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Comment by tibbon | Hacker News Reader

So two things that I've never understood.

1) Why is it just now that someone's actually providing competitive service in this space? We've had people selling CC machines and service for years...

2) Where (in general, not just with Square) does the money actually go? It seems that prior to Square announcing this, getting under 2-3% or so was nearly impossible. On the scale of the US economy alone, that's HUGE money. What are the fixed per-transactions costs? Its just pushing around bits in a system right?

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Hi tibbon!

To answer 1:

Almost all of the fee structure goes to players much higher up the chain than Square. The networks take a chunk, but in fact most of the fee goes to the originating bank (the bank that issued the card). This is a major source of income for most banks these days and can generally be arbitrarily set by them since merchants not only have no other options except cash, but also cannot tell what their interchange fee would be prior to accepting the charge (except with a flat rate system like Square). So, because processors (Square) do not control the rates, there is no way for entrants to create any real competition around them.

Not to mention that 2.75% is actually kind of high as an overall average and that the rumor is that Square actually operates these fees at a loss currently.

Now, as for 2:

As I said above, most of the fees go to the bank that issued the card (1.5-2.0%), another part goes to the network (VISA/MC), and the rest to the processor (Square). This is indeed HUGE money. It is literally hundreds of billions of dollars of revenue and profit controlled by a handful of banks. A high-ranking employee at a major US bank once told me that if you break down their corporate profits by division, interchange fees alone account for a significant portion of the entire bank's profits!

So, suffice it to say, if we (the entrepreneurial world) can figure out how to create an interchange free system, its inventors could possibly be some of the wealthiest people in history. I happen to have a strong business plan along these lines and would love to share/discuss it with anyone interested. Let me know!

edit: typo

Please do get in touch. My HN username @ gmail

I am interested in hearing what you have to discuss.

Cool. You can reach me at my username at gmail.com.

Actually most (depending on the card, the great majority) of those fees end up going right back to the cardholder. Those fees are what pays for all those airline points, cash-back discounts, guarantees and liability protections, purchase insurance etc.

Another way of thinking about credit cards is a way that a large groups of customers are able to band together to collectively demand discounts, rewards and other valuable protections from merchants in exchange for their business.

The banks compete amongst themselves to win your business as a cardholder by trying to negotiate higher discounts from merchants. (the fees paid by merchants are called MDR or merchant discount rate).

Very interesting!

Perhaps I'm a minority here, but I actually would more prefer just simple cards that are used for payment than a reward-based card (which is why i have a very basic debit card from a credit union). All the airline points and discounts just strike me as marketing more than a real benefit. US Airlines keeps reminding me of the number of points I've forfeited by not using them enough... as if that will make me want to use them more and still not get free flights.

Completely agree. But since VISA/MC control the network, even your basic debit card from a credit union costs merchants 2-3%.

What is needed is an entirely new network....

At least for Airlines it seems to be more about status than the flights.

Having a premium membership on United for example lets you use expedited lines for checking luggage, security and boarding. In addition you get free checked luggage, better customer support and are more likely to get upgraded to first class and are all around treated better by United.

I've never been into getting mileage or whatever, but rewards cards can be very handy. I basically get 1% off of everything I buy -- I've got a card through Amex with no annual fee that simply sends me a $25 gift card in the mail every time I spend $2500. It's basically effortless -- all I have to do is pay with two cards every once in a while after getting the gift card and buying something for more than $25.

If there are people willing to give you free money you might as well take it. :)

Amex has also consistently given me absolutely fantastic customer service. I'm really not in any hurry for them to be disrupted...

Not to be the debbie downer, as I use rewards cards as well. But there is not such thing as free money. This money you are getting is coming from somewhere. The banks are clearly raking in a$$ loads of cash from the merchant when you use your card. I think it's safe to assume the merchant increases the cost of their goods to offset the fees he pays for transactions. So, the merchant sets his prices 3% higher than he would have to, you pay that extra 3%, get 1% back and think "oh, goodie me, free money", and the merchant breaks even. Sure, you come out 1% above people not using rewards, but it's a net gain of -2%. Credit card companies win.

Like I said, I use rewards cards as well, it's a bit of a tragedy of the commons if you will, everyone just trying to offset their costs for a little, but this just causes the hidden costs to continue to rise.

This is a very good point, I wasn't entirely clear there. I meant free in the context of someone who's already using a debit (I assume processed-as-credit at most merchants) card, yet missing out on many of the benefits offered by many credit cards.

I disagree about the tragedy of the commons part -- specifically that it's any tragedy. In order to keep the discussion simple I'm not going to go into the potential for abuse (which is a serious problem) and the charge-vs-credit card distinction, but overall I find cards to be enormously beneficial compared to cash: I can buy pricier items without having to travel to the bank to take out cash in advance or mess around with checks (an annoying, less-secure system that rather scares me fraud-wise), I can buy gas without going inside the building, I can buy things online with ease, I can dispute charges in case of fraud or if a merchant trys to pull a fast one or never ships me the item (and I've been able to do this successfully), and I wouldn't really be out any money if someone stole my wallet, I'd just need to make a few phone calls and get some new cards overnighted to me. For free. It's tremendously convenient, and to me, completely worthwhile.

It's amazing how quickly the world can change these days: it's an industry that's about a hundred years old that pretty thoroughly changed the world and has already made it to the "unpopular incumbent" stage.

You make good points, I agree with the benefit of cards over cash as well. And who wants to lug around a checkbook when I can just put a small piece of plastic in my wallet? There is definite value in that. Maybe even 3% value. I think CC companies may get the "unpopular incumbent" label because most people are not even aware of how credit cards work, and their costs are often times hidden. I mean hidden in the sense that we don't realize the price increase of goods this convince is costing us. I bet if the apple store started selling mac pros at 3% under retail price for cash, more people would inconvenience themselves to pay in cash. But many people are not properly informed, and therefore do not act as rational players. Many jewelers seem to play in this realm of cutting prices for cash buyers. (I know, there may be other reasons for that, but it's an example of merchants incentiveizing buyers to use cash)

Most merchant agreements prohibit offering a discount for cash purchases. Those jewelers who do it are probably betting that they won't get caught and have their CC processing yanked. What this means is that in effect everybody pays slightly higher prices in to cover the fees for accepting credit cards.

Interesting to know, I was not aware of that.

Jewelers are different, they can negotiate price, nobody pays retail at a jewelry store, that gives them flex around these cc agreements you speak of. The other reason jewelers often take cash is they let you off the hook for sales tax, which can be risky for them, yes. The jewelry business is fascinating, and full of "old guard" industry type practices, I didn't get fascinated with it until I started looking into buying a high end watch. But I digress.....

This is not quite true. They can offer a discount when paying in cash, but they can't charge an extra fee when a credit card is used after the agreement to purchase.

Source: http://usa.visa.com/personal/using_visa/checkout_fees/index....

The 1% payout you describe seems to be about the max that customers end up with. Maybe some store specific cards are slightly higher, and maybe the right airline miles.

There are several cards that give 2% flat on all purchases. You can also do much better if you use specific categories across multiple cards, for example there are cards that give 5% for restaurants.

Most of those very high reward rate cards come along with significantly higher interchange fees (4-5% or even higher). Merchants abhor them.

I'm dubious. I just glanced at my interchange plus billed Merchant Account Statement, and the highest I saw was 2.95% + 20 cents for a couple international business rewards cards. I suppose you could count this as 5% for an under $10 purchase, but do you have a specific example of a card that exceeds 4% on larger transactions?

This is definitely not free money. The problem I have with rewards cards is that they lead to higher prices (since the banks aren't gonna give back any of their fees to pay for the rewards) and therefore merchants have to raise their prices to compensate. So it becomes a bit of an arms race -where people who don't use reward cards end up paying more (since they pay higher prices without the small discount from the reward).

If you're in a business with small-ish margins and your suppliers don't charge you extra for taking credit card, a cashback or other rewards card can actually measurably move the bottom line.

There are cards that do that - e.g. some of the merchants have store cards that give you immediate discount - e.g. I have one that makes 5% off anything I buy in a particular big store chain. I guess for airlines it is worth it even more since airline tickets cost hundreds of dollars, so if they can avoid paying couple of percents of each transaction to intermediaries by having their own card brand that adds up to serious money, and since they control points program they can give out points so that it's still profitable to them.

Well, yes and no. Indeed those fees do pay for cash-back and airline points and such, but most benefits-style cards have significantly higher fees than the standard 2-3%. For instance, my research last year showed that my AAdvantage Citi card was closer to 5% in total fees to the merchant. This is what is called a non-qualified rate. You can read more about it here:

http://en.wikipedia.org/wiki/Merchant_account#First_Tier_-_Q...

And an example of a processor's fee schedule here:

http://www.gotmerchant.com/merchant_fees.php

Meanwhile, my debit cards (which are almost always processed as credit since I don't like typing my PIN) still collect 2-3% and I get no benefits.

I'd be surprised to hear they're operating at a loss in terms of the fees alone. Most of us are used to seeing fees quoted by PayPal, Stripe, Amazon and other processors for internet transactions. Card-not-present interchange fees are higher than card-present fees because of the higher risk. Square should be getting much better rates from their processors since they're handling in-person transactions.

That's just the news I was hearing from people who have seen their financials.

Let's say they aren't operating at a loss though. The processor typically receives 25-50 basis points on a transaction (0.25-0.5%). Let's assume Square is receiving 0.5% and generating revenue from their transactions.

At $5B/year in processing volume, that means that Square's revenue is 0.005 * $5B = $25,000,000.

$25,000,000 in revenue for a company worth $1B+? That's an extremely high valuation (40x revenue or more). And that's before figuring in all of Square's costs.

Basically, all of the people who look at the numbers don't see how Square will actually become a highly profitable company in the near future.

I have no insight into Square's management or financials, but if I were Jack Dorsey, I would find it reasonable to operate at a moderate loss for a fair amount of time, before launching my own exchange system that bypasses cards completely.

Indeed, that seems to be the way they're going, what with _Pay with Square_ allowing for contactless, mobile-based payments.

First they disrupt card processing for small merchants with low transaction rates that just murder traditional merchant account fees. Next, they get themselves involved on the consumer side of the transaction, abstracting away the physical card. What's next? Why not do away with the card entirely?

How about _Pay with Square_ prepaid accounts? Allow users to fund their accounts via store-bought gift cards, or Dwolla, or perhaps even go crazy and accept Bitcoin. If they do that, then Square could give that 2.5% transaction fee back to the consumer, and profit from the interest on the float.

I agree that may have been a good strategy (and may have been their original strategy) but with $100m in cash from VISA, it's very unlikely they will launch a competing network.

Also, all of Square's payments including digital ones still get processed over VISA/MC/AMEX and still have interchange. Getting rid of the card itself does no good to lower fees.

Prepaid accounts would definitely work though. Again, Square probably isn't interested (and may be prohibited) from competing with VISA/MC though.

> but with $100m in cash from VISA,

I was unaware of this; that does make a significant difference.

Excellent analysis. Agreed that valuing Square as a credit card processor makes for a very frothy, perhaps unjustifiable, valuation.

My belief, however, is that some investors are betting on Square's potential as much more than a credit card processor -- really, more of a data and payments platform. If Square can own the marketshare of payment transactions happening offline, then other monetization opportunities appear and the credit card processing is more of a loss leader or infrastructure investment (e.g., Amazon investing in warehouses and supply chain management).

Some of the other opportunities include: coupons (they know exactly what you buy and can tailor deals); analytics (e.g., household good purchases dropped by 25% in San Francisco last month); recommendation engine (I ate at these restaurants last month, this week Square recommends these); and a replacement network for credit cards, though this seems unlikely in the near term because of the difficulty factor and the fact some big banks are investors in Square.

While there are assuredly other ideas, and while some of these may never yield profits, the macro point is that investors are betting that Square can monetize payments data and payment identity in new ways -- if it can become the new funnel through which everyone pays businesses in the offline world.

> would love to share/discuss it with anyone interested. Let me know!

How? The "about" field in your profile is blank.

My mistake! I've updated it and my email is my username at gmail.com.

"figure out how to create an interchange free system"

In my view, this is the potential of bitcoin...an open platform for payments that doesn't require trusted third parties. I don't think a single company (or even country) could pull it off, but a new open protocol (like SMTP but for payments) that runs on the internet could do it.

I'm making a bet in this space (see profile).

I'm working on an "SMTP for payments" protocol. I'd like to turn it into an RFC someday, after some problems are solved.

2-3% is over-estimating things. Online retailers pay that much, anybody charging credit cards at a physical location should be paying more like 1.75% in fees.

I take credit cards at a physical location for a physical product, and think I have good rates. We do $10-$20K per month, and averaged across all cards and including all fees we pay about 2.6%. I've checked with FeeFighters and others, and have never seen a legitimate quote as low as you suggest. I don't know if the savings are enough to cause us to switch (we use Square as a backup), but I think that for certain merchants this new offer is the best rate around. If you speak from experience and are currently paying less than 2% total fees in the US by some other means, please tell me how you are doing it!

I'm not currently paying less than 2.6%, because i deal exclusively with online transactions. All i know is that most of my clients who handle offline transactions through another provider are shocked at paying over 2% when they start collecting money online.

and my experience is in Canada, not the US, but in general our rates are slightly worse here. Your rates might be high because your volume is pretty low.

Perhaps Canada actually has better rates than the US, but my general experience has been that people who say they are paying less than 2% aren't actually looking closely at their bill. My guess is that your clients are wrong, and are quoting the best-case advertised rate they signed up for, rather then the actual all-included cost they pay. But maybe they could get that low if their average transaction is high enough and they are in an extremely safe industry?

because when you go up and up the ladder, eventually you end up with 5-6 huge companies that control everything...not too surprising when the companies end up with similar pricing.

I mean take credit cards for example. You have Visa and Mastercard with the majority of the market. Then you have American Express and Discover that have a tiny portion.

That's it. And that's more or less worldwide.

You'd think since the coming of the internet, we'd have at least some competition in this space. Just imagine how much money there is, in join Mastercard/Visa as a top 3 credit card.

Square is a little lower down the chain, so the main thing they are giving here is passing through their huge savings down the pipeline. But even then it's not 100%.

Their basic pricing is 2.75%. So essentially you need to sell $10,000 worth of stuff before you start profiting off the $275/mo...and you only have until $20,000 before you go up to the regular 2.75% pricing.

And 2.75% is pretty high...for credit card processing.

There are virtually no fixed costs to actually performing the transactions. The fees are levied by the not-so-competitive Visa/Mastercard/AMEX trio that would love to keep their fees artificially high.

There are plenty of costs though, operating global real time processing networks is not free.

there are actually a ton of costs for them.

They have to pay for infrastructure, they have to pay for customer support, they have to pay for fraudulent transactions and on and on. I think most credit card companies have something like 10%-15% ROI

Their fraud costs are not what you make them seem. The credit card companies do not take on the risk for fraud most of the time. They push that risk onto the merchants.

This is why large e-commerce companies have giant fraud departments trying to prevent fraudulent orders and charges on their site; because when they occur, they generally just eat the loss.

Actually the merchant is only liable for the loss if they did not follow all of the rules and regulations for processing the credit card.

From wikipedia (http://en.wikipedia.org/wiki/Credit_card_fraud#Merchants): "The liability for the fraud is determined by the details of the transaction. If the merchant retrieved all the necessary pieces of information and followed all of the rules and regulations the financial institution would bear the liability for the fraud. If the merchant did not get all of the necessary information they would be required to return the funds to the financial institution. This is all determined through the credit card processory."

From what I have seen, it is very common for the merchant to be liable for losses on a card not present transaction (e.g. online retail) but the credit card company stomaches the losses for a card present transaction.

I suspect that online merchants could reduce their liability by implementing things like Verified by Visa but choose not to because it causes them to lose too many legitimate sales.

The networks get very little (IIRC a small flat fee per transaction on the order of 5 to 10 cents, but I don't have our pricing in front of me and it's some of the most opaque pricing you'll ever see) - most of interchange goes to the issuing bank.

Blame the banks issuing credit cards for the high rates, not Visa and MC (both AmEx and Discover are, effectively, their own issuing banks - so go ahead and give them their fair share of the blame)

Interchange goes to Visa, MasterCard, et al not the issuing bank. This is their vig.

Sorry, no. Fees are paid to the issuing bank, acquiring bank, and network. The majority of it goes to the issuing bank, and that's the non-negotiable rate when you get a merchant account. That fee is known as the interchange fee. The processing fee is something you negotiate with your gateway and/or acquiring bank.

I work in the industry; it's my job to know how this works. Here is an example from Wikipedia (bear in mind the amounts are fictitious but relatively accurate): http://en.wikipedia.org/wiki/File:Gao-report-on-interchange....

It's great to know that you work in the industry, but it's irrelevant; argumentum ad verecundiam is a logical fallacy and only serves to demean your argument.

To address your point, I understand interchange as being set and collected by the card network, and is non-negotiable. Anything off the top is left for the banks to keep for themselves, e.g. the plus in "interchange plus" pricing). Another example assume a hypothetical interchange of 1.5% and a merchant that has a merchant account that costs 3.5% + 30¢ (gateway) per transaction. In this case the card network takes 1.5%, the gateway 30¢, and the banks 2%. Is this not how it works? It would be nice if you could cite something (not trying to be an ass in case it reads that way :).

2) Much of it goes to the credit card interchanges (Visa / MC / Amex / Discover). Those are the folks that end up with the bulk of all these fees. Processors are middle-men that make a surcharge on those rates. Many "traditional" merchants offer interchange-plus rates now.

As for 1), the emergence of mobile devices have really enabled this to happen. Square is really useful in the mobile environment. Prior to that, it was Internet merchants and traditional POS systems.

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