Business as Unusual: Partner ecosystems for new markets and channels
Crises become catalysts for customers and business partners to make the changes they only contemplated before, but now must make out of necessity. In some cases, these are the validation of nascent business models and accelerants for their adoption.
In this instalment, we explore Apple’s and Square’s ecosystems. In the case of Apple, financial terms and business practices are balanced in Apple’s favor, perhaps too much so for partners and customers. In healthier ecosystems, a platform player supports customers and business partners without subjugating them. The platform provider creates a hub of value, typically with a compelling anchor tenant offering to the ecosystem at its core. Rather than vertical integration, speculative add-on businesses or features, the platform seeks best-in-breed partners to enhance the core offering via rapid technological integration. The differences are subtle, but the best platforms cultivate rather than dominate their ecosystems.
(Bad) Example: Apple Store and Apple News
Apple is one of the most valuable companies in the world, and much of that value is attributable to its Apple Store. The platform has transformed the world, empowering entrepreneurs and customers with a platform of previously unimaginable scale, scope and speed; however, Apple’s model has notable flaws. It subjects App Store participants and Apple News content providers to onerous and unfavorable commercial terms. Mistakenly, as device-maker, Apple leverages its privileged gatekeeper position to extract up to 30% of in-app purchase revenue. As a result, user experiences become convoluted, consumers are subjected to as much as a 30% premium for purchases on their phone’s app versus those purchased via a browser (on the same phone). If the consumer doesn’t pay that fee, the app or content provider eats Apple’s charges.
The New York Times is “done” with Apple News
Apple argues that the App Store and Apple News provide a massive platform for entrepreneurs and businesses, that it treats all businesses equally (not necessarily fairly), and does many other wonderful things. While true, it misses the point and is unhealthy and won’t be sustainable. The market or regulators will intervene. While the little guys will, for a time, eat what they are rationed, established businesses, including Spotfiy, Rakuten, and The New York Times, find dealing with Apple’s onerous terms is too much. The New York Times recently pulled its content from Apple News, saying that the relationship made no business sense and damaged The Times.
It gets worse. Apple’s commercial policies artificially prop up Apple’s own businesses, such as Apple TV, Apple Music, or Apple News. It is also alleged that Apple cripples new features of successful Apps within its stores, while at the same time integrating those same features into its own core products. Regulators are not keen on the business model, and it appears that Apple is beginning to create side deals with large partners such as Amazon Prime Video to seek peace and avoid litigation or all-out war.
So, yes, Apple built an ecosystem that has facilitated much, and enabled many. As stewards of the ecosystem that is fraught with issues, consumers and partners deserve more. From the customer’s perspective, after a $1000 bi-annual iPhone refresh, should they feel right about Apple collecting 15-30% commission from every service they use on this device?
Example: Payment services / Square
Digital payments leader Square has been laying the groundwork for an ecosystem among the underbanked, both consumers and small businesses. While recently acquiring a bank and performing many of the functions of a bank, Square is not yet one. However, Square does partner with other financial services companies to serve both consumers and merchants in ways that large banks struggle. The Covid-19 crisis imperiled the consumer and small business merchants, at a magnitude and immediacy that no company anticipated. However, the company is architected to integrate core capabilities of partners and has used its platform to rapidly help both segments in ways that will endure after the crisis. Importantly, Square was able to “pause” many strategic initiatives just months ago seen as fundamental to the company, knowing that their time is certainly not now. This agility is core to Square, and fundamental in ensuring its relevance to the ecosystem it cultivates.
Square’s Consumer-focused ecosystem: Cash App
According to Ark Invest, a technology-focused investment company and publisher of related research, Square’s Cash App digital wallet had 24 million active users at the end of 2019, targeting the underbanked with bank-like services. Cash App’s user base grows via savvy marketing that targets the “digitally native” and enjoys healthy peer-to-peer network effects. According to Ark Invest, Cash App is easier to use than bank consortium-owned Zelle, and therefore is used more frequently and ad hoc than Zelle. Square was also opportunistic in the Covid-19 crisis, turning it into an opportunity.
According to Square and Twitter CEO Jack Dorsey in Square’s Q1 2020 quarterly newsletter, the company worked with its partner banks to enable its customers to access and use cash made available through the US CARES Act:
In April, we published a microsite and FAQs to help eligible Cash App customers understand the stimulus programs and how to easily receive funds using direct deposit, which coincided with Cash App’s rise into the top-10 overall rankings in the U.S. App Store. We also worked with our partner banks to expand direct deposit eligibility from 3 million customers in February to approximately 14 million customers ahead of the IRS’s second portal release on April 15. Our direct deposit product provides customers with a unique routing and account number that allows them to deposit their stimulus funds, tax refunds, or paychecks directly into their Cash App account.
- Jack Dorsey, CEO, Square
Cash App transacted 3x the number of direct deposits in April than it did in March on the back of the CARES ACT program. It stands to benefit from when these same customers receive their tax refunds. Pre-Covid-19, in Q120 Cash App generated $528m in revenue, and $183m in gross profit for a 35% gross margin.
At its core, Cash App is a digital wallet anchor tenant, performing the functions of a virtual bank account. Enabling this app-based virtual “non-bank” are an increasing number of ways to more conveniently receive, save, accumulate and spend. Starting with peer-to-peer payments and a virtual debit card for online and contactless payments, Square continues to add functionality to the Cash App that drives further adoption of the platform. Of the $583m Cash App-related Q120 revenue, $303m was related to Bitcoin functionality. While this functionality only drove $7m profit (3.8% of Cash App profit), it was a core driver of its use and adoption. The remaining $222m in Cash App revenue was in traditional “fiat” currencies, summing to $176m in gross profit (79% gross margin).
According to Marketwatch, “the company is thought to be packing features into the Cash App so that consumers will start storing money there and using an associated debit card to make purchases, allowing Square to collect transaction fees on the back end when users swipe their cards in store or buy something online.” By adding features valued by a generation untethered to the traditional bank, but also accessible to those who are, it creates low-cost on-ramps from which it will grow.
Square is rapidly accelerating Cash App products, including free online brokerage with fractional share trading. While it does so via its own broker-dealer, the functions of the trade life cycle are powered via APIs and a partnership with a “carrying broker,” DriveWealth, who handles clearing, execution, settlement, and custody on behalf of Square and the Cash App account holder. In partnering with white-labeler DriveWealth, Square is able to offer more value to the Cash App account, and thereby more cash assets to its platform, without the risky expedition of building a full brokerage operation, a complex, commoditized and highly regulated endeavor, from scratch. Equally, DriveWealth does what they do best, and can do so for other clients, without the need to market directly to consumers. While trading is “free,” Square and DriveWealth will monetize their order flow as is customary in the USA, lend stock, and likely add more features in due course. It will make money, and won’t spend much in marketing to acquire customers, unlike its new-entrant, millennial focused-peers with narrower capabilities (e.g. Robinhood, Coinbase).
Square’s Merchant-focused Ecosystem: Square Online and SBA Loans/Square Capital
Like with consumers, Square was also opportunistic in its commercial segment, turning the Covid-19 crisis into an opportunity on the merchant side. Square’s merchant customer base was among the hardest hit. It comprises small businesses with a physical presence, including small and medium-sized retail stores. Displaying an enviable agility, the company was quickly able to pull back, if temporarily, from initiatives that would not yield benefits to customers or shareholders during Covid-19. At the same time, they doubled-down and accelerated other efforts to support their suffering merchant base:
Square Online: Accelerated the broadening of the merchant services to include a fully integrated online-store to the existing “Dashboard” for physical payments. This accelerated many merchants’ moves online.
SBA Loans and Square Capital: provided an intuitive FAQ and application process for merchants and new customers to apply and obtain SBA PPP loans in Phase 2 of the program. Square uses optical character recognition, streamlined KYC, and a partnership with a Utah-based bank to quickly facilitate loans for small businesses who are unbanked, overlooked or not a priority for traditional banks.
With respect to PPP loans, a common complaint of truly small businesses was that traditional banks did not prioritize them in loan application processing. Their experiences with FinTech companies, including Square, is much different. As of June 27, 2020, 19 FinTechs, including Square, PayPal and others account for just 0.35% of the 5458 total lenders in the SBA PPP loan program, but have initiated 2.84% of total loan count comprising 0.74% of the total cash distributed in the program. These same FinTechs’ loans represent 10.1% of the loan count made by institutions under $1bn in assets, and 3.8% of the notional value loaned by this segment.
These are strong indicators of how nimble FinTechs, streamlined and scaled by APIs and ability to partner with others, are able to serve the long-tail of small business in the US. As Square builds out its ecosystem and emerges from the crisis, it will continue to add higher margin subscription services and be able to move upstream at scale with larger and more profitable customer segments.
Much like Amazon has used ubiquity, scale, and ease of use to become the platform for both consumers and merchants, Square is doing so in the transaction services space. It is doing so by empowering and enabling others in its ecosystem, and better welcoming small and underserved segments into that community. It is not moving into or cannibalizing its customers and partners, and instead finding ways to stabilize and grow them where others can’t or simply won’t.
Lessons:
Healthy ecosystems work for everyone, both in the short- and longer-term
Ecosystems and their anchor tenants should empower and enable rather than commoditize and disproportionately extract
Innovative partners are redeveloping industries rapidly; business leaders have the opportunity to be those partners, or work with them to unlock their potential
Whether you are a customer, supplier or otherwise, your business relationships should enable you to get to the next level, and if they don’t… consider alternatives.
Leadership Checklist:
Are your service providers, business partners and systems working for you, or are you working for them? It should be both, and in a way that creates new opportunities for all.
What would your business look like without that partner? What would theirs look like without you? Are you aligned and iteratively re-aligning?
Do your service providers and partners delight and surprise you with new opportunities to collaborate, or disappoint, restrain or underdeliver?
Do you have a “hot backup” for your key business relationships? Are you constantly shopping to see what innovations are available to the market, but perhaps not offered by your suppliers?
Do you have a plan to extract yourself from unhealthy relationships, and move to ones that are more aligned to your future than your past?