The Square Opportunity
How Square cracked the fintech playbook and positioned itself with an accumulating advantage at the centre of commerce
If you spend enough time in fintech a playbook emerges:
Get Unit Economics Working (this is very hard in fintech)
Become a Daily Habit
Bundle
Proprietary data + ML = New Lending Opportunities
Square is one of the few fintech companies globally that has succeeded at all four, and they’re just scratching the surface of the impact they could have in rethinking how people interact with their finances. While the Seller App and the Cash App will both be strong independent businesses, the magic in the Square opportunity is the accumulating advantage that comes from linking the two businesses together.
As with my thesis on Spotify, I’m bullish on Square because they continue to ship features quickly at scale, which is rare once you become a large public company. This gives me confidence they can continue to deliver on the opportunities ahead in the next 3-5 years.
Here I’ll break down the existing Square business, why both Cash App and Seller are well positioned to continue growing strongly in the medium term, and the long term upside potential from a product roadmap linking the two businesses together.
The Square Business Part 1: Seller
Square started off as an integrated hardware, software and payments offering that enabled small merchants to accept card payments easily using the Square Card Reader and free Point of Sale software.
In an unnecessarily complex payments landscape, Square was a product-first company that made the process of getting started as a business simple and delightful.
Get Unit Economics Working: Acquiring customers cheaply enough to be able to pay back your CAC in 12-18 months is extremely hard in fintech, and is why most fintech startups fail.
Square’s intuitive, integrated offering was so much better than existing products that in the early years word-of-mouth recommendations kept blended CAC low.
By selling hardware Square was able to recoup some of the CAC in the initial purchase, which helped keep that cohort payback at <15 months from the very start. And that 2015 cohort keeps on delivering LTV:
Become a Daily Habit: When your product becomes the default place a user goes to manage their finances, you earn the right to layer on additional products and increase LTV. By owning a merchant’s POS software, Square ensures daily use. To defend that position, Square customised its core offering to cater for all types of SMEs — there are three different hardware products depending on your price range, specialised POS software for Restaurants, Services and Retail, and a long list of tools you can integrate with (Quickbooks, Postmates and Mailchimp as well as Payments and Commerce APIs to build on). To build up balances kept with Square, the team recently added Instant Payments, which allows sellers to pay wages from their Square Balance to arrive one day later (or instantly with Cash App, vs the 4 days it takes currently).
Bundle: As soon as you get to daily use, it’s time to add revenue-generating products. Square added premium SaaS tiers for their specialised POS software to cater to larger customers, added the ability to accept payments through invoices and e-commerce, payroll functionality, marketing and loyalty tools, a debit card, the ability to transfer money instantly, and started lending to customers.
Not only does bundling add LTV, it also reduces churn. By doing everything an SME might need well (if not perfectly), they provide the full business-in-a-box that makes a customer reluctant to leave, even if a new competitor offers a better version of a single feature. Over time the customer has so much data stored within Square the friction to switch becomes too painful. Alongside beautiful design and the benefits of integrating hardware and software, this is another lesson Jack Dorsey learned from Steve Jobs.
The power of the bundle was evident during COVID as Square’s e-commerce functionality allowed businesses to transition online seamlessly without needing to switch to Shopify, and e-commerce is now 25% of seller GTV.
Proprietary data + ML = New Lending Opportunities: From the outset, Square’s key advantage was in risk management — using data to predict fraud. The big revenue opportunity to take advantage of that skillset is in lending. Square has proprietary data on a Seller’s transactions, revenue growth, payroll, invoices and inventory which can help the team underwrite loans more effectively than traditional banks, while also ensuring they are repaid first by getting paid back directly from future revenue. After receiving conditional approval for a banking license in March 2020, Square will be able to extend commercial loans and fund them with deposits.
The Square team also uses ML to predict fraud, recommend products to upsell to new and existing customers, and improve customer support.
The Square Business Part 2: Cash App
To understand why Cash App is so special, you need to understand quite how broken the US financial system is. There are still 20 million people in the US who are unbanked. For those who do have banks, the fees are extortionate. For many banks, if you have less than $1500 in your account there’s an average $10.99 fee per month plus $35 every time you accidentally go into your overdraft and ATM charges every time you use an ATM that isn’t affiliated with your bank.
Cash App started in 2013 as a simple way for users to send money to each other and in 2018 added the ability to add direct deposits, allowing consumers to set up an account and routing number and deposit paychecks and tax returns, effectively banking the unbanked for the first time.
Get Unit Economics Working: LTV will never be high in consumer fintech without mortgages, so it is imperative to keep CAC low. Cash App has inherent virality, allowing it to grow organically by friends encouraging each other to sign up to send each other money. But the Cash App marketing team is brilliant at accelerating that virality through smart social media campaigns that mobilise their target demographic: 18-35s.
The core of their social strategy is comments and $cashtags. They write tweets that beg you to engage, and will get you to sign up to Cash App just to get a reply:
But the primary source of growth is the Cash App giveaway — partnering with cultural icons and loved consumer brands to give away cash to consumers who comment with their $cashtag. To receive the cash you need a $cashtag, encouraging users to sign up, and when they comment the post is amplified to all their followers.
A few weeks ago Justin Bieber and Chance the Rapper teamed up to give away $250k to people enduring tough times in COVID:
Last year, nearly 100k users qualified to receive cash to help their students loans by tweeting their cash tags to Burger King:
Other Cash App sponsors and partnerships include the Joe Rogan Experience, Barstool Sports’ “Pardon My Take” podcast, and the e-sports team 100 Thieves.
These viral threads bring in new users, who then bring in their friends when they start sending money.
As an aside, this is either cultural caché or the wildest SEO strategy ever…
By keeping acquisition costs low, Cash App is able to pay back CAC in less than 12 months and push for strong LTV:CAC multiples:
Become a Daily Habit: When you dive into a neobank’s core metrics, some of the most interesting are deposits per customer and frequency of use as a way of assessing who is using the account as their core bank vs a product they occasionally use. This comes through in Square’s commentary, with direct deposit customers among the most engaged Cash Card customers, spending 2-3x more than other Cash Card actives. Square clearly uses Transactions per Month as their core engagement metric and in Q2 2020 Cash App users transacted on avg over 15x/month, +50% year-on-year.
Bundle: To encourage daily use and increase LTV Cash App added products starting with the Cash card which enabled consumers to access cash at the ATM and spend money. From there they added Boost, which gives discounts to select stores, Direct Deposit to deposit paychecks and tax returns, and investing in Bitcoin and Equities.
Proprietary data + ML = New Lending Opportunities: Square only started testing personal lending in August 2020 but the potential revenue upside here is large. By understanding consumer deposit, send, spend and invest data, Square should be able to underwrite credit more effectively than their competitors, who for many of their previously-unbanked customers are payday lenders charging extortionate rates. One day they could even move into the extremely profitable mortgage market.
The Future Feedback Loop that Guarantees Defensibility
Today the Seller and Cash App ecosystems are relatively independent. But there are exciting opportunities to connect those products and build in positive feedback loops that entrench Square as the centre of businesses and consumers’ financial lives.
Salary Advance
There are more than 80 million hourly workers in the US who regularly struggle for cash when getting paid on fortnightly or monthly schedules. Square recently announced the launch of “On Demand Pay”, allowing workers to transfer up to $200 of earned wages for free to Cash App or for a 1%/$2 fee to a linked account.
Payroll Instant to Cash App
In the same release, Square launched Instant Payments, allowing Square Payroll Sellers to fund payroll using their Square Balance and allowing workers to be paid via Cash App within minutes, or the next day via direct deposit.
Both enable a positive feedback loop, the workers of Square Sellers will be encouraged to join Cash App and will have a better experience than workers whose employers don’t use Square, encouraging more sellers to sign up.
Buy Now Pay Later
The BNPL market has taken off in the last few years as consumers choose low cost, fixed payment options. Square is in the unique position of having both consumer and seller data and could use its experience in ML to score consumers based on their likelihood of defaulting at this specific store based on previous spending. This would allow them to offer an integrated lending option at lower prices than competitors who don’t have access to as much proprietary data, encouraging more Sellers to join Square.
Boost Partners
The more users Cash App has, the more valuable Boost becomes to sellers. By allowing Square Sellers to uniquely offer discounts to Cash App users, becoming part of the Square Seller ecosystem will become a valuable source of new customers and revenue.
Cash App Business
Having a $cashtag as a Seller will become more valuable the more users Cash App has. Over time they could build a version of the WeChat ecosystem where paying a store becomes as easy as scanning a QR code and sending money to a $cashtag.
In addition to the positive feedback loops between Sellers and Cash App users, there will also be accumulating advantages for Sellers and Cash App users as more of each join:
Invoice Financing
As Square brings on a wider variety of Sellers across the supply chain and takes on more of their financial lives, Square should be able to offer invoice financing to Sellers at competitive prices because they are able to underwrite the credit more effectively than third party lenders for any counterparty who is a Square customer or who has interacted with Square Sellers in the past.
Group Accounts
On the consumer side, group accounts could help bring more consumers into the Cash App ecosystem. Whether for shared houses, holidays or joint accounts, being able to split spending effectively is still a largely unsolved problem and a tech- and product-first company has an opportunity to rethink those interactions in a way that encourages organic growth.
Savings Circles
Accountability is a core element of behaviour change. If Square enables Savings Circles — allowing friends to hold each other accountable to saving or investing by seeing how much each person added to their pots each week — this could not only spur more users to join Cash App but also encourages existing users to convert to higher LTV products like investing.
The Risks
The Economy: While early signs are strong that the economy is slowly bouncing back for SMEs, if there are more lockdowns economic activity could remain depressed, which could lead to a drawdown given how much growth is already in the price for Square.
Artificial growth: Growth in Cash App and Sellers was buoyed by stimulus measures. Square extended $873m in total PPP loans across 80k businesses in Q2 2020, 60% of whom were new to Square, while stimulus and unemployment cheques lifted Cash App balances and transactions. That growth could be hard to match again.
International: Management sees international as a large long term upside opportunity. I’m more sceptical — on the consumer side the banking system is more functional outside the US (fewer unbanked, much lower banking fees) and interchange is much lower making consumer fintech less profitable, while on the Seller side there is already competition from iZettle (now PayPal owned), SumUp and Tyro which will lead to higher CACs.
Competition: I wouldn’t want to compete with Stripe (and Adyen) ever. Added to this, Cash App will begin to see competition from upcoming neobanks like Chime and Current that could push CACs higher.
Valuation
The stock is +180% in the last 12 months and trading at 10x revenue. To see the upside from here you need to believe there is still considerable opportunity to:
1) Increase users of both Seller and Cash App
2) Increase Gross Profit per customer significantly by layering on additional products
3) Improve margin through product mix and operating leverage
I believe in all three of these, particularly 2), so on a 3-5 year timescale, I still see significant upside at this price even with multiple compression, although it may be more 2x than 10x.
Thank you for the strong and insightful breakdown. More pithy than both ARK and Net Interest decompositions. Looking forward to all of your future posts!
Loved the step by step breakdown of the strategy! It really shows how a business with good economics and significant scale all starts by simply building a great product for its customers.