Starbucks-Square Deal Says More About Square Than Starbucks

Todd Michaud runs Power Thinking Media, which helps retailers and restaurants tackle the convergence of social, mobile and retail technologies. He spent nine years delivering technology platforms to more than 10,000 retail locations as VP of IT for Focus and Director of Retail Technology for Dunkin' Brands.

One of the things last week's Starbucks-Square deal demonstrates is that Square found out just how hard it is to make a living selling services to small retailers and hotdog carts. For every coffee shop and dry cleaner that signs up to move their credit-card processing and POS to Square, there are likely dozens of other people who get a dongle strictly as a novelty. People like me, or the Girl Scouts, who use it one month a year selling a few hundred dollars worth of cookies. They are basically a next-generation ISO that is riding the wave of Apple-fandom to bring credit-card processing to the masses.

I think the Starbucks-Square announcement from last week has been overhyped and over-analyzed. It does not represent a large shift in the payment landscape. It does not mean a massive shift toward mobile payment. It does not mean anything more than that Square was willing to give up equity and a board seat to land a marquee client in an attempt to gain market share from the other big players.

Many media outlets seem to be splitting the credit-card acquiring and the $25 million investment in Square (and the associated board seat) into two separate things. In my mind, they are two sides to the same coin. I look at the $25 million as merely a prepayment on processing costs. In exchange for getting the money upfront, Square is offering equity and a board seat.

This is a win-win-win for Square. It gets a bunch of the contract value upfront. Square was supposedly in the middle of an investment round anyway, so why not take money from a company that would help it immediately gain credibility in its core market? The same goes for the board seat. I mean, wouldn't you love to have someone on the board who knows your core market as well as anyone else on the planet with their own marquee name? (Quick, how many other restaurant CEOs can you name in the next 15 seconds without using the Internet to look them up?)

Over my career in the restaurant business, there have been several times that I have been in talks with startup companies about purchasing their services. When I expressed concerns about the size and stability of the startup and being able to deliver to such a large client, it was not uncommon for these startups to offer up a board seat in an effort to pacify those concerns.

There are several reasons why a deal like this could only be struck with Starbucks. First, Starbucks has a history of being extremely progressive with its payment ecosystem. From the combo closed-/open-loop cards to pay by phone, Starbucks has proven itself willing to take risks in payments.

I would also speculate knowledge sharing and technical access is part of this deal (or at least I believe it should be). I would hope that Starbucks now has access to more mobile-payment developers at Square and that Square now has access to a top-notch POS team at Starbucks.

Second, Starbucks is a large restaurant chain that is largely company-owned. I cannot tell you how significant this fact is. It would be nearly impossible to strike a deal like this in another large restaurant chain simply because of the nature of running a franchise business.

Remember that while card-processing contracts are negotiated at a corporate level, most franchise organizations have each operator sign an individual contract with the acquirer and maintain a financial relationship at that level (the money is moved between the operator and the acquirer, not the corporate entity).I think it would be unlikely that any of the large corporate franchise chains would be open to prepaying millions of dollars in processing fees for their franchisees, even if it meant they could get a bigger discount. Even if you want to think that these actions are unrelated, how do you justify to your franchisees spending $25 million dollars to invest in a payment startup versus addressing declining customer counts?

Having negotiated several of these contracts over my career, I can tell you that the top seven priorities for this type of contract are typically (in this order):

  1. Reduce costs
  2. Decrease time to get the money from the sale
  3. Reduce costs
  4. Increase services (examples: system availability, customer support)
  5. Reduce costs
  6. Add additional services (example: loyalty)
  7. Reduce costs

I would imagine that the existing relationship between Starbucks and Bank of America/First Data was already one of the industry's best (financially, for Starbucks). For Starbucks to take the risk of switching processors (not a small project), there had to be a significant financial upside to the company. I would speculate that Square is giving Starbucks the processing costs for free, but I'm just not sure of its relationship with Paymentech and how that would work.

It should also be noted that Square merchants are charged a percentage (2.75 percent) of the transaction costs for "interchange." It is unlikely that the contract with Starbucks is on a percentage basis and is, instead, likely to be interchange plus markup, as most major retailers are configured. If this is the case, I wonder how Square's billing system can adapt easily (unlikely) or if Paymentech will handle the Starbucks billing.

I have said in the past that I think the payment industry is primed for a major disruption. Too many people are making too much money for executing very simple database transactions. I truly hope somebody can tear down the credit-card processing monopolies and create a system that is built around the realities of today. I think it is going to take a major disruption in the POS and payment ecosystems for that to happen. Unfortunately, I do not see the Starbucks-Square deal doing much in this area.

And yes, I understand that reports are that customers will eventually be able to use their Pay-By-Square application to integrate the Starbucks barcode with an open-loop card (Starbucks currently operates only with closed-loop stored-value cards). Although that may be great for a few Starbucks customers who don't want to set up auto-reload on their giftcard, I just don't believe it's that big a deal. Even though the current program has been a success at Starbucks, you haven't seen a flood of other restaurants or retailers follow suit.

What do you think? If you disagree (or even, heaven forbid, agree), please comment below or send me a private message. Or check out the Twitter discussion on @todd_michaud.