Square's Big Advantage as It Takes on Ecommerce

By Markets Fool.com

If you're setting up an online store, there are plenty of options available for payment processing. PayPal has made it easy for anyone to set up an e-commerce operation, but requires shoppers to have an account. Some shoppers would rather just punch in their credit card details, and Stripe has made it relatively easy for websites to start accepting direct payment. Now, Square wants in on the action.

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The payment processor best known for its in-store registers launched a new e-commerce API at the end of last month. The new product will offer similar functionality to Stripe and PayPal-owned Braintree. In fact, the pricing is the same, as well. With Stripe and Braintree well established in the market already, what makes Square think it can compete?

A unified platform
Square holds one huge advantage over Stripe and Braintree -- it processes in-store payments, as well. For retailers that already use Square in stores, it would be extremely convenient to use Square's e-commerce solution. It would allow retailers to see all of their sales -- both online and offline -- under a single dashboard.

PayPal is trying to offer the same thing. Having established itself online, PayPal is attempting to expand to stores as a point-of-sale credit card processor. Square's established software puts it well ahead of PayPal, though, and PayPal's disconnected nature (due to the Braintree acquisition) makes it a bit more difficult to keep track of sales across platforms.

Nobody else is offering the same unified experience to small and medium-sized businesses as Square. And with the low switching costs of replacing a few lines of code on a website, Square could find itself quickly taking share of the market.

Could e-commerce make payment processing profitable?
Square remains unprofitable despite strong growth of its core business. Its transactions business grew 48% in 2015, but it's weighed down by relatively low gross margins. There's not much Square can do to improve its 36% gross margin on payment processing as credit card companies take a certain cut for each payment.

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Square is currently in growth mode, but operating expenses are still growing more slowly than transaction revenue (even with heavy investment in its software and data products). The expansion to e-commerce has the potential to boost growth in transaction revenue with less of an impact on operating costs.

Just as important, more transactions and more merchants have the potential to increase sales of Square's burgeoning software and data products, which are much more profitable than transaction revenue. Last year, software and data products provided a gross profit margin of 61%, but only accounted for 5% of total revenue. Square is rapidly expanding its product offerings in this section, which means that each new payment-processing customer has a higher chance of opting for a second product from Square.

Don't count out PayPal
Not to be outdone, PayPal's Braintree launched its own system to allow small- and medium-sized businesses to process credit cards through their websites just a day after Square announced its new API. BraintreeAuth allows merchants to accept credit cards, debit cards, or PayPal all through a single interface for shoppers.

Braintree also supports Apple Pay and Android Pay, as well as its homegrown Venmo mobile payments app, so merchants will have a lot more options than with Square. Where Square provides the convenience of tracking sales across platforms for merchants, Braintree provides convenience for shoppers with various payment methods (theoretically driving higher sales). Each product has its own merits, and Braintree's newest effort should help it fight back against the new entrance from Square.

The article Square's Big Advantage as It Takes on Ecommerce originally appeared on Fool.com.

Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends PayPal Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.