Square Learns Painful Lesson From Money-Losing Starbucks Deal

  • Payments business needs bigger merchants, but not too big
  • Large chains have too much leverage on prices, fewer needs

Square Inc.’s documents for its first public share sale paint a clear picture: the payments company got the raw end of the deal when it partnered with Starbucks Corp. three years ago.

Every time Square handles a payment for Starbucks, it loses money. That resulted in losses of $27.9 million last year, according to the filing. The quid pro quo was that the coffee company was going to promote Square’s mobile-payments application, but it never took off and the parties later amended the agreement.

A cup of Starbucks Coffee inside a shop on the corner of Broadway and East 17th Street in Union Square in New York, New York, U.S., on Tuesday, July 21, 2015. Photographer: Craig Warga/Bloomberg *** Local Caption ***

A cup of Starbucks Coffee inside a shop on the corner of Broadway and East 17th Street in Union Square in New York.

Photographer: Craig Warga/Bloomberg

The good news is that Square expects to end the arrangement in about a year, and that its transactions business excluding Starbucks is doing fairly well, generating $255.9 million in net revenue in 2014. The money-losing relationship also shows how Square’s success can’t be built on deals with prominent chains that boast billions of dollars in annual sales. Those companies have too much leverage to negotiate better rates than Square’s typical 2.75 percent fee on transactions.

Aaron Zamost, a spokesman for San Francisco-based Square, declined to comment. Corey DuBrowa, a spokesman for Seattle-based Starbucks, didn’t respond to a request for comment.

A better customer for Square is a small business owner like Tod Wilson, who is expanding his Mr. Tod’s Pie Factory to four locations in New Jersey and New York. Square’s payment processing-fee works just fine for the pastry chef, who said he also benefits from Square’s financial software and credit services.

“The card swiping has almost become secondary to all of the other things they are doing,” said Wilson, who used a cash advance from Square to expand inventory for his food truck. “We’re in business together. They see my books every day.”

Square, a credit card reader is arranged for a photo in New York on Monday, Oct. 25, 2010. Photographer: Jin Lee/Bloomberg

Square, a credit card reader is arranged for a photo.

Photographer: Jin Lee/Bloomberg

Mid Market

Wilson represents Square’s ideal customer, and the area in which the company is growing most quickly. Businesses with annual payments volume of at least $125,000 made up 37 percent of Square’s transaction volume in second quarter, up from about 8 percent in 2011.

Essentially, mid-sized businesses represent Square’s sweet spot. While serving bigger merchants is part of Square’s growth plan, the company said in its filing that it sees “an inherent trade-off between the size of our sellers and our transaction revenue.”

“These are businesses Square can embed itself in, and offer not only payments, but provide capital, scheduling, payroll and a whole suite of other services,” said Jordan McKee, an analyst at 451 Research. “I don’t feel that Square has a strong story for merchants with 10 or more locations.”

Square needs large transaction volumes to fuel sales. So while the payments provider is popular with self-employed dog walkers and babysitters, who use it to accept debit and credit cards instead of cash, that doesn’t scale well. At the same time, Square can’t afford to have large customers that can negotiate deals that erode its margins.

Merchants that handle more than $5 million in payments annually are more likely to get customized software solutions from larger technology companies, putting them beyond Square’s reach, said Brendan Miller, an analyst at Forrester Research Inc.

“Starbucks was kind of an anomaly,” Miller said.