Is There a “Big Win” for the Payment Startups?

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When you say “PayPal,” everyone working in digital knows what you’re talking about. It’s one of the great online success stories, and one that’s even more impressive considering the challenges within the payment business. Security breaches, massive fraud vectors, state and international laws make it hard enough, and then the business must operate at the whims of massive national banks and clearinghouse companies.

More than a decade after PayPal’s introduction to the market, a new crop of startups, including Square and LevelUp, have entered the space with hip technological payment solutions. However, the problem is that none of these companies are filling a hole the same way PayPal did, and there’s no reason to believe that any of them can unseat the entrenched monsters dominating the market. In fact, one player, Verifone, is already exiting the mobile payment game. If established giants like Verifone can’t win in the payment processing space, where is the opportunity for the new venture funded entrants to profit? Customer relationship management and data mining are two likely, albeit difficult, potential models.

None of the new crop of startups can overcome the daunting economics of defeating existing payment processors on price alone. PayPal is widely known because it solved an unmet need for online commerce, but now, every small business already has a credit card processing system. And if they don’t, merchant account vendors are likely beating down the door to sign them up. Other small businesses are far less sophisticated, employing cash registers that are barely one step above a shoebox, with the sole function of storing cash. In short, very few delis or dry cleaners have an iPad waiting for a Square dongle.

Recently, Square has made news by handling Starbucks’ credit and debit processing following a $25 million investment from the coffee company. But as has been pointed out, it’s neither faster nor cheaper to use Square at Starbucks (and the startup is probably subsidizing Starbucks on every transaction). It appears that the payment avenue is closing quickly — so we might expect to see these startups try to carve out a niche in the CRM space, which brings its own set of issues.

Here’s why the move would be difficult to pull off: Major corporations and chains like Starbucks already employ CRM systems, meaning these startups now have to compete with Salesforce and Oracle. And the value of CRM to a small business is debatable. Yes, local businesses are built on relationships, but proprietors don’t necessarily need much more than a customer’s name, phone number and — if they’re really sophisticated — an email address. A barber could theoretically cut someone’s hair for decades without learning the customer’s last name.

Another option for a success story is a business built around mining data. Square itself seems to be headed in this direction, by marketing itself as an easy way to navigate the byzantine credit payment system world and simultaneously pivoting into the mobile app space.

Savvy small business owners — the ones who have carved out strong local bases and compete against national chains in their vicinities — can do a lot with customer purchase and loyalty data. Maybe companies like Square or LevelUp can mash up all of their purchase data into a Groupon-like platform or other offer-based system that encourages customers to revisit a retail or dining establishment. But none of this is necessarily new, and again, businesses can do this without a fancy system.

One more option for success among payment startups could be in aggregating an individual’s purchase history data, which industry insiders have indicated is worth far more to these startups than any merchant fees. Of course, this raises a new set of issues that keep it firmly outside the realm of legal activity. Will businesses willingly share data? Doubtful. Are there privacy implications? Well, if this practice was legal, rest assured that Visa and American Express would have cornered the market long ago.

There is opportunity here, but it’s all uphill, no matter which road you take. Payment processing involves fighting some entrenched vendors that won’t give up ground without a fight. CRM is a must-have for a big companies, but only a “nice to have” for smaller businesses. Data mining requires a lot of scale to extract any real value, and comes with a slew of privacy complications. This crop of startups likely won’t rip out the current credit card systems at every burrito joint South of Market in San Francisco, but they could still stand to profit from their innovations. Buzz from high-profile partnership and a pivot into either CRM or data mining might be just enough to generate a great exit at a lofty valuation.

Jon Elvekrog is CEO of 140 Proof, a social advertising technology company.


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