Square Has Filed to Go Public. What Did the Company That Invented the Phone Card Reader Do Next?

The first company to try to replace the wallet may not be the one still standing at the end

You may remember a little card reader that was briefly all the rage: a small plastic square that plugged into a phone's headphone jack and let you swipe a card.

Today its creator, Square, filed for an IPO, aiming to raise $275 million on the New York Stock Exchange. In 2009 Square launched a mini card reader that plugs into a smartphone, letting merchants take card payments from customers on the phone. Companies such as Lakala and Qianfang later brought the same idea to China.

Plugging a gadget into a phone to swipe cards started with Square

Small and medium-sized merchants often prefer cash to cards, because card processing fees and the cost of a POS terminal both add up to real money.

Square's first product was a mini card reader that plugged into the iPhone's headphone jack. The customer swiped a card, the transaction went through on the merchant's iPhone, and the receipt arrived by email.

Small merchants could now accept credit cards on a smartphone without buying a separate POS machine. POS machines often cost hundreds of dollars; Square's reader sold for $10, which made it close to free for a merchant, and once the merchant had taken a payment with it, the $10 was credited back to the merchant's account.

Square's card reader

The reader was once hailed as the future of mobile payments. Its fee of 2.75% per transaction was a little lower than the banks' 3%, giving small businesses another way to get paid while earning Square a profit. But the Square model still could not avoid paying fixed fees to credit card companies and banks.

Whether a card is swiped on a POS machine or on a mini reader, the banks get paid. They hold the initiative and the bargaining power, and most of Square's revenue goes to them and to the card companies.

Mobile payment has only just arrived in everyday life. Square tried it years ago and failed

Small merchants liked the reader because it cost less than the banks. But Square wanted more. To pull more merchants and consumers into its own payment system, it has spent the past few years trying one field after another.

In November 2010 Square launched Square Wallet. A cashier completed the sale by scanning a QR code the customer generated in the Square Wallet app. The app had every feature mobile payment needs: linked bank cards, transfers, location-based services, store information and store check-ins. It even checked you in automatically, so that by the time you opened your mouth to order a coffee, the barista already knew your name.

It worked much as WeChat Pay or the Alipay wallet do today at a supermarket, a bakery or even an airport. Square hoped the wallet would get people used to paying without swiping a credit card. It was the first transformation project Square threw its full weight behind.

Square shut Wallet down in May 2014. Users and merchants would not take a chance on a new service, and although nothing was wrong with the product itself, the company had to look elsewhere. Mobile payment met much the same resistance in China until this year's red-envelope battle during the Spring Festival Gala, when a chance to change people's habit of "pulling out cash to pay" finally appeared. In the Square Wallet years, Square plainly failed to build that habit among users or merchants.

The end of Wallet also marked a turning point in how the capital markets saw Square. The company went on to explore several new lines of business, and Wall Street began to ask whether it could ever make money.

The collapse of its partnership with Starbucks was the heaviest straw of all.

Starbucks was once one of Square's biggest customers.

In 2012 Starbucks invested $25 million in Square, and its chief executive, Howard Schultz, sat on Square's board for a time. From the third quarter of 2012, Square was Starbucks' exclusive payment provider.

That year Square processed $5 billion in payments, and it began expanding into international markets such as Canada and Japan. But the partnership did not deliver what Starbucks expected. In 2014 Starbucks orders paid through the Square app totaled $12.3 million, far below the $1,510 in transaction fees Starbucks paid Square for them.

By the end of 2014 Starbucks had all but stopped using Square's payment app and had launched its own. Schultz had left Square's board back in 2013.

Beyond hardware, Square tried these other ways around the banks

Square Cash launched in November 2013. Users send and receive money by email or through the mobile app, free of charge. When friends eat out together, they can split the bill with Square Cash, much as people in China split a tab with Alipay.

Recently Twitter and Square built Square Cash into Twitter as a channel for presidential campaign fundraising. A Twitter user clicks the link in a tweet, enters their details and the amount they want to give, and completes the donation without leaving Twitter.

Type a few words on a social network and you can donate money

As Google Wallet, Apple Pay and even American retailers turned to mobile payment, Square set its sights on a narrower field: food.

After shutting Wallet, Square tried to move into the restaurant business and bring those diners into its own payment system.

In May 2014 Square launched Square Order, a service for ordering ahead from restaurants. It worked a bit like Ele.me combined with Dianping: users browsed restaurants in the app, ordered and paid in advance, and picked up their food on arrival, skipping the queue, the ordering and the checkout.

Three months later Square bought Caviar, a San Francisco food delivery company, to round out the Order business. Caviar combines online ordering with fast delivery, draws its food mainly from mid- to high-end American restaurants, targets the upscale and corporate market, and charges both restaurants and customers.

But in the first half of this year, because it had fallen short of expectations, Square announced it was shutting down Square Order, less than a year after launch.

Square Order lasted less than a year

Its services for businesses, however, may be gaining some ground.

In October 2013, to win over small and medium-sized merchants that had never used its card reader, Square launched Square Market, an online classifieds platform aimed at merchants who sell and promote online. Merchants can also use Square Market's online tools to market themselves on social networks. Square charges the same 2.75% fee on online sales.

In May 2014 Square launched Square Capital, which lends to small and medium-sized merchants. According to its SEC filing, Square had lent $225 million as of June 2015. By comparison, PayPal said in an official blog post in May this year that its small-business lending arm had lent $500 million over the previous 18 months.

Its rivals are no longer startups but America's biggest tech giants

"We've caught the era of electronic payments," eBay chief executive John Donahoe said when he told investors of the decision to spin off PayPal. To respond more nimbly to the electronic payments market, PayPal has completed its separation from eBay and is looking for partners far and wide.

This is the era Square faces as it heads for an IPO. Its rivals are not startups selling triangular, square or otherwise odd-shaped card readers, but several of the most valuable tech companies on the planet.

In June Facebook announced it was adding payments to its Messenger app. Once users link a bank card to their Facebook account, they tap the "$" button in a chat with a friend, enter an amount, and the money is sent.

Meanwhile, the biggest phone makers, among them Apple, Google and Samsung, have charged into mobile payment. In theory Android Pay works on any Android phone with an NFC chip, and Apple Pay, little more than a year old, already has the backing of banks and retail chains.

Startups and giants like Apple, Facebook and Google alike may run into plenty of problems in their pursuit of mobile payment. And Square, the earliest to start, has not built much of a lead in this market.

In its SEC filing, Square describes one of its "risk factors" this way: "Our growth may not be sustainable, and depends on our ability to retain existing merchants, attract new merchants, and help them increase their sales."

A single large customer like Starbucks once accounted for 14.5% of a year's revenue, so losing merchants could also cut sharply into this payments company's sales.

What kind of company is Square today?

Founded in 2009, Square has raised $590 million over 9 funding rounds and is valued at $6 billion.

According to its SEC filing, 446 million transactions worth a total of $23.8 billion went through Square in 2014 alone. Square has worked hard to change how small businesses get paid; at every stage of the effort to replace cash and credit cards, Square has been somewhere in the picture.

Yet every form of mobile payment has run into one problem or another, and cash and credit cards remain the usual way to pay in physical stores. Consumers are not convinced. People do not believe that paying with a phone at the register is faster or safer than paying with a credit card.

Square's revenue rose 54% to $850 million in 2014, and this year it is expected to top $1 billion. But its losses have grown at about the same pace: in 2014 its net loss widened from $104 million to $154 million. What this cash-burning company must prove is that it has a revenue stream steady enough to justify so high a valuation.

Square's business today has three main parts: payments, financial services and marketplace services. Mobile payment is where Square started; it includes Square Cash, a peer-to-peer payment app similar to Alipay, and the POS business that helps small merchants take cards. Financial services include Square Capital, which lends to small businesses, and Square Payroll, which helps businesses pay their staff. Marketplace services cover marketing and analytics for merchants. On top of that there is Caviar, the food delivery service.

Square's merchants by industry: mostly small and medium-sized businesses

In its prospectus, Square says its growth strategy is to improve its products and services, expand the number and range of its merchants, deepen its ties with large merchants and expand globally. But when it comes to Square's strengths, claims such as "technological innovation in money transfer, merchant scale, deep understanding of merchants and a growing payments ecosystem" are not enough to convince investors that its business model has anything new to offer.

The CEO has to run two companies, and one of them is being overhauled

Earlier this month, Jack Dorsey, who had returned to Twitter as interim CEO three months before, was confirmed as Twitter's permanent CEO. With 316 million monthly active users, Twitter is still one of the most influential social networks in the world, but it is doing far worse than it once did.

Twitter has just announced a formal round of layoffs, and that is only the first step in Dorsey's plan to revive it. Perhaps it will turn into a story like Steve Jobs bringing Apple back from the brink of bankruptcy. But for Square, a CEO who spends half his day or more running another public company is hardly the start of a good story.

Over the past two years, Dorsey has returned 20% of his shares to Square, and he may give up another 10% to attract potential investors.

"Facing any challenge, there are two possible responses: fight or flight," Dorsey once said in an interview. "Either you keep fighting, or you get out."

This CEO, who recently shaved off most of his beard, has clearly chosen to fight.

Cover image from Fast Company