By Trevor Muchedzi and Zamangwane Ngwane
History doesn’t repeat itself, but it often rhymes. To understand the idiom, one doesn’t have to look further than the strikingly similar stimulus behind how US-based Square Inc and its cross Atlantic competitor, iZettle AB were founded.
The original inspiration for Square occurred to Jack Dorsey in 2009 when his friend, Jim McKelvey, was unable to complete a $2,000 sale of his artistic glass sculptures-come-water fountains because he lacked the mechanism to accept credit card payments from potential clients. They had to pay cash! Across the pond in Europe, iZettle’s eureka moment was coincidentally similar: One morning back in 2010, the ex-wife of Jacob de Geer, the company’s founder, was unable to sell her glasses to shoppers at a trade fair in Stockholm because, as a sole trader, she didn’t have a Point of Sale (PoS) terminal to accept debit and credit card payments. None of her enthusiastic potential customers had cash and so they left empty-handed.
Prompted by these two incidents but unbeknown to each other, the two gentleman looked at the merchant side of the credit card business to ask the basic question, why was it difficult for small businesses and sole traders to access to business tools as mundane as PoS terminals? At the heart of it, big banks are like huge whales – sprawling businesses built over decades and have become too big to serve customers on the margins. Traditional banks do not give enough attention to building products that specifically address the needs of small businesses and sole traders. Fintechs on the other hand are nimble piranhas, able to attack a small parts of the banks’ business model. By leveraging technology and disrupting archaic processes coupled with excellent execution, fintech solutions provide an opportunity for the companies to systematically and gradually inflict more pain on the bank’s overall business model; leading to death by a thousand cuts.
The two companies developed credit card readers that could be plugged into any smartphone or tablet, effectively turning the device into a portable PoS terminal without the need to apply for a merchant business bank account. Their initial pitch was targeted towards the low segment of the business market e.g. street magazine sellers, market stall holders, ice-cream van owners and individual contractors etc. These clients typically have low transaction volumes individually and are therefore not targeted as prime clients for merchant banking services. Both entrepreneurs understood the huge potential in leveraging technological capability to offer a low cost payment solution, whilst at the same time aggregating individual small business transactions into a lucrative market segment. Today, Square and iZettle are known for offering small businesses and individuals with an array of business tools that were previously only privy to medium sized and big businesses.
“It’s a segment that is traditionally underserved…” iZettle CEO said. “The same had been for the case in card payments, where sole traders and small businesses were regularly not accepting cards simply because the cost of doing so was too high for them, a problem we solved by turning ordinary smartphones and tablets into point of sale terminals with the help of a dongle.”
Investment case for payment companies targeting mom and pop-up businesses
Square and iZettle have leveraged their popular payment solutions as catalysts to build an ecosystem of business tools for entrepreneurs. According to iZettle’s CEO, there are over 28 million small businesses in their target markets, many of which are low hanging fruits. As the wave of entrepreneurship sweeps across the globe, opportunities will be boundless to provide budding entrepreneurs with tools that have historically been a privilege of the few. Below is a synopsis of the investment case for the two companies.
Democratizing business tools
Small businesses are inherently at a disadvantage when they compete with their well-established counter parties. Find a way to level the playing field and you will have a loyal customer base that will provide an annuity type income. Square and iZettle are aggressively expanding their product offerings with the aim of becoming a one-stop shop of commercial tools for small businesses and sole traders. Today both companies provide a myriad of business solutions including: invoicing tools, point of sale data analytics, payment widgets, e-commerce platforms, payroll capabilities, inventory management tools etc. With them, a small business with two employees can now access the same business tools which the likes of Starbucks or McDonald’s historically enjoyed alone. Talk about leveling the playing field!
Nibbling at more banking revenue pool
The two payment companies are easily expanding into another banking areas like lending. Given the data they collect from their clients’ card transactions and access to revenue flows; they are utilizing big data analytics in order to quickly assess and approve short term business loans and working capital facilities. Furthermore, they have the capability to automatically deduct the monthly loan repayments as a percentage of card sales done through their PoS terminals. By streamlining the approval and collection process, a typical small business loan of around $6,000, which is considered too small and/or not viable by big banks, is now worthwhile and profitable for payment companies.
Forcing high value customers to reconsider value for money
Like Capitec Bank, Square and iZettle initially targeted the lower segment of the market which has been traditionally underserved by the banks. Through leveraging technology, they delivered simple, effective and low cost solutions which have in turn prompted middle and bigger size businesses to question the value of the products and services they currently receive from the incumbents; most pay 3% – 4% in merchant fees for solutions that can now be delivered at half the price. In 2017, Square added more established businesses to its platform faster than small businesses and solo traders. With a lean business model, the company is taking the fight to the big banks which are structurally inflexible to fight back effectively.
Investment play available to investors
Square Inc (New York Stock Exchange)
Square is listed on the New York Stock Exchange. The company had a difficult flotation back in 2015 but its share price has since quintupled and now has a market capitalization of US$19 billion. In 2017, the company processed US$65.3 billion in payments, up 31% from the previous year and with the biggest increases coming from client’s with an annual revenue of $500 000 (the sort of levels average high street banks would very much welcome as customers). Furthermore, the company is also expanding into new areas unveiling the Square Cash App which has bitcoin trading capabilities. In April 2018, the company also announced its acquisition of Weebly, a web-site builder and web-hosting service company that allows small businesses and sole traders to design, build and manage their online shops to complement their physical presence.
iZettle AB (acquired by PayPal)
The Swedish payment company is one of the fastest-growing companies in Europe with revenue growing by a CAGR of 103% between 2006 and 2013, according to the FT 1000 list of Europe’s fastest-growing companies. Today, the company has expanded out of its Nordic home market into other countries including the UK, Spain, Mexico and Brazil. It provides a holistic suite of digital payment products to small businesses and counts some of the biggest names in payments, including: MasterCard, American Express and Santander, as investors, together with venture capital firms Index Ventures and Dawn Capital.
On 7 May 2018, iZettle announced its intention to list on the Nasdaq Stockholm Stock Exchange in H2 2018 at a valuation of US$1.1 billion. The company set an annual net revenue growth target of at least 40% in the medium term and a positive consolidated EBITDA by 2020. Three weeks later, iZettle announced they have agreed to be acquired by PayPal in a deal worth US$2.2 billion (twice their target IPO valuation)
Payment companies provide an interesting play for the billions of dollars in banking revenues worldwide. As Square co-founder, Jack Dorsey aptly pointed out, the banking system works – it’s just not accessible to everybody. Square and iZettle provide an interesting play for the under served mom and pop businesses. Investors only has to look at one of Mr Dorsey’s unusual metric: How many trips to a bank does Square save its clients. Downloading Square Cash instead of opening a bank account – that’s a trip saved. Getting a quick loan from Square Capital – that’s another trip saved.
Important Disclaimer: The author owns shares in Square Inc