Square just announced new and better pricing, dropping their $0.15 transaction fee, meaning that swiped transactions using the Square reader will cost a flat 2.75%, which makes Square much more competitively priced.

Square is already rumored to be signing up 100,000s of customers / month, which is amazing, given that only around 6,000,000 merchants accept credit cards via other methods in the US.

Can they make money at their current pricing since they are massively undercutting the competition (intuit, verifone and GPRS terminals) ??

Yes, I believe they can, but not that much.

 

Square, like all other merchant account providers has to pay interchange fees, which are ultimately sent to the banks that issue credit and debit cards, and assessments, which are how Visa and Mastercard make their money. It is possible that they have negotiated a sweetheart deal with Visa and  Mastercard, for lower interchange rates, but I think it is unlikely.

With their new pricing scheme Square will lose money on every transaction below $6 in size.  They will make money for transactions between $6 and $15, will lose money between $15 and $18 and will make money on transactions larger than $18.

The reason for the weird discontinuity at $15 is that Visa cards and Mastercard Debit (but not Mastercard credit) cards have a special, lower, rate for small transactions called a small ticket rate.  If you are a merchant with a very small average transaction size, you absolutely should use Square - their price is so low for those transactions they are losing money and subsidizing the user.

The above calculations are based on an assumptions about the interchange rates for which Square’s customers qualify. Interchange rates are super complicated but the major variables are: 1. card type (ex. rewards, debit, etc) 2. business type 3. transaction size 4. swiped vs. not swiped.

Assumptions

At FeeFighters we have lots of data about the frequency of various transaction types.  I made some simplifying assumptions and used the below interchange rate distribution to come up with the above estimates.

For Transactions	Share of	Interchange		Assessments		Total
Larger than $15	transactions	$	%	$	%	$	%
Mastercard Debit	15%	0.15	1.05%	0.0185	0.11%	0.1685	1.16%
Mastercard Credit	11%	0.1	1.58%	0.0185	0.11%	0.1185	1.69%
Mastercard Rewards	8%	0.1	1.73%	0.0185	0.11%	0.1185	1.84%
Mastercard World	10%	0.1	1.73%	0.0185	0.11%	0.1185	1.84%
Mastercard World Elite	2%	0.1	2.20%	0.0185	0.11%	0.1185	2.31%
Mastercard Business and Int	4%	0.1	1.80%	0.0185	0.11%	0.1185	1.91%
Visa Debit	26%	0.2	0.95%	0.0195	0.11%	0.2195	1.06%
Vias Credit	7%	0.1	1.54%	0.0195	0.11%	0.1195	1.65%
Visa Rewards	14%	0.1	1.65%	0.0195	0.11%	0.1195	1.76%
Business	3%	0.1	2.10%	0.0195	0.11%	0.1195	2.21%
Wtd Average						0.15	1.91%
Avg Ticket	18.00000
Square Cost	0.50
Interchange and assessments	0.50
Breakeven ticket size	18.0

For Transactions	Share of	Interchange		Assessments		Total
Smaller than $15	transactions	$	%	$	%	$	%
Mastercard Debit	15%	0.04	1.55%	0.0185	0.11%	0.0585	1.66%
Mastercard Credit	11%	0.1	1.58%	0.0185	0.11%	0.1185	1.69%
Mastercard Rewards	8%	0.1	1.73%	0.0185	0.11%	0.1185	1.84%
Mastercard World	10%	0.1	1.73%	0.0185	0.11%	0.1185	1.84%
Mastercard World Elite	2%	0.1	2.20%	0.0185	0.11%	0.1185	2.31%
Mastercard Business and Int	4%	0.1	1.80%	0.0185	0.11%	0.1185	1.91%
Visa Debit Small Ticket	26%	0.04	1.55%	0.0195	0.11%	0.0595	1.66%
Visa Credit Small Ticket	7%	0.04	1.65%	0.0195	0.11%	0.0595	1.76%
Visa Rewards	14%	0.04	1.65%	0.0195	0.11%	0.0595	1.76%
Business	3%	0.1	2.10%	0.0195	0.11%	0.1195	2.21%
						0.08	1.45%
Avg Ticket	6.30000
Square Cost	0.17
Interchange and assessments	0.17
Breakeven ticket size	6.3

American Express

Amex costs 2.89% + 0.10 for retail swiped transactions. They have more flexibility to negotiate deals, and it’s probably safe to assume that Square does have a special deal with Amex, but given the higher initial starting point, I suspect that the resulting deal is not cheaper than Visa and Mastercard.

What About Other Costs?

Interchange and assessments obviously are not the only costs that Square must bear.  They use the Chase Paymentech processing network. Chase frequently sells transactions to smaller Merchant Acquirers like Square for a few cents per transaction.

Traditional merchant account providers have setup and application costs of around $20 / application.  I am sure Square does better that that figure, but let’s assume it costs them $5 to setup the account, $5 for the card reader and $5 for shipping on the care reader, for a total of $15 / account.  Since their economics are so dependent on average transaction size (see above) it is hard to know exactly how much they are making per transaction, but I think it’s probably fair to estimate that they make $0.01 to $0.10 / transaction after they pay Chase for the processing.

When do They Break Even?

If setup costs are $15 and Square is making $0.01 to $0.10 / transaction it would take between 150 and 500 transactions to break even on a customer.  It sounds like Square is doing ~$10M of volume / month and signing up 100,000 customers / month.  Most of those customers must not be active – for example, if they have 250k customers that means they are only doing an average of $40 / each in revenue each month, or 1 or 2 transactions.

With the above assumptions it will take years to break even on each customer, unless they begin attracting larger customers (not entirely farfetched given how competitive their pricing is for merchants of all sizes that have small average transaction sizes).

So, is Square going to flame out?

Even though they are losing money on most customers with the new pricing scheme, Square has $40M in the bank and will be able to grow quite large and find a way to use that size to their advantage.