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How Square Makes Money - YouTube
Channel: CNBC
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Square, Inc has grown from a scrappy
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payments startup to a $26
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billion FinTech giant.
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Square shares soaring on Thursday.
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I love this stock.
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It's Square SQ the payment technology
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company that can turn any smartphone or
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tablet into a credit card reader.
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Not bad for something that started off
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as a side project for Twitter inventor
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Jack Dorsey. We're building a tool for
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small businesses that actually rivals
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and is much better than what most big
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businesses have. Square credits its
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success to a mission of economic
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empowerment, giving business owners an
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ecosystem of tools to seamlessly accept
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payments and finance growth.
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We have designed a beautiful experience
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for our buyers and sellers that has
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really set us apart in the industry.
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But critics wonder if it's overvalued
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and getting distracted from its core
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business as it faces fierce competition
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on all sides.
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This is clearly broken. It's like the
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trend is not there. Still way too
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expensive. More downside to go.
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We are steering clear of this one.
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So how does Square make its money and
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can its growth spurt last?
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The company's beginnings are said to
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trace back to a St.
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Louis area glassblowing studio in
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2009.
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Jim McKelvey owned the studio and like
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many small business owners around the
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country, he faced a daily dilemma of
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whether or not to accept credit cards.
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He could use a complex structure of
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exorbitant fees to run any kind of card
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or only accept some forms of payment
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and watch a chunk of his customers walk
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out the door. A computer scientist and
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economist by training McKelvey figured
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there had to be a way to create an
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affordable and simple card processing
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system for small business owners like
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him. And lucky for McKelvey.
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He happened to have an old friend who
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could help him make that happen, Jack
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Dorsey. Dorsey and McKelvey realized
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that almost everything you needed to
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run a card already lived inside a
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relatively new and increasingly popular
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invention, the iPhone.
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Computer chip, network connection,
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TouchPad for signing...
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the only thing missing, a card reader.
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So the two got to work building a
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little square shaped reader capable of
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plugging into a headphone jack.
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That square reader became the company's
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namesake being released to the public
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in 2010. Square would send out the
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reader for free.
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Then, like most other card processing
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companies, Square took a cut of every
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swipe 2.75%
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plus 0.15.
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But that was it. Unlike other
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processors, Square did away with
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complex contracts and additional fees.
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And soon it even dropped the one extra
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fee it did have, that 0.15
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on top of every transaction.
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By early 2011, the company was
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reportedly shipping 50,000 readers
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and processing $66 million in
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payment volume. We sat down with
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Square's hardware lead, Jesse
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Dorogusker, to learn more about the
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company's design ethos.
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At the very beginning, we were really
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just trying to build the simplest thing
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we could for as many people as
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possible. A free piece of hardware that
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was very simple, plugged into the
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smartphone you already have, download a
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free app, get started in five minutes.
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Suddenly that housecleaner, dog
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groomer, farmers market vendor, cash
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only takeout restaurant or even cookie
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selling Girl Scout troop could all
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swipe credit cards.
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But then something interesting started
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happening. Sellers who could afford to
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pay standard card processors started
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using Square. Checking out on a sleek
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Apple product became trendier in many
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ways than using a standard card reader.
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By 2013, the company said it was
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processing $15 billion per year.
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We're not just for small businesses.
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We can't be a company that says, hey,
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we only serve small businesses because
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that means as soon as they grow, which
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is part of our mission to help them do,
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then they would grow out of us and we'd
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have to point them somewhere else.
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We're going to make sure that they see
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us all the way along the path.
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And as they go from 10 locations to
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20 locations or from a coffee cart to
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the size of a Starbucks, we can handle
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both extremes. Square started to
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realize it had the ability to compete
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in these larger payment processing
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business, creating an ecosystem of
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hardware and software products
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businesses could pay extra to take
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advantage of. There was Square stand
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which could replace a register, a suite
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of software products to help manage
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things like payroll, and even small
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business loans. Building off that
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momentum, Dorsey took the company
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public in 2015.
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An important day for tech as Square,
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the mobile payments company, goes
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public at the Big Board.
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CEO Jack Dorsey is due to ring the
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NYSE opening bell.
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But ringing the opening bell with his
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mother, Marsha Dorsey.
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Not a bad Twitter follow in her own
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right.
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3.7 million shares of Square
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open at $11.20.
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That's a very good price.
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I mean, it's all about getting the
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business of accelerating the business.
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And that's what we came here to do
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today. And we did it. But after the
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billion dollar company went public, its
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share price started faltering, dipping
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below its IPO price three times in
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less than a year. Analysts began
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questioning whether Dorsey could run
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two major companies.
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It requires a full time CEO.
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I know Jack's being stretched and
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pulled in different directions with
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these two firms.
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Jack's an incredible product thinker,
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an incredible person, but I think it's
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hard to see both companies going
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through the cultural change as public
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companies while his time is split.
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New trendy payments companies like
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Toast and Clover started pushing into
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Square's core market.
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Then Square reported worse than
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expected losses.
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I read a lot of analysts notes who
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think they just have no path to
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profitability like ever.
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But Jesse says Square has always been
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able to offer something its competitors
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struggle to replicate.
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What's really powerful about building
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an ecosystem top to bottom, the
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hardware the software that runs on the
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hardware, the iOS and Android apps and
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all the backend systems is that you can
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really observe how they all work
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together. Our competitors in this space
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are much more siloed. And in
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retrospect, the stock did rebound.
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A big part of that rebound came from
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growth in a part of Square's business a
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lot of people don't even know exist,
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Square Capital. While Square is not a
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bank, it partners with financial
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institutions to offer loans to many of
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its small business sellers.
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Jackie Reese, head of Square Capital,
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sat down with us to explain how a
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payments processor got into the loans
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business. We started lending years
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ago after listening to our sellers talk
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about their biggest pain points.
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What Square says they discovered is
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that a ton of these sellers just
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couldn't get access to capital from
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traditional banks. Our biggest
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competition is competing with friends
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and family. It's not going to a bank
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because banks don't even come close to
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offering loan sizes that are in the
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scale that we offer at Square Capital.
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Sixty five hundred dollars or a five
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hundred dollar loan or a fifty thousand
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dollar loan. And so when a small
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business owner wants to gain access to
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credit, they have an emergency on a
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Saturday morning before Square capital
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they would go ask the parents.
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They would go ask their sibling, which
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is in many cases an uncomfortable
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relationship to be in.
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Square's payment ecosystem gave it a
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unique look inside businesses that most
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lenders never had.
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It's very unusual to have real time
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data, which can show revenue of a
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business regardless of how small it is.
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We can see increases, decreases, number
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of transactions per day, types of
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credit cards, day to day business
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behavior based on the types of
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transactions that happen in a business.
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We think that type of granular data is
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extraordinary in terms of understanding
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risk. In fact, they say this data is so
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powerful that they don't even use
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credit scores. Instead, they run their
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own AI based model daily, extending
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loan offers directly to thousands of
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businesses via the Square dashboard.
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Square also developed a different model
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for getting paid back.
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Once a seller takes out a loan, they
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pay it back based on their average
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daily card swipes.
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So that if their business grows faster
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than expected, they pay back more.
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If their business is a little bit
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slower, they're closed for a day, they
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don't have the pressure of paying back
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the loan. To protect themselves from
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holding all of this risk on their
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balance sheet, Square also sells off
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the loans for a lump sum to other
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companies and then continues to collect
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a servicing fee from the buyer until
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the loan is fully repaid.
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After dipping its total into the market
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with one point eight billion dollars
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lent out to more than one hundred and
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forty thousand businesses, the company
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announced its intent to go all in with
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a bank charter application in 2017.
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It's a move that could give Square a
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leg up on an even wider array of tech
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companies offering small business
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loans– like PayPal, Amazon and Stripe.
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Square has also upped its game against
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other fintech competitors with Cash
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App. Originally launched in 2013, the
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Venmo like peer to peer cash transfer
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app opened a whole new market for
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Square. Cash that really came out of
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nowhere. I mean, this was not a
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meaningful piece of the business two
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years ago now it's a quarter of
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revenues and far outgrowing the rest of
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the business. Like Venmo, Cash App
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makes money by charging small fees to
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link credit cards instead of debit
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cards and for expedited balance
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withdrawals. I think the popularity of
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peer to peer apps is because of the
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utility that they offer.
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You can see the structural growth of
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that market evolving for decades.
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There's so much opportunity for banking
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services across peer to peer apps
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because they really save consumers a
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trip to the bank. Square already offers
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a collection of banking services on the
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app through its partner banks and has
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stayed relevant with younger audiences
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by offering the ability to trade
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cryptocurrency on the app– a passion
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project of CEO Jack Dorsey.
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It does provide an opportunity to give
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more people access to the financial
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system. So we're going to make sure
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that we are learning and leading here.
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In 2018, Cash App's users doubled from
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7 million to 15 million
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and there may be more growth ahead.
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We would absolutely expect that they'll
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start to extend credit on the consumer
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side through Cash App.
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Probably fairly soon.
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It's a no brainer extension.
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By late 2018, Square had hit its
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stride. Its core payments business
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continued growing.
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While Cash App's unexpected resonance
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wowed investors and the small business
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loans' high performance teased a huge
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new banking market.
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The success made Square a Wall Street
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darling. The outperformance here is
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Square. The stocks had an incredible.
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Run it up 100 percent year to date.
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This is a potential $50 to $60 dollar
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opportunity, pushing the stock high
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from its post IPO low of just below $9
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to $99.
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But then Square's future began to look
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a bit more uncertain.
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Tough day for Square investors.
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That stock plummeting. A Square beat
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down, the stock falling nearly 30
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percent since August.
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Suddenly this former market darling, it
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has become a complete battleground
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stock. Some analysts began to
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wonder if the company had lost focus.
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Their GPV growth, which is their core
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volume growth, purchase volumes, the
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volumes of payments running over their
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point of sale systems decelerated for
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the fifth or sixth quarter in a row.
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And investors are getting very nervous
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about why that core business, which
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generates all the profit of the
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company, is decelerating.
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Is it because they're just not
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investing in sales and marketing
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sufficiently? Which we think is what's
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been happening and now they're upping
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the investments and everything would be
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rosy again? Or actually, is there a
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deeper problem that that they're
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starting to struggle a little bit with
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growth? This focus issue came front and
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center when Square sold Caviar, its
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high end meal delivery service.
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That market is just fiercely
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competitive. That business has had
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dramatically slowing growth over the
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last year. It's very unprofitable.
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It's very labor intensive because it
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has all these delivery people.
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It's just not anything as attractive as
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the core business. And so, you know,
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we're thrilled they sold it.
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Some analysts have also begun to worry
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whether Square can sustain such
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positive returns on its loans,
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especially if the U.S.
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experiences an economic downturn.
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Square, however, has pushed back hard
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against this assertion.
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If there is a downturn, we think we're
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incredibly well positioned.
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Payment processing isn't discretionary.
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It's how people run their business.
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Second, as it relates to capital.
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Interestingly, our loans are 9 month
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duration. So these are very short
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duration and they can adjust to the way
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that the payments models adjust
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literally every day.
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These concerns have likely contributed
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to a lagging stock in 2019.
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Even as other companies like Visa,
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MasterCard and PayPal hit a rally.
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Of course, the payments giant has gone
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through changes and dips in its stock
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price before. The question now becomes,
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is Square losing an edge?
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Or just gearing up for its next big
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play?
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