When crunching the numbers, it appears Square Inc. can't possibly make a profit in its new deal to process transactions for Starbucks Corp.
Starbucks says it will save money by switching to Square, a claim that suggests it might be getting a discount on Square's typical 2.75% transaction fee. Even if that is not the case, Square is likely spending more to handle each transaction than it stands to gain in revenue from Starbucks alone.
The deal is not even good for promoting the visibility of Square's flagship product, an add-on card reader for smartphones, since Starbucks won't be using Square's hardware. The most immediate benefit for Square, besides the $25 million investment from Starbucks, is a sudden promotional boost to a less prominent product: the Pay with Square digital wallet.
"With the Starbucks deal, Square has limited chances of making a profit on its own, but it can expand the business into new avenues," says Gil Luria, analyst with Los Angeles-based Wedbush Securities. Since Square remains a private company, "they don't need to make a lot of money in the short term with every new initiative," he says.
Taking into account interchange rates and general processing fees for card payments on low-value transactions, such as a $5 cup of coffee, the economics can't work for Square, says Nebo Djurdjevic, CEO of Cardis Enterprises International, a provider of payment aggregation software that saves on transaction costs by storing low-value sales as "units" for later one-time payments.
Even at its standard rate, Square stands to lose money on purchases a consumer makes of less than $10 with a payment card through the Pay with Square mobile wallet, Djurdjevic says. A $5 cup of coffee should cost Square 8 to 10 cents a transaction, depending on the card used, according to Djurdjevic's calculations. (Square did not respond to inquiries regarding its cost breakdowns or philosophy on marketing the mobile wallet.)
Even if the consumer uses the Square wallet's "put on my tab" option to combine purchases, it won't do Square a lot of good, Djurdjevic says. "It aggregates two or three coffee payments, so how much are you going to save with that?" Djurdjevic asks.
But despite the numbers, "I'm not saying the Starbucks deal, overall, is bad for Square," Djurdjevic says. "I understand they are going to benefit from the publicity, but I am saying they just need to watch [the bottom line on the transactions]."
In addition to its investment, Starbucks is placing Howard Schultz, its chairman, president and CEO, on Square's board. Starbucks also plans to incorporate some of Square's software into its own mobile payment system, which is tied to a closed-loop Starbucks Card.
This arrangement should significantly help Square get its Pay with Square wallet in front of more users, Luria says.
"Consumers will be using the Square wallet to buy other things," he says. If consumers use the Square wallet with other merchants, each user's overall spending could compensate for the losses Square might be absorbing at Starbucks.
This seems to be the way Square CEO Jack Dorsey is thinking. In his letter to Square merchants and consumers last week announcing the Starbucks deal, Dorsey said the partnership "gives Square new visibility, driving more customers to opt-in to Square."
Brian Riley, senior research director and analyst with Needham, Mass.-based CEB TowerGroup, agrees it is a game of "sheer throughput" for Square in trying to gain more mobile wallet users.
The Starbucks loyalty program provides an element Square has long needed: an incentive to use Pay with Square instead of cash or plastic cards, Riley says.