The LevelUp mobile payment system, best known for providing free incentives to consumers and free payment processing to merchants, picked up 4,000 merchants and 300,000 end users since its July 2011 inception.

But with so much being given away for free, is there a future for the startup once its new clients become regulars?

LevelUp earns money by bringing merchants new business. Merchants fund ad credits and LevelUp charges a fee when the credits are redeemed. Merchants control the amount and frequency of credit to give customers and can choose among different campaigns.

"[Charging] money to move money is a really antiquated way of doing business,” says Seth Priebatsch, "chief ninja" (CEO) at SCVNGR, the company behind LevelUp. “Sure the cost of moving a dollar is a lot more than the cost of serving up a search ad, but the value of delivering a real live customer with, on average, a $10 transaction is a hell of a lot higher than a click.”

LevelUp might have problems making money in the future, says Paul Tomasofsky, president of Two Sparrows Consulting.

“Merchants are willing to pay for new business, but how long will they want to pay for recurring business?” asks Tomasofsky. “If you’re a veteran business, how much of the transactions are being generated by the merchant’s product and service and how many by LevelUp?”

Other companies are careful about tying low transaction pricing to other products. Google learned the hard way, with its Google Checkout product in 2006, that offering free payments might not be a sustainable model. Google raised its rates in 2009 – and eliminated Checkout as a standalone product last year.

Groupon, which recently launched a mobile payments app, is taking a less aggressive approach. It offers low transaction rates to existing Groupon merchants, but it does not require them to run additional daily-deals campaigns. It plans to offer a higher-priced version for noncustomers.

LevelUp allows consumers to link their credit or debit card to a quick-response (QR) bar code presented in an iPhone or Android app. To make payments and redeem promotional credits, users scan the QR code at a merchant terminal or with the retailer’s phone.

Demand for the app jumped this year after LevelUp eliminated card processing fees.

The Cambridge-based startup deters fraud by using a triple-blind token system that rotates codes dynamically. This helps keep LevelUp's own payment costs low.

On average, businesses running loyalty campaigns through LevelUp see a 20% increase in customer visitation and a 7% boost in average ticket price, Priebatsch says.

With LevelUp’s analytics, every campaign is tracked so merchants can compare their expenses against revenue. For every dollar of credit merchants deliver through a LevelUp campaign, businesses bring in about $18, Priebatsch says.

But the LevelUp experience differs for each retailer. While Piccolo Café in midtown Manhattan sees four to five customers use the app daily, Michael Johnson, sales supervisor at Texas Rotisserie & Grill in downtown Manhattan says its LevelUp app is used by only one customer per month.

Emily Samiomato, manager at Piccolo Café, says she’s happy with the app’s performance in the vivacious Times Square area, but Johnson explains the app isn’t meeting its goals in the less bustling downtown area of the city.

Level up is inking deals to add even more merchants. Last week, it announced a partnership with the processor Heartland Payment Systems. It also announced a white-label version of the app.

The partnership with Heartland allows LevelUp to take advantage of the processor's restaurant focus to increase distribution.

The other announcement, a white-label version of LevelUp, is geared towards merchants with 15 to 350 locations and a solid mobile budget. LevelUp’s white-label product is custom-priced but usually costs between $40,000 and $50,000.

That is "much less than the cost and time required for a merchant to work on building their own mobile payment app from scratch,” Priebatsch says. He estimates that from scratch, such a project could cost $750,000 to $3 million.

Tomasofsky, who questioned LevelUp's long-term plan, says the startup has a good model to grow with currently.

“Free is always a good number and it’s a good number to sell,” he says.

The use of bar codes and QR codes is gaining momentum because it requires less investment in hardware than technologies such as Near Field Communication do.

While QR-code payment methods are an interim method, Rick Oglesby, senior analyst at Aite Group, says NFC technology will win out in the end.

“But solutions that are utilizing bar codes today very easily adapt to use NFC tomorrow,” Oglesby says.

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