Trends & Tactics: Square Moves Beyond Micro Merchants

Two recent deals by startup Square Inc. indicate that the specialist in mobile payments for part-time sellers and tiny businesses is moving up the merchant ladder.

In mid-August, San Francisco-based Square introduced a $275-per-month fixed pricing plan that may appeal to higher-volume, established small businesses. That announcement came shortly after Square struck a headline-grabbing deal with coffee giant Starbucks Corp. that will integrate the two companies’ mobile-payment technology at 7,000 Starbucks locations. The deal also calls for Square to process all of Starbucks’s bank card transactions.

Under Square’s new pricing option, a merchant generating up to $250,000 in annual charge volume can opt to be charged a straight $275 a month, with no additional fees. Square’s normal charge is 2.75% of the sale for swiped transactions on mobile devices that use its cube-shaped card reader.

The new plan wouldn’t make sense for merchants generating less than $10,000 a month in Square volume. But for merchants with annual volumes between $120,000 and the $250,000 maximum, the plan offers lower expenses with each additional transaction, all the way down to 1.32% of the sale.

“One monthly fee and 0% processing is the first pricing option that gives small businesses a lower processing fee than bigger merchants,” the company said. “Square is committed to offering prices that eliminate uncertainty and are lower than those traditionally only available for big businesses.”

Square’s merchant base of 2 million businesses and individuals includes many startups, micro-merchants, and part-time sellers that generate an average of only $4,000 to $5,000 a year in charge volume, according to Rick Oglesby, a senior analyst at Boston-based Aite Group LLC.

Like the Starbucks deal and the Square Register product that converts Apple Inc.’s iPad into a snazzy point-of-sale terminal, Oglesby sees the new pricing plan as a tool to expand beyond those core merchants.

“I take it as a move to go up-market,” he says. “I think it is a move to get them more in with small to medium-sized merchants in the traditional space.”

Square’s deal with Starbucks for the first time puts a large national retailer in its camp. Square will integrate its consumer-facing application, Pay With Square, with Starbucks’s mobile-payments app. It will be usable at 7,000 Starbucks stores this fall.

Pay With Square already enables consumers to walk into 75,000 locations and buy without pulling out their mobile phone; instead the store clerk sees the customer’s photo on the point-of-sale system. Starbucks customers also will be able to use the so-called Square Directory to find nearby Starbucks locations.

Seattle-based Starbucks is investing $25 million in Square, whose other investors include Visa Inc., and Starbucks chairman and chief executive Howard Schultz is joining Square’s board of directors.

Starbucks already is a major mobile-payments-accepting merchant with its bar-code-based smart-phone app and closed-loop prepaid card. A spokesperson says the company generates more than 1 million mobile-payment transactions per week in the U.S.

But the disclosure that Square would process all of Starbucks’s U.S. credit and debit card transactions marks a watershed for Square. The news implies that Starbucks has changed merchant acquirers, though neither company would confirm that when asked by this magazine’s sister publication, Digital Transactions News.

Several sources who asked not to be named say Bank of America Merchant Services (BAMS), a joint venture of Bank of America Corp. and processor First Data Corp., is Starbucks’s incumbent acquirer. A BAMS spokesperson declined to comment. Banking giant JPMorgan Chase & Co.’s merchant-acquiring subsidiary Chase Paymentech is Square’s acquirer.

Nor would the companies disclose Starbucks’s discount rate for card transactions through Square. A jointly issued press release suggests Starbucks’s processing expenses will be lower than they are now.

Google Wallet 2.0: Google Tries Again

It’s no secret Google Inc.’s mobile wallet hasn’t exactly set the world on fire since its commercial launch a year ago. Only one bank (Citibank) and one carrier (Sprint) signed up for it, and while 25 retail chains said they’d support it, merchant response has proven tepid, at best.

But with Google behind it, the product remains the biggest thing available in a crowded field of wallets. And it’s the best hope so far for near-field communication (NFC), the interactive, Bluetooth-like technology that automatically links mobile devices to point-of-sale equipment.

So it came as little surprise last month when Google announced an overhaul aimed at smoothing out the wrinkles in version 1.0. Indeed, a key feature of the new Google Wallet is that it is now open to any credit or debit card from American Express Co., Discover Financial Services, MasterCard Inc., and Visa Inc. No longer does the online search titan have to go to issuers hat-in-hand to get them to play in the wallet.

American Express Co., however, has other ideas. Within hours of Google’s announcement, the T&E kingpin intoned that it had not authorized its cards to be saved to the new wallet. As red-faced Google officials scrambled to explain the embarrassing turn of events, the two companies sat down to iron things out.

Entertaining no such qualms, Discover days later helped out Google by saying it will let its cardholders install their Discover cards through an account center on the card company’s Web site.

Now the question is whether Google’s new NFC venture can not only give NFC a much-needed shot in the arm, but turn around its struggling wallet, as well.

The first version of the application allowed payments only with a Citibank MasterCard or a Google prepaid card, both of which were stored in a secure chip in the phone.

With the new version, Google dispenses with phone-based card storage and ushers in the fabled cloud: Consumers now are able to load card credentials onto Google servers. There’s still a virtual card embedded in the secure element: A Google-issued, prepaid MasterCard that triggers contactless connections to point-of-sale readers and identifies users to the Google cloud.

Google matches user IDs with the user’s designated card and sends the transaction on to issuers through any of the four networks. Transactions with online merchants, by contrast, flow directly from the cloud-based cards.

Google is clearly looking to add consumer appeal by using the cloud to open its wallet to cards most people are already carrying. “Users have been telling us they want all their cards added [to the wallet],” says Robin Dua, head of product management for Google Wallet. “This will enhance our distribution because [limited card availability] was a barrier to usage.”

Still, Google Wallet so far is available on just six NFC phones and one NFC-enabled Google tablet. And AT&T, Verizon Wireless, and T-Mobile, the big networks behind rival Isis, have effectively shut it out.

What’s more, while 25 chains have signed up for SingleTap, the electronic offers system Google created as part of its wallet product, only a small percentage of U.S. retail outlets, about 200,000, are equipped to handle contactless payments.

While Google is sticking by NFC, it is dropping card emulation, the process by which electronic versions of plastic cards are stored in the secure element of an NFC-enabled phone. This lets users move their cards into the wallet on their own and frees Google from having to sign bank issuers one by one.

“They obviously were struggling to get banks to participate,” says Rick Oglesby, a senior analyst at Boston-based Aite Group LLC who follows mobile payments. “That’s no longer a requirement. It really makes sense.” A recalcitrant issuer like AmEx in theory could shut off cardholder access if it wanted to, but Oglesby figures that’s unlikely.

The move to the cloud will raise transaction costs, says Oglesby, since payments on the virtual card will earn Google lower interchange than the card-not-present interchange it will have to pay as the merchant on the subsequent transactions against the saved cards.

But he figures Google will be in a position to reimburse merchants for incremental costs from the revenue it expects to earn on the consumer data it will generate. “Google might have to eat a little bit of margin,” he notes.

Still, the race in NFC and in mobile wallets will ultimately go to the provider that signs up the most consumers, Oglesby says. Here, its new wallet may have given Google a chance to get ahead, one it will have to act fast to exploit.

A Raw Deal for Merchants?

The bank card networks and their allies painted the proposed settlement in a massive set of credit card interchange lawsuits as virtually a done deal after it was announced July 13. Yet each passing week since then seems to bring new criticism that the plan is bad for merchants and frees the networks from any future challenges over interchange and their card-acceptance rules.

Wal-Mart Stores Inc., Target Corp., and some major retail trade associations have blasted the proposed settlement to the 7-year-old litigation since lawyers for the merchant plaintiffs and network and bank defendants unveiled it after many months of negotiations.

One of the latest denunciations came Aug. 14 from Adam J. Levitin, a professor at Georgetown University Law Center who follows payments issues. Every other page in his 13-page analysis has the header, “A Raw Deal.”

“To accept this settlement is short-sighted to the point of near blindness, and will leave merchants and ultimately the U.S. economy’s payments infrastructure at the mercy of the card networks’ profit motive, rather than subject to the competitive dynamics of the marketplace,” Levitin concludes.

The plan includes up to $1.2 billion in credit card interchange relief over eight months for class merchants. The deal also offers $6.6 billion to settle merchants’ damage claims and relaxation of certain Visa Inc. and MasterCard Inc. network rules, chiefly their bans on credit card surcharges.

A key component of the agreement would give the networks broad releases from interchange and rules-related liability based on conditions in place up to 2012.

In contrast to the damages part of the case, which appears to be a take-it-or-leave-it proposition for merchants, the so-called injunctive relief involving the non-monetary aspects is becoming the new main battleground between the networks and merchants.

Settling this feud is the task of Judge John Gleeson of U.S. District Court in Brooklyn, N.Y. His court set an Oct. 19 deadline for the plaintiffs to formally request the settlement’s approval.

That request will be just the first step in a process that lawyers say could easily take more than a year. Major parts will include a so-called fairness hearing and preliminary court approval, and then final court approval.

Many merchants question whether recovering card-acceptance costs through surcharging will be worth the possible customer ire and operational hassles of putting surcharges in place under the settlement’s prescriptive terms. Plus, 10 states, including many of the largest, already prohibit surcharging.

“The release is extremely broad when contrasted with the limited injunctive relief, which may be of little value to most merchants,” says attorney Anita Boomstein, a partner at Hughes Hubbard & Reed LLP in New York who specializes in payments issues.

Probably no judge in America is more familiar with interchange and network rules than Gleeson. About a decade ago, he presided over the so-called Wal-Mart case involving debit card interchange.

In the credit card cases, he pushed both sides—the plaintiffs include both individual retailers as well as class merchants—to negotiate a settlement ahead of a trial that had been scheduled for this month.

Boomstein says the proposed settlement’s terms surprised most merchants. “Until this document was released in July, no merchants other than the ones directly involved had any idea what would be in it,” she says.

Thus, whether Gleeson will sign off on the deal is far from assured, she believes. “Up until final approval of the settlement, merchants can still object,” Boomstein says. “If the judge is made aware of the feelings of a more representative group of merchants, the judge might feel this is an unfair settlement.”

While some large retailers and trade groups have strongly criticized the settlement, the merchant community is far from unanimous on the issue. Some small merchants have expressed satisfaction with the damages and temporary interchange relief (based on the equivalent of a 10-basis-point reduction) as well as the possibility of surcharging.

And in recent conference calls with analysts, the chief executives of Visa and MasterCard expressed support for the plan. “We are comfortable with the terms, which we do not anticipate will impact our current [financial] guidance,” said Joseph W. Saunders, Visa’s chairman and chief executive.

Will Same-Day ACH Rise Again?

The automated clearing house is an efficient electronic payments network that lets parties exchange transactions for mere pennies in cost. And payments initiated on day one typically settle on day two. Pretty quick, but in the age of mobile payments, not quick enough.

NACHA, the ruling body for the ACH, tried to speed things up. For two years, the Herndon, Va.-based group labored over a rules-change proposal that would have allowed for same-day settlement for both credits and debits.

But NACHA members, which are mostly banks, had to approve it. And last month they voted it down.

To be sure, the proposed change, known as Electronic Processing and Settlement (EPS), had a high hurdle to clear: As a proposed change in network rules, it required a 75% yes vote. Although a majority of members voted for it, the margin wasn’t big enough as the nation’s biggest banks voted against and smaller institutions were split.

The results came as a distinct letdown to banks and merchants that had advocated for faster transaction times. Many payments executives argue that the advent of mobile applications in particular has created a consumer expectation that transactions should clear with near-immediate effect.

A number of smaller banks backed the proposal in hopes it would help them attract consumers and merchants. “It’s getting harder for community banks to stay in the payments business,” says a disappointed Bob Steen, chairman of Bridge Community Bank in Mechanicsville, Iowa. “This [vote] doesn’t help.”

At the same time, the nearly 40-year-old ACH network finds itself under increasing pressure from competing payment channels to speed up settlement time. Check image exchange, for example, is capable of clearing funds the same day. And some financial institutions have formed direct links among themselves outside the network in part to enable faster funds movement, especially on returned items, a development that concerns NACHA.

Meanwhile, three of the country’s largest banks—Bank of America Corp., JPMorgan Chase & Co., and Wells Fargo & Co.—have formed a person-to-person payments network called clearXchange that relies on transfers just among the three institutions.

Some observers blame these private exchanges for the collapse of the EPS initiative. NACHA says some members balked because of cost. “The EPS ballot did not pass because of some concerns as individual organizations looked at their costs and benefits and impact on operations,” said a NACHA statement released after the balloting.

But EPS is potent enough that it could be resurrected in some form, despite the entrenched opposition of the money-center banks. “I don’t think it’s dead, but it’s probably dead for another year or two,” notes Nancy Atkinson, a senior analyst at Aite Group LLC who follows the ACH.

Indeed, some observers expect NACHA itself to revive the effort. They point to the fact that EPS did win a majority of votes.

“I don’t see how NACHA can let this linger for too long,” says David T. Bellinger, director for payments at the Association for Financial Professionals, a Bethesda, Md.-based trade group that represents corporate finance officers. The AFP had favored the proposed change. “Banks need to think about staying competitive.”

NACHA may be thinking along the same lines. In its statement, it said, in part: “NACHA will continue to explore solutions for faster processing and settlement. In balloting EPS, NACHA was responsive to industry requests for faster processing and settlement, and we will continue to be supportive of user needs.”

So why did the big banks balk? They don’t see enough revenue potential in same-day service to compensate for the costs the service would create, says Bob Meara, a senior analyst at Celent LLC. “Why would you be quick to do this” if you can’t charge premium prices for it, Meara asks.

Some banks also feared the service could cannibalize their more lucrative wire-transfer business. “As long as they can’t do same-day ACH, they can convert [the transaction] to a wire transfer if it has to be same day and make more money off it,” Atkinson says. Expected increases in the cost of wires, though, will likely cause businesses to put more pressure on banks to support same-day ACH, she cautions.

Ultimately, the federal government may have to step in to make same-day ACH a reality, these observers say. “I wouldn’t be surprised to see the [Federal Reserve] put something forward if banks don’t take action,” says Bellinger. The Fed has a similar service, which it introduced two years ago, but it applies only to certain ACH debits and leaves bank participation voluntary.

Atkinson would like to see the payments industry create an electronic transfer service combining ACH and wire. “That will take government backing to some extent,” she observes. “The government has to take a stand or it doesn’t happen.”