In Square's (NYSE: SQ) fourth-quarter letter to shareholders, it named Instant Deposit first in its list of revenue growth drivers. Instant Deposit allows consumers and merchants to transfer funds from Square to their bank without waiting the usual clearance time of one to three days. Next on the list was Cash Card, the prepaid debit card that allows Cash App users to spend their balance directly instead of transferring it to a traditional bank first.
The two products oppose one another. You can either request an instant deposit and spend funds using your usual bank card, or you can leave funds in Cash App and spend on the Cash Card. But Cash Card and Square Card -- its prepaid debit card for merchants -- are growing quickly and cannibalizing Instant Deposit.
Comparing revenue production
The business model for Instant Deposit is simple. Square takes a 1.5% fee of all Instant Deposits from the Cash App. Square charges merchants just 1%. That amount is deducted from the final deposit in users' bank accounts.
Square has steadily raised its Instant Deposit rate on Cash App, perhaps as a way to encourage users to sign up for Cash Card as a cheaper alternative. It wouldn't be a surprise if the rate increased for merchants this year after the release of Square Card.
The Cash Card and Square Card are a bit more complicated. Square receives interchange fees every time the cards are swiped. Those rates are set by Visa and Mastercard, and vary depending on the merchant category. The range goes from 0.65% + $0.15 to 1.9% + $0.25 with some hard caps at certain types of merchants (like supermarkets for Visa). Mastercard's interchange fees cover a similar range, but rates may be higher for business debit cards like the Square Card.
On average, Square generates less revenue per dollar spent with its prepaid debit cards than it does through Instant Deposit. So the direct impact of Cash Card and Square Card is a negative for Square's top-line growth.
But there are ancillary benefits to these products.
Keeping it in the ecosystem
One of the biggest competitive advantages for Square is its growing ecosystem of products and services. It's primarily focused on merchant services, but it has expanded its consumer services in Cash App over the last couple years as well. Encouraging merchants and consumers to keep a cash balance in their accounts makes it easier for Square to sell them other services.
"We believe that keeping people within the Cash App in that ecosystem is generally positive, first, for the customer and also for us because of the other financial services that we're going to continue to look at and add and the utility that we're going to add to the card," CEO Jack Dorsey said on Square's fourth-quarter earnings call.
Last year, former CFO Sarah Friar said Square wants to offer the same services you might find from a traditional bank through the Cash App. Square also reapplied for a banking license, which could open up more possible services. It already offers a host of valuable bank-like services to merchants including Payroll and Square Capital.
That said, Square's debit card products encourage certain behaviors from cardholders already.
Square gives Square Card users a discount at other Square merchants, which produces a network effect where merchants encourage their biggest vendors and suppliers to use Square. While it gives Square Card users a 2.75% discount for using the card at a Square merchant, Square ends up pocketing most of the 2.75% it charges merchants for processing payments, so it's a tiny marketing expense.
On the consumer side, Square is still building out Boosts, its cash-back program for Cash Card users. Friar previously noted Boosts will eventually become a marketing product for merchants, and Dorsey hinted as much on the earnings call. "We think there's a lot of incentive both for consumers and also our seller partners on it," Dorsey said, indicating Square might soon open the door for sellers to offer promotions through Boosts.
While Square might be sacrificing some top-line growth by cannibalizing Instant Deposits, it's gaining a lot of value by keeping users' funds in its ecosystem. That's already important as is, but with the potential for Square to develop more banking services on both the merchant and consumer sides, it could become a lot more valuable in the long run.
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