The New Money

In Silicon Valley, every serious startup has a founders’ story.

In Christmas of 2008, Jack Dorsey, the creator and chairman of Twitter, was visiting his parents in St. Louis. At the time, he was at loose ends. Twitter had five million users, but in October he had been replaced as chief executive by his better-known cofounder Evan Williams, who, rich from the sale of an earlier company to Google, had funded the original development of the communications network. Dorsey was wondering what he should do next. He felt it should be something big and complex. The economy was in a recession, but that was the best time to begin a new venture, he believed. “Everything has been cleared away and you can start fresh,” he explains.

In St. Louis, Dorsey came across Jim McKelvey, a serial entrepreneur he knew. “Jim was my first technology boss,” says Dorsey, who at 15 had written CD-ROM software for McKelvey. “We’d not spoken in years, and I had to tell him what Twitter was, but we immediately decided that we wanted to work together again. We didn’t know what. But we spoke every week. One day in February he called me and said, ‘I’ve just lost a $3,000 sale because I couldn’t accept credit cards.’”

McKelvey himself was in semiretirement from technology: he had become a glassblower. “I was trying to sell a lady from Panama a glass faucet,” he recalls, “and I couldn’t process American Express from my studio. I was talking to Jack that afternoon on my cell phone, and I was struck by the irony of the fact that I was holding in my hand most of the hardware I needed to complete the sale.”

“There we were,” Dorsey adds, “with these general-purpose computers pressed to our ears, because we were both iPhone users, and I began wondering, ‘Why couldn’t he make that sale?’ And the next time Jim came into San Francisco, we sat down with a programmer and said, ‘We want to figure out how to process credit cards.’”

It took a month to create a prototype. Dorsey concedes, “I had no idea how to start.” In fact, an iPhone doesn’t have all the hardware necessary to accept credit card payments; McKelvey had to build a magnetic reader through which cards could be swiped. Dorsey wrote the software for the server that would process the payments; Tristan O’Tierney wrote the iPhone app.

In March of 2009, the founders demonstrated the system at a small, private conference run by the boutique investment bank Allen and Company. They toured the offices of the credit card companies that would be their most important partners and showed them the prototype. In November, they raised their first $10 million in funding. And on December 1, @jack posted to Twitter: “Announcing our new company, called @Square, which I’m thrilled to be a part of …”

On a bright winter’s day in January, I visited Square’s offices, which occupy a floor of what was once the San Francisco Chronicle Building. They were new digs. When I complimented an ushering employee on their design, she said that Dorsey cared about such things, and accurately described their décor as “Apple meets Mad Men.” There were long rows of white benches with large Mac monitors, surrounded by glass conference rooms with modernist lighting and geometric wallpaper. The floor was polished concrete; the original wooden paneling of the Chronicle’s offices had been preserved. Most of the benches were unoccupied: there was room to grow.

In one of the conference rooms, Jack Dorsey, a slight 34-year-old who speaks in quiet, measured tones and smiles seldom (and then only gently), told me he soon discovered that there were good reasons why ordinary people couldn’t accept credit cards: the payment system is extraordinarily complex, opaque, and expensive. More, the complexity benefited a number of established interests.

“If I start a coffee store and I want to accept credit cards because no one uses cash or checks anymore, there’s this massive friction,” Dorsey explained. First, one must apply for a merchant account from a bank or through an independent sales organization (ISO), a middleman that serves smaller merchants. The application requires a credit check, which can take a week. There are startup fees of $35 to $40. One must buy hardware, which can cost as much as $900 for a system that’s wireless and mobile. Transaction fees can be to $15 to $25 a month, even if customers don’t buy anything.

“So there I am,” said Dorsey. “I’ve got my cash register I bought from Costco for $700 that’s basically a calculator with a cash box. And now I’ve got this other ugly box for taking credit cards. And when someone finally wants a cappuccino, I’ve got to type into the first box what they’re buying, and then type into the second box the number that comes from the first box, and then swipe their card, and then give them a piece of paper to sign and the receipt from the first box, so now they have two receipts—and it just becomes this mess.”

“And that’s just to get started,” added Keith Rabois, Square’s chief operating officer, who formerly directed business development at ­PayPal and LinkedIn. “The way the payments industry works is obfuscation. Everyone teases you with low rates like [a] 1.7 percent [charge on transactions], but the real rates are much higher.” Accepting payment with a debit card might incur the lowest rate for the merchant; a charge card such as American Express might demand a 2.79 percent fee on transactions; but a credit card, which is asking the merchants to subsidize its rewards program, might charge 4 percent.

Square’s innovative payment system eliminates all of this: there’s no credit check, no hardware costs, and no fixed costs. For any transaction, Square charges 2.75 percent plus 15 cents, a blended fee from which it repays the card companies and earns its profit. That’s it. (UPDATE: On February 22, Square dropped the 15 cents charge: their fee is now just 2.75 per transaction.)

Rabois demonstrated his company’s product. He plugged a 2.5-centimeter white plastic square into the audio jack of his iPhone, launched an app, tapped a number, and showed me a simple gray screen. (It cost me two bucks to see Square demoed.) I handed Rabois my American Express card; he swiped it through the card reader, also called a “Square.” (Invisibly, the reader converted the card’s magnetic data into an electrical signal; the app turned that into an encrypted file; and the phone sent the file to Square’s back-end servers, which transmitted the transaction through the global payment network.) A second, equally simple screen appeared and prompted me to sign a field with my finger. I was asked whether I preferred a receipt by e-mail or SMS; I chose e-mail, and typed in my address. A final screen told me the transaction was complete. Seconds later, the receipt appeared in my in-box.

That’s all it takes to pay someone using Square. Creating an account to accept payment is only a little more complicated. All one has to do is download an app from the Apple App Store or Android Market to an iPhone, iPad, iPod Touch, or Droid device; read the terms of Square’s service; type in name, address, telephone number, and Social Security number; and answer a series of personal questions that verify identity. Two days later, a free Square arrives in the mail, but even before then, one can take payment by manually typing in a credit card’s number, expiration date, and security code and the card holder’s zip code. To get paid, one gives Square one’s bank routing and account numbers.

All this feels surprisingly satisfying. Square is elegant. The user’s flow through payment or application has been reduced to the fewest possible steps; the app has minimal features. This emphasis comes directly from Dorsey, who says, “I’m really good at simplifying things.” He espouses a tremendously attractive belief that good industrial design wins customers’ trust by disappearing.

He explains, “People think of design as being visual, but to me it is editorial: ‘What can we take away to get to the essence of what we’re trying to do?’ What I love about a really well-designed product is that you don’t think about it. Steve Jobs is a great editor: when you use an Apple phone, its form fades away and all you think about is the content. I want a similar thing for Twitter. With Square, we’re trying to accept payments. We have two groups we need to address: our users—the merchants—and their users, consumers. We want the merchant to be focused on taking a payment. And for the consumer, for me, I want to be able to walk into a coffee store, enjoy my coffee, and walk out and eventually question whether I had paid or not.”

Square is the child of two trends, one technological and the other social: the proliferation of networked mobile computing devices and the decline of cash in favor of payment cards (see infographics).

Plugging a magnetic reader into the audio jack of a modern phone is a smarter way to process card payments. But Square is not really a hardware company. The company assumes that more phones will have card readers built into them; perhaps emerging technologies like near-field communications, which transmits data over short distances, will eliminate readers altogether. Square’s little white dongle hardly matters: it just introduces the idea that anyone with a smart phone can now accept credit cards. Square is a software company whose essential innovation is a disruptively simpler process for payments.

Already, Square appeals to a large number of people, who are unusually passionate about what is, after all, a financial service. Fifty thousand people enrolled in a pilot program, which began shortly after Dorsey announced the company on Twitter. From the system’s official launch last October through December, 100,000 activated accounts. In January, 65,000 signed up. Rabois says that the company hopes to process $1 billion in transactions in 2011. (It would be a stretch: today, it is processing $2 million to $10 million per week.)

Ayr Muir, the founder of Clover Food Lab, which runs vegetarian trucks and a restaurant in the Boston area, signed up for Square’s pilot. “Credit card systems are awful,” says Muir, who is a graduate of MIT and Harvard Business School and a former ­McKinsey consultant. “The merchants [the ISOs] are shady: they’re not transparent, they don’t give you fair rates, and you end up paying much more than you expect to pay. Everything is very expensive. We had iPhones and Touches, so an alternative way to take payments was exciting.”

But the system was built to serve a broader group of users than small merchants like Muir who already have some kind of mobile credit card terminal. In fact, it’s difficult to delimit the startup’s ambitions. Rabois says the company’s first likely customers are around 27 million American businesses that cannot accept payment with cards. Additionally, there are 33 million Americans who sell goods and services occasionally, taking payment in person in cash or checks. There are seven million American business owners who, like Muir, already have a credit card terminal but want a better way to process mobile payments. Finally, Square wants to begin offering payment systems outside North America in 2012.

Dorsey talks about ubiquity. “I think of Square in the same way we thought of Twitter,” he elaborates. “We’re building a utility. Square scales from individual commerce—you’re selling a couch on Craigslist, or you’re a piano teacher—to small businesses like lawyers or house-call doctors or interior designers, to established retailers like cafés or food trucks.”

Its growing list of devoted users, the allure of its potential market, and Dorsey’s celebrity have all made Square a sought-after investment in Silicon Valley. In all, the startup has raised $37.5 million from Sequoia Capital, Khosla Ventures, J. P. Morgan Chase, and a long list of celebrated entrepreneurs and angel investors, many of them Dorsey’s friends. (There is a common sentiment in the Valley that @jack’s replacement by @ev was a grave injustice.) The Wall Street Journal reported Square’s valuation to be $240 million, a swollen sum for so new a company.

A different kind of endorsement has come in the form of large corporations joining the mobile payment business. VeriFone has launched Payware Mobile, Intuit has launched GoPayment, and TF Payments has launched FocusPay: all allow users to accept credit cards by fixing magnetic card readers to smart phones. These large companies have observed the same general trends that sired Square, and they know that global mobile payments totaled $79 billion in 2010; the sum is expected to grow to almost $119 billion in 2011 (see infographics).

Rabois claims not to worry about outsize competitors. Their hardware may resemble Square’s, but they are not offering users a new payment system. Like traditional ISOs, they resell merchant accounts, and with those accounts come the complexities, opacities, and expenses of the traditional payment systems. “I worry about internal issues like having a zero-defect product,” Rabois says.

Rabois should worry. Internal issues plagued the launch of Square’s service.

People who signed up for the pilot program waited a long time for their Squares. When the readers finally arrived, they were not easy to use. Because the read head was so much smaller than conventional heads, it didn’t always capture the card data: people were forced to swipe cards repeatedly. In addition, the original Squares wouldn’t work with the iPhone 4’s external metal antenna bands. (Ridiculously, users were seen slipping a scrap of paper between the reader and the phone.) There were problems, too, with managing the risk of fraud: to limit its exposure, Square at first imposed a $100 cap on transactions, which severely constrained how the system could be used.

These problems disappointed many early adopters. “I had to swipe two, three, seven times,” says Clover’s Muir. “It was sort of goofy.” He applauds the simplicity of what Square is doing, but he adds, “For me, they only need to do a few things, and they need to get those things perfect.” Those things involve speed, dependability, and what he calls “price parity.” He means that Square’s transactions fees should be no more than the rates advertised by ISOs and banks: if he’s selling a $5.00 sandwich, a fee of 2.75 percent plus 15 cents is too expensive. (Square would tell Muir that he’s paying more than 2.75 percent on many of his transactions but can’t see it because the traditional system is so opaque. Dorsey says, “When you ask, most merchants don’t know what they’re really paying.”) Muir concludes, “Payments are a mess, and someone is going to solve the problem, but I don’t know if it’s going to be Square, or Verifone, or someone else.” For now, he uses Square as a secondary system if his credit card terminals fail.

Square’s executives say they’ve fixed the initial problems, although they are committed to their blended fee. McKelvey, who until recently was in charge of the company’s hardware, increased the size of the reader, and the startup’s engineers improved the app’s ability to process the signal: today, a card will very often be read with a single swipe. Square abandoned the unpopular $100 cap in transactions and in its place imposed a “threshold”: if a user takes in more than $1,000 in one week, the amount over that sum is not paid out immediately but held for 30 days in case the funds must be returned. If a user provides Square with additional information or proves trustworthy over time (another kind of information), the threshold is raised.

Dorsey insists he doesn’t mind if Square makes mistakes. “I think we should make lots of mistakes and learn from them,” he says. “Mistakes are great, so long as the users aren’t hurt by them.”

McKelvey’s glass faucet (a lovely, ridged golden-orange spiral) is now installed behind a bar at the company’s headquarters. ­McKelvey sold it to Dorsey on Square.

There may be great value and even beauty in making simple and transparent a system that was complex and opaque, but that’s not what makes Square really interesting. The source of its fascination is that the startup could digitize payments now made with cash or checks and the resulting data could be mined to extract valuable information. “Ninety-four percent of all transactions are now offline,” Dorsey told me, shaking his head at the possibilities.

Certainly, that’s the real reason Square’s investors are so interested. Gideon Yu, who was the chief financial officer of Facebook and treasurer of Yahoo, and who is now a partner at Khosla Ventures, spends one day every week at Square, minding his firm’s investment. He says, “Complex problems are necessary but not sufficient to create an opportunity. The information, the analytical benefits, that Square provides are going to be the major driver of value in the future.”

No one at Square really knows what “value” the information will provide. The governing assumption is that surprising things will happen as Square becomes broadly adopted, just as they did as Twitter grew. Yu offered this example: “Here’s just one, which in itself could be a billion-dollar business—what if we could combine your transaction data, your geodata, your social data, and analyze it to give you a much better, multidimensional idea of your credit score?”

Dorsey provided another: “What’s most interesting is the data. Imagine you had Google analytics for your coffee store—not just how many people bought your cappuccinos, but what was your busiest hour and how many also bought biscotti. Online businesses have that data; maybe Starbucks and Peet’s have some; but most businesses don’t. Businesses need that data to grow. You can make critical decisions with that information. We’re the only ones with itemized data of what people are buying and selling.”

When asked the difficult, personal question—why Square after Twitter?—Dorsey began to talk about these larger opportunities. “My background is in real-time transactions,” he said. (It’s true: after dropping out of New York University, he moved to Oakland and wrote dispatch routing software.) “I love low-level stuff. Twitter is about minimizing frictions around communications. But there have been innovations in communications for hundreds of years, and lots of them had really good design. But you can’t say the same thing for payments. When I think of the opportunity to design that, to get down to its essence—I don’t think anyone has ever done that before.” He asked me to try to visualize a real-time map of how people are spending their money: “There’s no greater indicator of interest than purchasing something,” he said.

I was finished with my interviews. It was the end of work on a Friday. I was invited to stay for the company’s weekly “Town Square.” Employees pulled chairs into a makeshift theater, opened microbrews, drank wine. At these events Dorsey sometimes rouses the troops. But on this occasion, in keeping with his guiding management philosophy of the chief executive as Zen editor, he didn’t say much, happy for his staffers to tell each other about their work. Rabois moderated. He presented the volume and number of transactions processed; the company’s graphic designer unveiled a minor refinement of the already austere logo; someone in customer relations explained a new interface for online support.

They were all cool kids: the boys wore Buddy Holly glasses and low-slung jeans and had stubble and tattoos; the girls wore flat shoes and tight jeans and had bangs and tattoos. If it had been Brooklyn, they’d have been affectless artists. But it was San Francisco, so they worked for a technology startup, and I listened as they cheered each presenter, transparently sincere in their enthusiasm for Jack Dorsey’s vision of making payments beautiful.

Jason Pontin is Technology Review ’s editor in chief.