

Earlier this week I shared my initial observations of PayPal’s new phone-based credit card acceptance service and how I thought it stacks up against Square, the reigning champion. Overall, I gave PayPal Here the advantage, provided it works as advertised. But there is more that I want to say about business models developed specifically to enable consumers to accept credit card payments.



See, to the casual observer, it may look as if this is precisely the situation that would favor the small, nimble, innovative type of start-up that would be the quickest to enter a brand new industry and take the early lead by default. Moreover, one could say that this is precisely what took place. After all, Square did come out of nowhere and grew like wildfire. Well yes, but Square had a famous founder who was able to attract plenty of capital to get the project off the ground and has since pulled in more than $100 million in funding. And therein lies my point: you really need that much money to stand a fighting chance in this type of a project. This is why Square’s competitors are not other start-ups, but PayPal and Intuit. And there is a good reason for that.



Where Does the Money Go?



There are at least a couple of ways to do this, but any way you take inevitably leads you to the ongoing expenses associated with the maintenance of each individual user account. Yes, you do need the capital and expertise (which also costs a lot of money) to build the system in the first place, but that is more or less a one-time expense, as the ongoing system maintenance isn’t that big of a deal.



But once you get going and if you do manage to get the customers to pour in by their hundreds of thousands, that’s when it gets interesting. The thing is that the vast majority of these “customers” will never make you any money. They may use their cool new service once or twice a year, if ever, and that would be all. Because let’s face it, how often would you need to accept a credit card payment, if you don’t have a business? And even if the service provider does make a few cents from these transactions, that would not be nearly enough to cover the cost of keeping these accounts active.



Of course, it is a numbers game and the Squares of the world know that those few percent of their customers who do actually take cards regularly will make up for the losses from the others and there will be some profit left. But for the numbers to work reliably, you do need to get big enough and do it quickly, before you run out of money. Because if your growth isn’t fast enough, you won’t be able to get more funding to keep the thing going. Well, Square had enough money to pour into marketing when it got started, it grew big quickly and then investors themselves started banging on its door.



Where Do We Go from Here?



The launch of PayPal Here marks the coming of age of the industry. No start-up can possibly compete with what PayPal is offering, nor will anyone invest money in it. In fact, there may even be a question of whether Square, big as it already is, will manage to keep up.



See, PayPal gives me immediate access to my money and a live phone-based customer service to help me resolve any service-related issue. Why would I choose Square, which offers neither and charges me slightly higher fees to boot?



So PayPal has set new standards for the industry and they are quite high. Square will be forced to build its own live customer support center, which it should have done long ago anyway, but probably didn’t want to invest any precious resources into it. But whether or not Square will be willing or able to match PayPal’s immediate funding provision (Square takes a couple of days to make funds available to its users) and lower rate remains to be seen. What is certain is that few others will be able to come anywhere close to that.



The Takeaway



Square was the company that put phone-based credit card acceptance on the map. It was also the first to enable consumers to take cards directly. Ever since Jack Dorsey launched the start-up with a tweet in October 2010, Square has been the undisputed leader of the industry and everyone else has merely tried to keep up with its pace. Now that PayPal Here is live, however, the roles have changed and Square finds itself for the first time in the unfamiliar and uncomfortable position of the laggard. We don’t know how successfully Jack Dorsey’s company will respond to the challenge, but what we do know already is that the consumer is the ultimate beneficiary. I’ll take it.



Image credit: PayPal.