get a free reader.

Square became a public company in November of 2015. The company is extremely focused on growing by adding new services for its customers.

Square started out providing technology that allows merchants to process payments, but now its growth is mostly driven by the Cash App, which allows people to send and receive money. The Cash App has more than 30 million monthly active users.

Square is building powerful ecosystems of financial-, merchant and Peer Peer services (payments, f- and cryptocurrency trading, etc.) which are completely transforming the fintech industry. 

Square’s growth is impressive, but more importantly, it is building a very broad economic moat around its business model, laying the ground for long-term success in the financial services industry.

Square has even more upside potential, particularly if CEO Jack Dorsey is able to further expand Square into commercial banking and with its bets in bitcoin.

Square is a major threat to banks because of Deposit displacement and by enabling Cash App customers to invest that money (Bitcoin or not), Square is preventing someone else (e.g., Robinhood) from deposit displacing them.

Of course, Square is not the only fintech company and strong players like Apple (Apple Pay), Alphabet (Google Play), Paypal are fighting tough for their market share.

But Square is consolidating services at a massive pace, their ecosystem will become a challenge to brick and mortar banks which in fact have a very limited service offer and a very unfavorable cost structure. Banks have a huge infrastructure, they own and run large buildings, each of them has its own network of branches. So, a bank’s margins have to be high in order to run a successful business.

The banking industry is extremely vulnerable to disruption by technology businesses that have another approach and don’t need these broad margins.

The banking sector – at the core – is a punitive system. The financially weaker a customer, the more it will be kicked by the bank. For instance, when someone borrows money from a bank and misses a payment, a penalty fee is charged. Late fees are a multi-billion revenue stream for banks. These institutions punish clients when they are down when their financials are or become stretched by applying a higher interest on the mortgage loan.

Another aspect is that banks usually refuse some businesses e.g. granting a small mortgage loan when risk-reward is not attractive enough. As stated before, due to its cost structure, banks have to focus on high-margin businesses. What banks are slow to realize is that they are more and more loosing low-margin customers, but in the medium and long run also high margin businesses. Banking is on the basis of relationships, but here the way of making business and services are offered becomes steadily less appealing to more and more clients.

When a bank does not want to deal with my small business, why not looking at alternatives?

Just think of that, an Ultra High Net Worth Individual with tens of millions of assets administered by a private bank. This person owns several small businesses, all using Square for transactions, that company offers a platform to invest conveniently into stocks and cryptocurrencies, you can lend through Square, etc. …. and all is aggregate in the same business: Square.

Square has recognized problems and provides solutions and it is even ahead of customer expectations, in fact to some extent it creates demand.

Square is in two areas of business. One is seller-oriented. It provides the terminal, allowing to use of credit cards for goods and services. Square helps businesses to do social marketing, they created a payroll system, an accounting system helping small business owners keeping track of their business.

Square has insight, how the client businesses are run. So, they can take very calculated risks by granting them small loans. e.g. when Square grants a USD 7’000 loan to a retailer or restaurant, there are major differences compared to a bank. First, a bank does not move one finger for a loan under USD 100’000 loan amount. But secondly, and more important, Square does not apply a punitive approach, as its data-driven. Square knows exactly well its business client through services its already providing, so it does not have to apply a punitive interest just to compensate a risk factor due to information asymmetry.

Now let’s turn to the Cash App which can be used for anything. You can buy bitcoins, stocks, etc.

In the US, 95 % of the population has a relationship with a bank. On the worldwide scale, almost one-fifth of the population does not have a relationship with a bank. These people don’t have the ability to write a check, have a credit card, etc. These people have to constantly deal with cash, which is uncomfortable and to their disadvantage.

A deposit with Square allows them to pay for goods and services via their mobile phones and not be punished with an outlandish transaction fee (like Western Union). Just think of an immigrant that wants to send money to his family and they don’t have a bank account, via Square there is a solution.

Being data-driven sets Square apart. Handling the infrastructure for small businesses gives them a tremendous amount of information, a bank could never have.

Square is currently focused on the US, but it is predestined for a massive global presence. Square has just begun to expand.

Watch out, Citigroup, UBS and HSBC, etc. all over the world. Disruption is on the way.

Disclaimer
You are responsible for your own investment and financial decisions. This article is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.

About Savy Fox

SavyFox is an investment blog that writes about various interesting investment topics and shares research and opinions with respect to Stocks, Peer 2 Peer Lending, or Crypto Currency investment opportunities.

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