Can Square Really Make Money as Starbucks' Little Helper?

By Jonah Loeb  SEP 21, 2012 12:00 PM

Jack Dorsey's highly-valued payment service is trying to be a cleaner fish for the coffee giant.

 


 MINYANVILLE ORIGINAL For a little gadget, the Square reader is making some big moves.

The company has seen its valuation more than triple in the past year, rising above $3.25 billion and making founder Jack Dorsey (you might also know him from his side project, a little social-networking site called Twitter) into a billionaire. Furthermore, its recent addition of a monthly-fee option makes it a much more attractive proposition for small and medium-sized businesses than it once was. Rather than its original 2.75% processing fee, Square is now offering businesses that process up to $250,000 per year a flat $275 monthly rate, which means that anyone making more than $10,000 per month can now breathe a little easier.

The biggest move, though, is Square’s recent partnership with Starbucks (NASDAQ:SBUX), which is a massive marketing coup for the payment service that immediately makes it one of the world’s hottest gadgets. The deal could boost Square’s value by $2.2 billion and make the company very attractive indeed to other companies with quick turnover and a high transaction volume. (Chipotle (NYSE:CMG) and Dunkin’ Donuts (NASDAQ:DNKN) come to mind.) Only the purchase of Square competitor PayPal by eBay (NASDAQ:EBAY) back in 2002 comes close to this deal in terms of the degree to which it will change the way that the larger company operates. By partnering with Square, Starbucks is actively endorsing the idea of the digital wallet.
 
However, as Wired's Marcus Wohlsen has pointed out, Square’s move isn’t just a departure from its comfort zone; it appears to be a departure from good business sense. With the new flat-fee model factored into the equation, Square needs an average transaction of $75 to remain profitable, a figure which will almost certainly be impossible to achieve, given the fact that Starbucks, whose average transactions (a scone, a latte, a breakfast sandwich) are below $10, will make up a massive part of Square's business.
 
Is latching onto a larger company a good idea? If Square’s dream is to fade into a combination of invisibility and indispensability, then it has to make sure that its product becomes a central part of Starbucks’ operations. This is clearly part of the plan -- Starbucks has been leading the charge when it comes to mobile payments, and this deal puts them in on the ground floor in a big way.

Even if Square gets a massive amount of publicity from this deal, though, will that outweigh the financial risk it is taking?

The question, it seems, is what sort of strategies can Square employ to help alleviate the average-transaction problem? One solution would be for them to aggregate a bunch of lattes together and process them as bundles of sales; Starbucks sells something like four billion cups of coffee each year, and there’s no way that Square could process that many tiny transactions without losing money. According to Dorsey, though, Starbucks' massive stature and Square's ability to prevent expensive problems like credit card fraud have allowed the partnership to save enough money to make the deal viable.
 
Symbiosis can be a tough goal to reach, and Square is walking a very thin line here by betting on its own ability to cut costs. Either this deal will cause every fast-casual food company to buddy up to Square and Jack Dorsey will be heralded as a genius, or retailers will be put off by financial uncertainties and Jack Dorsey will probably still be heralded as a genius. Either way, it’s a story -- and a gadget -- to watch.
No positions in stocks mentioned.