Disruptive Innovation for Merchant Acquirers: The Story of Square, Amazon, and Chinese Steel

In 2010, Square was still the new kid on the block. With a model focused on micromerchant processors, you may have thought Square wasn't going after your market. If you cared about it at all, it was probably as an idle curiosity. After all, Square was just a fresh faced upstart in the neighborhood where you've been doing business for years. The problem is that Square has hit a growth spurt of billions and you're still treating it like it's the new kid. Its market may be micromerchants, but that doesn't mean that it can't disrupt your business model, or seep into your market over time. In one of our blog posts written four years ago, we warned that "by monopolizing the long-tail customer segment, Square will be able to establish a foothold in the industry and eventually pick up enough momentum to challenge the status quo." Instead of looking at where Square is, merchant acquirers and payment processors need to start asking themselves where Square is headed, and consider the steps needed to offset its growth in their industry.

Disruptive Innovation

Square's trajectory is virtually textbook Disruptive Innovation, to use the term coined by Clayton Christensen.
According to Christensen, there are 4 points regarding disruption theory that are often overlooked. Try to consider Square using these points as a lens.

1. Disruption is a process.

Square didn't spring up overnight as a company worth billions, on the verge of seriously infringing on your market. It began as a simple way to help small businesses and long-tail customers, but it is steadily growing and looking for ways to expand its reach. Even if Square is not having a direct effect on your business today, that doesn't mean it's not disrupting your market.

2. Disrupters often build business models that are very different from those of incumbents.

Square stands out from its competition, not only due to its unique apps, hardware, and fixed cost model, but because they're primarily a tech company that works in the merchant payments industry, unlike others who brand themselves as Merchant Acquirers who happen to use technology. But what truly sets Square apart is its ability to expedite the onboarding process. Square's meteoric rise is largely thanks to building a customer base at a fraction of the time (and consequently, the expense) of its competition.

3. Some disruptive innovations succeed; some don't.

While we'll get into more depth later in the article, remember that you cannot discount Square's effects solely by its ability to succeed in the industry. New companies can take losses, or remain unprofitable for years, and still have a significant impact upon incumbents. Take Amazon as an example. It began as a humble online bookstore in the mid-1990s, but in a few years began to expand into other markets. Now it's a titan of the retail industry, and has surpassed Walmart in value. And yet it still doesn't make a profit. We don't know whether Square will be a success or not, but even as its shares drop, it can still rock the boat.

4. The mantra "Disrupt or be disrupted" can misguide us.

Christensen points out that it's dangerous to respond haphazardly to disruptors: "Incumbent companies do need to respond to disruption if it's occurring, but they should not overreact by dismantling a still-profitable business. Instead, they should continue to strengthen relationships with core customers by investing in sustaining innovations." Rather than panic about the strides Square is taking, begin to carefully consider how you can make innovative changes to your business to compete, without abandoning your current model. If one of Square's primary selling points is its quick and easy onboarding, consider what steps you can take to offer your potential clients the same convenience without compromising your underwriting process.

Case Study: China's Steel Manufacturing
How China undercut American Steel

Since the mid-1990s, China has established itself as the largest steel maker, producing almost half of the world's steel each year. The industry receives support from the government for its sheer volume of jobs created and taxes paid, and its structured around low-cost labour. Yet even as domestic demand for steel is decreasing, companies are still manufacturing it at a high rate. Consequently, there's a surplus of steel created for China that China doesn't need. Instead of slowing down production, steel producers export steel at low costs around the world. This is severely disrupting the American steel industry: "U.S. Steel is an example of companies suffering from Chinese overcapacity. It has a high cost structure, that's why it is affected by Chinese exports. This company, one of the biggest US steel manufacturers, was founded in 1901", yet its size and age haven't improved its situation. It doesn't matter that American steel is safer and of a higher quality. China's lower prices are an irresistible siren song for buyers.

Like China's steel industry, Square's low cost, convenient model is in the process of disrupting the payment processing industry. Jack Dorsey's dream of a simple, elegant payment model is a nightmare for established behemoths that take years to change direction. Square is disrupting the industry through an ability to onboard at a fraction of the cost – and time (it only takes 15 minutes to set up an account) – compared to traditional companies, as well as introducing an array of accelerated software and hardware developments that are exponentially changing the face of the game. Banks and payment processors need to wake up and realize that, as we've written before, "merchants' expectations for client onboarding quickly follow the industry best practice," and you need to compete with Square on that front.

Does Profitability Matter?
How Square Can Be Disruptive Without Making a Profit

Now, given that Square's valuation dropped precipitously at its IPO last year, and the fact that it has yet to make a profit, as well as losing around $420 million in its blockbuster deal with Starbucks, you may argue that it is viable to wait for Square to fail rather than try to match them. The problem with that line of reasoning – besides the tunnel vision that ignores how the industry is changing – is that Square will disrupt your business regardless of its own short term issues. Amazon has yet to make a profit, yet Jeff Bezos' juggernaut is still redefining eCommerce, and that's an understatement. Amazon has virtually taken over.
Even if we return to the Chinese steel situation for a moment; steel manufacturers there have recently been hit hard by the continuing drop in domestic demand, and combined with China's credit funding collapsing, that means that China's steel production "may eventually shrink 20 percent."
But these losses have only furthered its disruption in the United States, because Chinese companies are lowering their prices even further to compete for a shrinking market, and their exports climbed 22 percent in the last year. Certain barometers of success don't necessarily halt the disruptive process, and it's a mistake to assume that you can wait for Square to fizzle out.

Square has been relatively unconcerned about its losses, admitting in its IPO filing that "we may not be able to achieve or maintain profitability." Yet this is what drives them to expand their horizons and encroach on more traditional market space. As Square grows, they're looking for bigger and better merchants. Over the last three years, Square's payment volume from companies with more than $500,000 in annual payments has risen from 4% to 7% to 11%. It's smart to realize that there are plenty of chinks in Square's armor, but it is necessary to remember that even if it falls, it can send aftershocks through your market.
Stop worrying about their business and refocus your attention on how you can rise to the challenge.

Innovation Is Not a One Way Street
Don't let Square Be the Only One Innovating

As infrastructures evolve within the industry, it's the elastic companies that will thrive, those who are willing and able to stretch themselves beyond their old model to keep up with the Squares, Paypals, and Intuits. However, the key to competing isn't necessarily emulation; Square is able to do what it does through taking higher underwriting and security risks while depending on a micromerchant market. Take time to assess your own internal practices and how you can streamline your processes.

Implementing merchant onboarding software does not only increase the rate at which you can open accounts and provide your clients with peace of mind about the process, it also makes financial sense: "a study conducted by the Oliver Wyman Group reported that 75% of banks estimate that automated onboarding will lead to revenue increase per client of about 10-30%." Connect with new software and practices which trade bloat for speed and convenience.

Innovation is the only way to withstand the onslaught of disruptors, and innovation thrives in the face of adversity. As the fintech sector grows, new start-ups continue to sprout up, the old guard cannot allow itself to stand still and stagnate. Innovation is the only way to keep pace with the future. Allow yourself to worry when Square rattles its sabres, but then take a step back, size up how Square is directly disrupting your business, and confront it head-on. Square is not likely to go away any time soon, and if you want to stay relevant, you're going to have to reckon with it sooner rather than later.