Square Is Pushing Merchants to Use Multiple Products

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Square (NYSE: SQ) made a small change to its product lineup recently, but it has big implications for its business.

The payments company revamped the pricing for its Appointments service, which makes it easy for merchants to set up an online appointment booking system. Single-person businesses will now have free access to Appointments while merchants with two to five employees will still pay $50 per month and those with six to 10 will pay $90 per month. (Individuals previously paid $30 per month.)

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Importantly, merchants with multiple employees using Appointments will be able to process transactions at a rate of 2.5% plus $0.10 instead of a flat 2.75%. That rate presents a discount for merchants with average transaction values above $40.

Square is willing to take on more risk on its transaction take rate if it means its merchants use multiple products. Square CFO Sarah Friar noted earlier this month that the company is investing in products that result in customers using multiple products from Square. This move represents one strategy to do that.

A gateway to using more products

While Square has been attracting more and more large sellers the last couple years, its core customer base are still micromerchants like the one-man pet groomer or the single-woman tailor shop. Square first attracted those merchants by offering an easy way for them to accept card payments, but there are a couple challenges facing that business.

The first challenge is the profit margin on payment processing is relatively small. Transaction revenue gross margin was 36% last year. Add in the fact that Square takes a loss on its hardware sales, and it's easy to see how payment processing as a business isn't much of a profit maker. In comparison, subscriptions and services produced a gross margin of 70% last year.

More importantly, payment processing is a highly undifferentiated service. As long as a merchant can take credit and debit cards, they probably doesn't care about the company behind the service, and they're probably more interested in which one's best for their bottom line.

As such, Square is pushing its merchants to use multiple products. From Appointments to loans from Square Capital to its Payroll service, Square has a growing portfolio of services.

The ecosystem lock-in

The move with Appointments is effectively a way to ensure merchants don't put together a piecemeal solution -- using Square for managing appointments, another company for processing payments, and perhaps a third for managing payroll. Getting (or forcing) a merchant to use a second Square product makes it more likely they'll use a third or a fourth, since they all play nicely together in Square's merchant dashboard.

That product ecosystem increases the switching costs for merchants. If they want to change one service, it will negatively impact their ease of doing business. Square's suite of tools is what can give it a competitive advantage over other payments processing companies.

Some products lend themselves to using a second product. Appointments and payments processing probably go together well, and Square is just providing an extra push. With multiple touch points, Square can then market its other services to merchants as well, building up the average number of products its merchants use.

Growing margins

As mentioned, subscription services carry a higher margin, on average, than processing payments. To that end, any way Square can bundle one or more of its services with payment processing -- which still made up 87% of total revenue in 2017 -- should have a meaningful impact on profit margins.

Square guided for adjusted EBITDA margin of 19%, which represents about 5 percentage points of expansion. That's a pace that management believes balances investment for growth with profitability. Square's move to offer Appointments for free to single-person operations and offer a discount on payments processing to bigger merchants represents an investment with expectations that it will grow the service overall and increase retention in the long run.

Investors should look for Square to offer more product bundles and experiment with its pricing in the future.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of Square. The Motley Fool has a disclosure policy.