At Square, Growth is Good — At Least It Could Be

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starbucks_square-2In the market for a billion dollar startup? You can cross Square off of your holiday shopping list.

In an interview published Wednesday, Jack Dorsey, chief executive at the payments firm, told the New York Times’ Farhad Manjoo that the company has never “been in any talks about an acquisition with anybody for our nearly six years as an idea and over five years as a company.” He also rejected rumors that the closely-watched firm was under duress financially, framing the losses — pegged at $100 million by the Wall Street Journal — as intentional investments in the business.

“‘Loss’ is an interesting word. You can consider it a straight loss, or you can invest in the company to grow the company so you can grow the network and the base of people using the service,” said Dorsey. “At any point, we can decide that we want to have a profit from our payments business and slow down the growth of our business. That’s not the choice we’re making, because we want to grow into a global business.”

It’s unclear whether Dorsey implied that the company currently profits from the payments business and reinvests elsewhere; or whether he considers the low rates it charges merchants for interchange a form of reinvestment. Dorsey defended the payment processing business in the interview, but he did suggest that the growth of the company could eventually come in part from secondary products that build around the payment data it processes for consumers.

“I think it’s important for every business to have a core you can depend on, and that is payments for us,” said Dorsey in the interview. “But there are businesses [like Square Capital] built around data that have a higher margin, because it’s all software. So we are investing in those businesses to build up the core business.”

The idea of offering a product at or below cost to grow a business early on would not be unique to Square. Uber, for instance, is widely known to slash prices upon entering new markets in an effort to starve out smaller, and less-capitalized competitors. The network effects implicit in the on-demand model create far higher switching costs for both riders and drivers, allowing the company to eventually raise prices without sacrificing liquidity once the network is large enough.

The problem for Dorsey is that Square has largely failed to build the type of consumer-to-business network needed to lock in consumers and merchants. Earlier this year, the company killed its wallet initiative, once considered the future of the firm, replacing it with a still immature online ordering app for cafes. That leaves the company in the dangerous position of building a billion dollar software-as-a-service business in a fragmented small business market seeing immense investment and innovation.

To an extent, Square’s mistake was in trying to tackle the consumer market in the first place and ignoring a far subtler, yet potentially larger, network: the merchants themselves. As I’ve argued before, cloud-based business software firms, Square included, have an unprecedented opportunity to create products that help businesses share resources more efficiently.

Consider Square Capital, the company’s micro-lending service which Dorsey highlighted as an example of high-margin product in the interview with the Times. With access to the operational data of thousands of businesses, the company can identify strong targets and eliminate some of the costs implicit in small business lending.

The basic idea is that these companies can use software to replicate the economies of scale that have given large local sellers a competitive advantage for decades and create a platform whose value grows exponentially with each additional user. These networked products — applications which become more valuable with each user — will allow a handful of business software companies — possibly Square — to thrive from the same network effects that helped Facebook, Twitter and now, Uber dominate their respective markets.

Steven Jacobs is Street Fight’s deputy editor.