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Block: Square, Cash App, and Economic Access – Business Breakdowns, EP.53

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Jesse (00:01:18):

This is Jesse Pui, and today we’re breaking down Block, formerly known as Square. This software and financial services business was founded by Jack Dorsey and Jim McKelvy in 2009. It’s expanded from its first product, a payments card reader into a $75 billion company with six different businesses. All six businesses build on the firm’s mission of economic access and empowerment. Those six businesses are Square Cash App, Afterpay, title, spiral, and TBD to Break Down Block. I’m joined by Payments expert and investor at TDM Growth Partners, Hamish Cort. In this breakdown, we cover the common threads that have enabled block to organically build two major businesses, how their recent Afterpay acquisition can strengthen the connective tissue between those businesses and the competitive frontiers that block faces. Please enjoy this business breakdown. All right, Hamish Corlett, welcome to Business Breakdowns.

Hamish (00:02:15):

Thanks very much, Jesse. Great to be here.

Jesse (00:02:17):

Today we’re breaking down a business that’s near and dear to my heart, mostly because both the founders are from my hometown, my current town of St. Louis. We’re breaking down block, so let’s just jump right in. Block formerly known as Square, tell us what is Block, what does the business do, and give us a quick overview of it.

Hamish (00:02:35):

It’s a big question now because Block has certainly grown up from the original inception of the company in 2009, which was the Square card reader, which I’m sure most people have come across or are familiar with. Fast forward to today, block is a financial services and software business, which has grown up from that 2009 founding to a $75 billion market cap business, which is roughly equivalent to Citigroup fourth largest bank in the us. And it started out serving these micro and small businesses that didn’t have access to accept card payments. And now it really serves not just small businesses, but small, medium, large businesses, serves consumers, it serves developers, and now with the title acquisition serves artists. So the breadth of its services certainly expanded over that period of time. It’s got over 40 products and one of the special things that does is that it combines its capabilities in hardware, software, and financial services, which is quite unique, but if you look across all those businesses, the common thread is its mission, which is around economic access and empowerment. So if you look at all the big strategic moves they’ve made, it all ties into that one common mission. So it’s been an extraordinary growth story since IPO in late 2015. It’s grown gross profit dollars from 500 million to over 5 billion, and most of that’s organic growth and that’s a 50% odd cagr. So a similar kind of growth profile to an Airbnb or a ServiceNow.

Jesse (00:04:17):

And how is it organised? Like you said, it does so many different things today. So if we were sitting here looking at a 10 K or p and l for it, how do they organise the business? And maybe you can give us a little one-liner on each of the divisions.

Hamish (00:04:27):

Yeah, sure. So it’s organised really the way we think about it around that common purpose. There are two main ecosystems. There’s the square ecosystem and the cash app ecosystem, which you can think about as essentially a merchant ecosystem and a consumer ecosystem. The merchant ecosystem is a financial services and software businesses that provides those services to small, medium, large businesses. That’s everything from payments processing where it started to integrated payment software loans, square card, instant transfer, essentially helping businesses to start manage and grow their business. The other side is the consumer ecosystem, and that’s largely under the Cash app banner. Our Afterpay with that acquisition there, they have within a cash app consumer ecosystem that’s essentially a financial consumer application and in the former CFO’s words, that really is becoming something like a full service banking suite for consumers. So it started off with peer-to-peer transfer. They then introduced a cash card. It’s now got Bitcoin trading, stock trading and a range of other services that they’re continuing to build out. So the organising framework that we really think about is square merchant ecosystem on one side, the consumer ecosystem on the other, and then layering Afterpay, which the most recent acquisition, which is really about driving more connectivity between the two ecosystems

Jesse (00:06:03):

And beyond the 75 billion in market cap, I guess you mentioned 5 billion in gross profit. Can you give someone listening a sense for other scale, how many merchants do they power, how many users are on it? What’s the revenue scale? Just give us a sense for some of those things.

Hamish (00:06:16):

Yeah, sure. So on the merchant side of things, and I don’t disclose this exact number, but I’d say they’ve got around 3 million merchants that they serve and call it 90% of those would be in the us. They’ve also got operations in Australia, uk, and increasingly in the eu that’s a $2.3 billion gross profit business. And on the consumer side of things now with Cash App, they’ve probably got about a hundred million annual active users in that consumer ecosystem. So it’s serious scale. Again, most of them are in the us, but with Afterpay did add some international footprint there, but even after Bay half the users were in the us. So it’s largely a US-centric ecosystem. So if you compare that to say JP Morgan, the biggest retail bank in the us, they’ve got 71 million retail card holders and about 4 million businesses. So all Bank of America, the number two, they’ve got about 40 odd million digital consumer and small business banking customers. So the scale is comparable to some large financial services businesses in the us

Jesse (00:07:22):

Which is sort of crazy because as you said, it started 12 or 13 years ago, 2008, 2009. Can you take us back to the founding story? I’d love to hear the story, but in particular I wanted to zoom in on what was the insight, what was that insight they had and how did they continue to pull on that string to develop it so fast and to such a large business?

Hamish (00:07:40):

It’s an extraordinary story. It’s worth touching on both the Square founding story and the Cash app founding story, which happened within the Square business. I think if you told Citigroup that in 2009 that this little startup with a hardware magnetic strip reader was going to be a similar market cap, you’d get laughed out of the room. So 2009, Jack Dorsey’s been, I think effectively asked from Twitter and he gets in touch with his former boss that he worked for when he was a teenager. He did a summer internship for Jim McKelvy who had a software business at the time. Jim tells a story about, as he calls him, Jack the genius, where the first day he pulled an all-nighter and obviously those two had a close relationship. So Jack leaves Twitter calls up Jim and says, I want to start a business with Jim and originally suggests an electronic vehicles business, but Jim had this glass blowing business that he was operating at the time, and he tells a story that he missed a $2,000 sale because he couldn’t accept an Amex card, which really pissed him off.

They dug a little and they realised that, well, they obviously observed that this cash to card transition was happening and it was happening rapidly and there were all these micro and small businesses that weren’t able to accept cards, and so they’re effectively being excluded from the financial ecosystem. And so they saw this opportunity whereby if you’re a small micro business and you want to accept cards, the painstaking process that really mostly still is in traditional financial services of applying to the traditional financial institutions going through all the paperwork, the KYC, the 2, 3, 4 week approval period and only 40% getting approved. I thought, okay, well can we do something about this? Can we give these small businesses access to the financial system? We’ve got this smart device, this computer that we carry around with us now all the time, can we turn that into a payments device? So pretty extraordinary. Within a month they came up with a prototype, which was the Square Car Reader, and they went and raised Venture capital and away they went and the product market fit out of the gate was off the charts so good that it attracted a heap of competitors including Amazon, Intuit and PayPal in the very early years.

Jesse (00:10:08):

So they get the card reader going, what were sort of the next big milestones that happened in the business day? By 2010, the card reader was at, I remember I had one on my phone. I thought it was super cool, but obviously they’ve evolved significantly since then. So what were some of the other major milestones in the last 10 or 12 years?

Hamish (00:10:26):

I mean the major milestones is really spurred on by this viral growth that they saw with the card reader and they started digging deeper into is this a bigger opportunity than just providing a card reader to micro merchants? And the more they dug, the more they realised that there were all these small and medium sized businesses that were really underserved, both in terms of software running their businesses and financial services. They were getting really good brand recognition amongst the small business community because this card reader became really conspicuous and the brand was really getting some traction of being the friend of the small business. And as they understood the problem more, and this is a really important part of Square, they go really, really deep on problems and they have intense customer empathy that they were able to develop other hardware products and integrate software within those hardware products.

So the Square Terminal Square Register, which were for not just micro merchants but for cafes, for flower shops, for all sorts of small businesses to give them much better software, which they weren’t getting with the legacy providers and an integrated payment solution as well. So a much, much better customer experience. And then they introduced Square loans. So one of the special things that Square was able to execute on from a very early stage was to use the data from the originally with an amazing onboarding experience. So they transformed the onboarding experience from a 3, 4, 5 week paper intensive process to basically an instantaneous onboarding for 99% of merchants. And they’re able to do that for a range of reasons, but one of the key reasons was their use of data. So their approach was trust first, verify second, whereas the traditional financial institution approach is verify first and then maybe we’ll think about trusting them. So Square use the data, use the AI capabilities to look for fraudulent activity, nefarious behaviour, and that was really their verification process. So that really led them into Square Loans. Not only can they actually provide essentially merchant acquiring services, but they can then provide loans to help the businesses grow. Then they introduced things like Square Card to give access to funds for Merchants instant transfer to give instant access to funds and payroll and other business management tools. So they really built out a full suite of software and financial services, businesses, products for small business.

Jesse (00:13:07):

The merchants, obviously they had all these different components that have just grown and grown and grown, and I want to go deeper into them a little bit later. But then somewhat out of nowhere, this cash app pops up. So what is the Cash app and what’s the story behind that?

Hamish (00:13:21):

I love this story particularly because I think it took a bit of courage to go after the Opportunity. Cash app was originally a hack week project in 2013 led by Brian Grassed, who’s still the cash app general manager at the time. Venmo actually had a fair bit of traction. It was owned by Braintree and there was apparently a lot of internal detractors from the Cash app idea. The idea that it’s difficult to make money out of peer-to-peer payments. It’s already been done. And they persevered with the idea. And one of the insights that they had was again, going back to the mission access and economic empowerment. At the time around 60 million people in the US were unbanked and that created an opportunity in the same way they went for micro businesses that were totally unserved and small businesses that were underserved, was there an opportunity for Cash App to grow into that unbanked and underbanked market opportunity?

And that was really the inception. If you listen to Brian tell the story of Cash App, it really rhymes with the Square Merchant story initially starts with creating a beautiful product that is easy to use and really simple frictionless onboarding, really building in speed of innovation into the products. So get the user into the app layer in more products and functionality over time. And one of the really special things that Cash App was able to do was they were able to build peer-to-peer network effects, which was kind of an added benefit if you compare it to the square merchant ecosystem that didn’t quite have the direct network effects that the Cash app ecosystem does. The other key things that the two had in common was they were able to build really strong brands that really resonated and they were able to crack the code on mass distribution in really hard markets at scale with unit economics that have made sense since inception. So payback period for Cash app is still less than 12 months, and that’s been consistent over time. The ROI of a Cash app user is over three years is six times in Square ecosystem. You’ve got an 18 month payback and a three times ROI. The net gross profit dollar retention of the Cash app cohorts is 125%. So these are businesses with really good strong underlying unit economics. And those key three themes run throughout both.

Jesse (00:15:55):

Is there some kind of a network effect between the two?

Hamish (00:15:58):

Yeah, so in more recent years, square or Block now really started talking about connecting the two ecosystems. So you had really strong direct network effects in Cash App and they started working towards creating two-sided network effects between the demand side and the supply side, consumers and the merchants. And they had a few products that over the last few years that have started to get that two-sided network effect going. So they had an integration between Cash app and Square payroll, for example. They had cash for business and a number of other products, but this was the key to the Afterpay acquisition. That was the strategy to really introduce Afterpay to drive more connectivity between the seller and the consumer because that’s nut that Afterpay really cracked. That is a business in my investing career. I haven’t seen too many two-sided network effects that have been as strong as that one. And the beauty of that network effect is that it’s happening at the transaction level. You’re getting transaction level data and lead generation for merchants.

Jesse (00:17:12):

Wow. Kind of crazy because I guess up until 2013 or 14, they were really just a merchant side business where from what it sounds like was sort of a separate business that just popped on consumer side and now they’re sort of building the connective tissue between the two of them. Is that right?

Hamish (00:17:25):

Exactly. There’s good complementarity between the Afterpay and the block business in that their missions are very similar. I think Mick Molnar and Jack Dorsey were good friends, or at least personal acquaintances before the acquisition. Afterpay had a really strong footprint in larger merchants. Square was stronger in smaller merchants, Afterpay Stronger and Online Square, obviously very strong in offline. But I think strategically the two key components of that acquisition is number one, merchant discovery and really a demand gen element and the opportunity that Afterpay introduces. And the second one is the ability to create more in-network transactions than trying to create a closed loop network between the consumer and merchant ecosystem.

Jesse (00:18:19):

And we’re going to talk about m and a little bit later on, but just because we mentioned so many times, maybe just explain what Afterpay is and how it creates that connection between the two.

Hamish (00:18:27):

Afterpay originally Australian business founded in around 2014 by Nick Molnar and Anthony Eisen. It is really the original or certainly one of the original buy now pay later businesses. So both of them had the insight that Gen Z and millennials were moving away from credit cards and there was this moving ’em away from credit cards in general and that the credit card industry was kind of flawed in any case, and they saw an opportunity to create a win win-win ecosystem, consumer merchant and credit provider. And the basic idea was essentially I want to buy a hundred dollars pair of shoes. I go online as a consumer, I buy the $100 pair of shoes using Afterpay and instead of paying $100 to the merchant less the merchant transaction fee merchant ends up with $97 I pay with Afterpay and I pay four $25 no interest instalments over a six week period.

The merchant gets their money the next day, so they get about $96 the next day and I provide as a consumer a linked debit card which extracts the money every two weeks and Afterpay provides the credit essentially. So that elegant idea became a compelling value proposition for merchants. Broadly speaking, merchants on average found the customer acquisition conversion. Average order value went up in the order of 20 to 30%, and consumers absolutely loved it because it was not a traditional credit product and it gave them more power over managing their finances and the product market fit out of the gate was really, really strong. They were able to sign big marquee merchants initially in Australia and New Zealand, but when they launched in the US they signed the Urban Outfitters, which was the big win. The rest is history. Now they’ve got probably 20 million consumer annual actives and over a hundred thousand merchants, a lot of which are large merchants on the platform.

Jesse (00:20:41):

And my understanding, we actually did a different breakdown on it, is drove up merchant sales conversion rates dramatically. Consumers obviously loved it, especially younger ones in the fashion world, and it just became this win-win win, which is pretty remarkable, especially in the payment space. On the payment space. I want to dive into the revenue of block and how it works and how they make money. Before we do that, I’m wondering ish if you could give us just a 1 0 1 on the payments egos. There’s so many different players. There’s MasterCard, there’s Visa, there’s credit card companies, there’s banks. I don’t have a mental model in my head for how they all tie together, so I’m wondering if you could just give us a quick 1 0 1 and then explain where and how block fits into that. Yeah,

Hamish (00:21:18):

Sure. It’s a really complex ecosystem. I was on a award of a merchant acquirer payments business in Australia for six or seven years and I’ve been doing payments for many, many years and the complexity certainly doesn’t get any less at a very high level. The way I think about it is you’ve got three key constituents. You’ve got the card networks, call it Visa and MasterCard and Amex with their closed loop system. We can kind of touch on that. You have the card issuers and the merchant acquirers, so having a look at each of them. So let start with the card issues. These are generally speaking banks, but increasingly not that issue cards to consumers. So you want to get a debit or credit card. You go to a card issuer called it Bank of America or now Cash App, and they will issue a debit card for you, which gives you access to your money in your bank account.

On the other side, you’ve got merchant acquirers, so their job is on the merchant side of things to service the merchant’s payments. They’re the ones that when one of those consumers comes along with their card and the merchant needs to accept payment, they will acquire that transaction on behalf of the merchant and it’s the merchant acquirer’s job to essentially acquire those funds for and on behalf of the merchant. But the problem is you’ve got generally speaking, fragmentation on the issuer side of things and fragmentation on the merchant acquirer side of things. So you need something in the middle to make them all talk together. What are the rules of the game? How’s the clearing and settlement going to work? How do you make sure that this is a valid transaction? And that’s really the job of Visa or MasterCard. They’ve done an incredible job. They’ve got a huge motor around their business because they’re really just that protocol layer in between merchant acquirers and card issuers that make the whole system work together. In terms of how the transaction economics work out, it’s actually the card issue is that get most of the economics, call it two ballpark numbers, two thirds of the economics, the acquirers gets say 30% of the economics and the card networks actually don’t take a big clip, but they get the piece in the middle, which is proven to be a very defensible income stream

Jesse (00:23:36):

And to bring that to life. So I go in and I spend a hundred dollars on a T-shirt or a dinner or something like that who gets a hundred bucks,

Hamish (00:23:43):

Put it in the context of square ecosystem. So you’re going to spend that $100 at a square. Merchant Square will take, call it again, round numbers, 3% of the transaction Value Square will end up keeping a bit over 1%, whether you’re a small, medium or large business. They generally charge three take home just over one. The 2% in the middle will go to card issuers and the card network.

Jesse (00:24:10):

Got it. And my understanding is even of that 2%, 90% of it goes to the Citibank or the issuer and then only 10% of that 2% goes to the Visas or MasterCards of the

Hamish (00:24:20):

World. That’s right. That’s right.

Jesse (00:24:21):

Okay. Let’s go into the p and l of block. Let’s just do the two businesses independently I guess, and then we can talk about any of the crossover. So starting with Square, the original, the merchant business, if someone spends a hundred bucks the merchant, they end up making, I’m just playing back what you said. They’ll make $3 from that. They’ll keep one of the $3 roughly speaking, so it’s like a 33% gross margin business. Is that the right way to think about it?

Hamish (00:24:44):

Yeah, if you look at the gross level, it’s something in that order at the gross level, a low gross margin business, but then below that a very good margin business

Jesse (00:24:54):

And what sits below that

Hamish (00:24:56):

In the Square ecosystem, a number of things sits below that. There’s still a cost of revenue that sits below that and a gross margin that sits below that because Square isn’t just offering that payments, call it the payments processing service, but it’s also providing traditional software products, so call that a ballpark, 80% gross margin business, typical software margin business, and then it starts to look more like a traditional software business where you have sales and marketing expenses, RD expenses and GNA that sits below that.

Jesse (00:25:31):

Got it. And so when you think of the entire p and l, so let’s just talk about the square side for a second. What’s the blended gross margin look like in that business?

Hamish (00:25:39):

The blended gross margin and the way square now discloses is that they’ve disclosed a net revenue number, call it adjusted net revenue this year for the square segment. Must be around, I think it was around 2.8 billion and a square segment gross profit of around 2.3 we’re in that order.

Jesse (00:25:59):

So it really does look like a software

Hamish (00:26:01):

Business. Yeah, it does.

Jesse (00:26:02):

Is that payment processing kind of like a loss leader for the software? How do you think about that and the square business?

Hamish (00:26:09):

The payments business has proven actually to be very profitable. I mean it is a scale business to an extent, but if you look at still the bulk of gross profit in the square ecosystem, it still comes from what they call sidecar payments, which is kind of the traditional payments, hardware, devices and software and integrated payments, which is more the kind of integrated software and payments offering. And so there’s probably about $2 billion of gross profit coming out of that pure software and payments business. The rest comes out of three or four other products being Square Loans, square card and instant transfer.

Jesse (00:26:48):

Are they building those to serve their customers or is there unique margin profiles or kind of accretive margin profiles to those products or both?

Hamish (00:26:55):

The level of engagement is highly correlated with the gross profit dollars on a unit basis. The idea is, I mean the payments business is certainly profitable on a standalone basis in terms of unit economics, but if you introduce obviously Square Loans, retention goes up. Likewise with Square Card and Instant Transfer, the gross profit dollars coming out of those customers that have multiple products is multiples of those which are just standalone payments or integrated payments customers.

Jesse (00:27:27):

Yeah, it’s almost like the more lines you have in the water, that core line of the payments and also the most scalable piece of it sticks around. Not to mention, I assume lifetime value goes up dramatically when you have multiple lines.

Hamish (00:27:38):

Absolutely, and one of the amazing things that they’ve done is while Square has continued to move up market from Micros sellers, they’ve maintained both their gross and net take rate as they’ve moved up market, they’ve delivered more value to those merchants. They’ve been able to hold price along the way and they’ve been able to improve the unit economics as they layer in more products that drives more virality, that drives more customer acquisition and retention.

Jesse (00:28:06):

Is there something distinct that’s allowed them to do that? Because typically you think of these old school merchant acquisition guys as race to the bottom, but what is it about them that’s allowed them to do that?

Hamish (00:28:15):

Well, I think initially it was out of necessity and it built the muscle, and I’ve got to put this down to the culture of leadership. At the end of the day, if they were going to make selling payments and software to smaller and micro businesses work in the early days, they had to do it super efficiently and they had to do it differently. And the onboarding experience is a good example of this. They were able to flip that on its head. It was thought it couldn’t be done. You couldn’t accept the merchant instantaneously and you couldn’t accept 99% of them because that’s just not the way things were done. So they were able to build these beautiful, easy to use products. The culture has been awesome at delivering incredible product innovation at speed, and that is incredibly hard in a hardware, software, and financial services business.

Jesse (00:29:06):

Yeah, it makes sense. When you think about sales and marketing and RD and you’ve used this comp of Citibank or JP Morgan, is there anything noteworthy in those buckets on a percentage basis? Do they spend more or less on each of those relative to the old school players?

Hamish (00:29:18):

Well, in terms of customer acquisition, we don’t have good data on this, but anecdotally, the customer acquisition costs for the traditional financial institutions, both on the seller side but definitely on the consumer side is many times that of Square. So the best example is in the consumer side of things where Cash App has been acquiring customers at $5 or better until last year, they put pedal to the metal and it’s more like $10 now, but even $10 now compares to hundreds of dollars for traditional financial institutions. So they’ve got 10 x plus cost of acquisition advantage over the traditional players.

Jesse (00:30:01):

Wow. So let’s switch gears to the Cash app here. So walk us through how does a Cash app make money and what does their p and l look like?

Hamish (00:30:08):

Sure. Cash App originally started as P two P payments, but P two P payments within Cash App is essentially free, but that was the main kind of utility for the Cash app. The largest gross profit pool within Cash app is instant deposit. So if you want to essentially take money out of your Cash app, get access to it instantly, then Square will charge a fee for that. So that is probably about half of Cash App gross profit. Then a few years ago they introduced Cash Card, which has been incredibly successful, growing very, very fast. So Cash Card is a Visa debit card issued by Cash App, which again gives cash app users access to their money. And so again, it’s the usual square playbook where if you’re a Cash App user, it doesn’t cost any money to get a cash card, you get it for free, you get to design it yourself, and then you get to use that cash card and Square or Block will essentially earn interchange when you use it outside the ecosystem.

So they charge anywhere between 25 basis points and two or 3% per transaction to use the cash card. So that’s the next biggest piece. So that’s probably about a $500 million gross profit business, 30 odd percent of Cash App users now a cash card and that continues to increase. And the profitability going to your point before in terms of more products, more unit economics is about five times the gross profit for a cash card customer than it is for just a peer-to-peer payments customer. The other components, they’re kind of two main other components. One is Cash for business, which is essentially micro businesses or small businesses using Cash App essentially as a selling tool. So accepting card payments, cash app payments for selling goods and services. And the final piece is Bitcoin, which was one of the first products they introduced. You can buy and sell Bitcoin in Cash app and Block will take about a 2% fee for the transaction value and that’s probably about a $200 million gross profit business.

Jesse (00:32:18):

That’s like a Coinbase competitor essentially?

Hamish (00:32:21):

Yeah, I mean it is the Coinbase competitor of sorts, but it’s really just enabling Cash app users to buy and sell, invest in Bitcoin.

Jesse (00:32:30):

And then the cash card thing, I want to hit that home as far as I understand it, we talked earlier if you spend a hundred dollars, the 3% goes from a merchant perspective, then 2% gets paid out. My understanding, and just correct me if I’m wrong, is when you use a debit card, it’s maybe a little bit less than 2%. It’s a percent and a half or one to one and a half, but there’s no credit card company, there’s no Citibank or Chase, so all of that money typically goes to the bank issuer. So it’s just a very profitable way of doing payments essentially.

Hamish (00:32:56):

That’s right. I mean card issuing certainly for block going forward card issuing opportunity is a very profitable opportunity. We’re also issuing cards to Square merchants as well, and the key there is really owning that customer relationship. And if you can do that, then that’s card issuing business becomes profitable in and of itself. But the other thing that enables them to do is to create this closed loop network. If there’s a transaction between a square seller and a Cash app user or cash card user, then the economics they need to pay away to others basically disappears. From a square seller point of view, the net take rates was just a bit over 1% In a closed loop cash app, consumer square seller ecosystem at 1% goes to 3% ballpark numbers.

Jesse (00:33:52):

Wow. You can imagine a world where they offer both sides discount when they know it’s one of their users, one of their customers and one of their merchants, and then everybody truly wins in that

Hamish (00:34:00):

Situation. Exactly. And that’s why has Amex been able to offer the best rewards because they’ve got a closed loop system. They’re both the acquirer and the issuer. That’s essentially the roadmap for Block with their consumer and merchant ecosystems. And that is really all about scale of the two ecosystems. The bigger the scale, the more of that transaction efficiency that they’ll be able to earn. And the introduction of Afterpay is key here because Afterpay delivers that transaction connection between consumers and square sellers. It’s not just the transaction fee benefits, but if you think about the square seller ecosystem that gives them a real cost advantage over say Toast one of their competitors. Certainly in the restaurant space Toast is an awesome business. They’ve got an awesome software offering, but Square can have a pricing advantage there if they have this closed loop ecosystem because on a like for like basis, the Toast net take rate, call it 1%, if Square has more of that closed loop network working, they’ll have more transactions happening at 3%, which gives them more flexibility on pricing around acquiring a merchant.

Jesse (00:35:13):

I want to go into competitors in just a minute and some of the differentiators before I do that, I mean this is a financial services business and I’m not an expert in those, but I know the balance sheet’s really important for any bank. Is there anything about the balance sheet in the case of Block that’s worth discussing or talking about one way or the other?

Hamish (00:35:30):

I’d say with Afterpay there’s more complexity in the balance sheet. To date, it’s been a pretty clean balance. I mean even with Square Loans, that was a pretty clean business where third party institutions would acquire the loans on a flow forward basis Square would just take a 6% loan service fee from the loans they write. Going forward, the balance sheet becomes much more important because they’re introducing Afterpay and they’re also introducing, I think this year they’ll be introducing Cash App Borrow, which is a borrowing product for Cash App consumers. It’s not exactly clear how they will fund that or how that will be structured, but that could add another layer of complexity

Jesse (00:36:17):

Going to the competitive differentiation point, I mean I’ve heard you say a few things. I just want to kind of play ’em back. One thing you said is that on both cases for Cash as well as Square, they’ve been able to get to brand and ubiquity very quickly and fast. So what is it about marketing or their ability to do that? How have they done that? How have they uniquely been able to win out in such a competitive space?

Hamish (00:36:37):

Jim McKelvy, the co-founder of Square has written a book about this recently because if you look at how that originally started, they went up against Intuit, Amazon, PayPal, and a million other fast followers, and they won that battle. They were the clear leader and that is hard with a hardware product in small business starting from scratch and a product, they weren’t able to patent it. I think what that comes down to is the part of the culture is real empathy with the customer. I mean, they go really deep on understanding the customer’s needs and that’s opened up new TAM opportunities, but it’s also helped them understand what the jobs to be done are. It’s helped them understand life from the customer’s perspective and again, running the mission through that customer empathy lens. How do they improve access and economic empowerment for the customer? So I really think it’s the secret source of how they’ve continued to deliver such incredible product innovation organically at speed over time and how they’ve been able to develop these viral growth loops because it really does marry with ultimately delivering the best customer experience

Jesse (00:37:51):

And the product. That philosophy makes obviously a tonne of sense. Is there something distinct about their product organisation or the way they do product? Because as you mentioned, it started with one thing and now it sounds like almost 30 different things, including Square, which is this incredible, it’s almost like AWS and core Amazon. Is there something unique about their product, organisation or talent or something that’s allowing them to do this at the speed and pace they’re doing it at?

Hamish (00:38:14):

Well, I’d say there’s something special about the broader organisation and my take on is that comes from leadership first and foremost. I think Jack has to get a lot of the credit here. The culture is very much built around focus and customer empathy and courage. The focus bit, you can see that throughout the organisation. I mean the meticulous detail to product, this is something that if you speak to employees or former employees, certainly comes from Jack in terms of caring about every single detail. There’s a great quote from Jack, which he said, there are two things I’ve got to do as CEO, something along these lines. I’ve got to make sure every detail is perfect and then limit the number of details. So there is incredible focus and rigour in the product organisation, but throughout the organisation. So that focus is key. The customer empathy piece is key, and the courage bit is key because so many of the key strategic moves they’ve made were gutsy.

They were ballsy moves out of the gate, trying to go after micro businesses, then trying to go after the unbanked with cash app, then putting a flag down with Bitcoin and saying, we want to be a leader here, building it into the Cash app. These are things that there’s been a fair bit of internal and external criticism, buying title. People scratch their heads, why the hell are they buying a music service? So this theme of courage and having the willingness because they really understand the customer and they’re really dedicated to their mission, I think has been the common thread that’s made a lot of these moves possible.

Jesse (00:39:50):

Yeah. One tactical question on the product side. My understanding with most financial services businesses, one of the reasons they don’t offer first then verify is fraud is just rampant. What have they done or how did they avoid this fraud issue? That seems to be everywhere in a financial services business.

Hamish (00:40:06):

Fraud is a key issue clearly, and this is where I think if you look at Square now versus certainly the incumbents, it’s really daylight in terms of what they can do with the footprint they have, both consumers and merchants because they’ve built this technology stack which is highly scalable, which is modern, which can actually use data to not only be able to successfully manage fraud and nefarious behaviour, but actually add value to consumers and merchants and ultimately create a better customer experience. They’re been developing this data capability from the get-go essentially. And so when you look forward in terms of who and what is going to be the bank of the future, what is going to be the trillion dollar financial services enterprise over the next five or 10 years? There will be one, there’s got to be one. It’ll be a player with a modern technology infrastructure that has both a consumer and merchant side to their business and that has the data capabilities where data isn’t stuck in silos and they’re not constrained by legacy technology. Yeah,

Jesse (00:41:19):

Yeah, I mean it certainly seems like they’re moving in that direction. Maybe you could do a couple examples on the competitive front. There’s businesses out there like PayPal, there’s the banks. How do you think about the competitive environment? And again, maybe just to bookend this discussion, how are they winning against all these various different kinds of players?

Hamish (00:41:37):

Yeah, sure. To go to the traditional financial institutions first, initially Square was taking a market from them that they didn’t want. And now we’ve seen clearly that yes, that is the starting point, but where Square Block have been so successful is growing the TAM and growing upmarket. So I think we can say that for both the Square ecosystem and the Cash app ecosystem, and they’re able to do that ultimately, whether it’s the traditional financial institution certainly or other players, by delivering just a better customer experience. I mean, ultimately that’s what it comes down to, and that’s everything from the brand, the onboarding experience, the ease of use, the look of feel, the hardware, the software, all the different components, the fairness of the ecosystem, and again, really understanding the customer versus the traditional financial institutions. I’d say they still have the traditional financial institutions still have incredibly strong brands and they’ve got scale, but I think over time that is under threat from a player like Square. I mean those franchises are really built around scale and trust. So if Square can continue to scale successfully and continue to build the trust, which I think they’ve done a very good job on both sides of the ecosystems, then that is a real competitive threat in the retail and small business banking segments. Certainly for the traditional financial institutions, that’s an issue.

Jesse (00:43:06):

Is there lacking a balance sheet or the balance sheet orientation impact them negatively or is that a threat to their business at all?

Hamish (00:43:12):

The balance sheet is a motor around the traditional financial services players. It can also be a constraint. It’s uncertain at this stage how block approaches that balance sheet question, but I would say over time they will use their balance sheet more intensively and probably more like a traditional financial institution than they do now, which has been more of a software business. So that’s kind of a hard question because I think, and you can see that with the FDIC licence that Blockers has got recently. So they’ve essentially got a banking licence. You’ve got to be really careful once you get that banking licence that you don’t get bogged down, that they don’t get bogged down by all the regulatory hoops and requirements that go with that licence. But there are also a whole bunch of benefits. They’ve done it because it gives them more control over Square loans, for example. It gives them the ability to connect directly into the Fed now real-time payments rails, which is this new initiative, real-time payments that’s going to be launched in the US over the next couple of years. So there are some real advantages there, but they also need to be careful of not getting bogged down by all that regulatory baggage.

Jesse (00:44:26):

And if we switch to talking a little bit more about the PayPals of the world and maybe the smaller guys like the chimes or the upstarts, how do you think about their differentiation there? PayPal in particular, since PayPal is sort of the original two-sided and internet base, all that stuff.

Hamish (00:44:41):

PayPal is a wonderful business with a huge mode in and of itself really where they go head to head first and foremost is Venmo and Cash App. I mean there are other elements of competition and they do tread on each other’s toes a little bit in other areas, but that’s really the head to head and I think both of them can be successful. But Venmo was the original peer to peer leader and it was a decent sized business when Cash App was just getting started, the cash app’s become the leader in the peer-to-peer space, and the gap appears to be growing even though Venmo is continuing to grow reasonably well. But Venmo now is less about user growth, more about ARPU growth, and there’s still a big opportunity I believe there. Whereas I’d say Cash App, you’ve still got both the MAU, the user growth element and you’ve got a very significant opportunity there.

And I think that really comes down to, again, squared really understanding the customer, being able to build a brand that really resonates with the customer. Cash app have done an incredible job there. Cash App has really become a part of the culture for Gen Z and millennials Cash App is now in one or 2000 song lyrics. There’s a couple of hundred songs called Cash App or with Cash App in the title. They do Cash Tap Fridays where they’re giving away money each Friday, which has huge viral impact. They’re partnering with celebrities and cultural leaders to do giveaways, so they’ve even got their own street wear line. How they’re building that brand is so much more than just a financial services brand. It’s a brand that deeply resonates with younger customers and I think that is where they’ve really nailed it.

Jesse (00:46:28):

Yeah. One other observation I have is that we’re sort of not saying it, but one backdrop to all of this is the TAM is just massive. So you can have a very successful PayPal and a very successful square just because of the size of the tam,

Hamish (00:46:39):

And that is definitely the case. So if you look at financial services broadly, whether it’s on the merchant side or the consumer side, yes there is competition, but there is so much legacy there. There’s so much legacy financial services, there’s so much legacy software and there are so many poor customer experiences. When I think about key risks for Block, it’s really coming down to can they continue at scale to deliver wonderful customer experiences? Can they continue to iterate at the speed they have deliver awesome products to their end users? If they do that, they’ll continue to grow.

Jesse (00:47:18):

Yeah. Let’s switch gears to talk about their m and a. You’ve mentioned a couple, obviously we talked about Afterpay, you mentioned Title, they bought a lot of businesses. I guess walk through maybe some of the highlights of m and a and how you reconcile it with their overall strategy.

Hamish (00:47:30):

I would say they’ve made a bunch of Bolton acquisitions over the years. The bulk of the earnings, all organic. So if you look at the seller ecosystem and the consumer e care system, I mean the vast majority of those earnings are all organic. Afterpay was the big acquisition they issued. That was an all stock acquisition. They issued about 25% of the capital to acquire it. But apart from that, the acquisitions have all been smaller or the larger ones are in the hundreds of millions of dollars. Title is a good example there. The music streaming business, which they bought for a few hundred million dollars,

Jesse (00:48:04):

Why did they buy it? Music streaming.

Hamish (00:48:06):

So I think a lot of people ask that question at the time, and maybe they still do ask the question. Going back to the mission, which is access and economic empowerment, there is no more underserved in my view, constituents than music artists and certainly the long tail of music artists. So if you’re a top music artist, then no problem. But even those even more popular music artists and not being served to the extent that Block thinks they can develop. So what they’ve bought with Title is a music streaming service with a strong brand, I’d say for what it is, and the opportunity to run the Block Playbook, which is go off on an underserved market layer in more value added products over time, deliver a much better customer experience, not just for the listener, the consumer side of things, but for the artists. And that’s where the real focus is.

So Block really thinks about artists as small businesses. It’s akin to going after the micro merchants when they have the Square Car reader. If you are Spotify now and someone said Watch out for title, you’d get laughed out of the room and the same way as someone from Citigroup would laughter you out of the room when they came out with the card reader. But you don’t want to underestimate Block, you don’t want to underestimate that management. They have delivered from Standing Starts, huge innovation, really big ecosystem. And so if they can deliver more value to the artists and there’s a lot of road to go there, then maybe they can build that into a real franchise in terms of the music streaming business. But the other piece that’s probably big part of the acquisition and certainly Jack has referred to this is that brand piece. The Cash App brand was a real culture led brand. A lot of music artists use and promote some paid, some unpaid their cash tags and Cash app and there’s elements there in terms of that brand alignment and working with artists that can feed that Cash App brand flywheel as well.

Jesse (00:50:13):

M and a perspective after Pace come up a lot in this episode as a connective tissue between the customer and the merchant side. Beyond that, the closed loop system, is there anything else notable about that acquisition?

Hamish (00:50:24):

I think the other key component is really around merchant discovery. So this is really a demand generation piece that could be really powerful, putting Afterpay in between the consumer and merchant ecosystems. If you think about what’s happening in the broader ecosystem, transaction players like PayPal and Block are trying to get further up the funnel, further up the consumer pathway. And you can see that with PayPal’s acquisition of Honey, you can see it with Shopify’s shop app. They’re trying to get closer to where the consumer journey starts. So one of the stats that Afterpay talk about is that last year they provided a million leads a day to Afterpay Merchants on a user, a base of call it 16 million annual actives. So now that Merchant Discovery functionality has been built into Cash App. So not only do you have an engagement lever for Cash App users to go into Cash App and actually discover merchants either browse merchants to discover or browse for a specific merchant that you’re after to see if they offer Afterpay.

So that’s a really powerful engagement tool for Cash App users, but you’re exposing that merchant discovery to four times the number of users. So if you just play that out, a million leads a day under Afterpay exposed to now four times the users that’s call it just on the current footprint, over 2 billion leads per annum that the ecosystem could be generating at that same kind of rate. If you say average order value is 50 to a hundred dollars, then there’s a 100 to $200 billion GMV opportunity there. And to put that into context, square seller ecosystem will do about $200 billion of GMV. The clip on that is somewhere between at the bottom end a bit over 1% or at the top end if it’s an Afterpay transaction, a bit over 2%. So there’s a multi-billion dollar revenue opportunity just in that merchant discovery piece and it’s driving more engagement in Cash App. So that could be a really interesting opportunity that they’re pushing hard on.

Jesse (00:52:46):

And to your point, I mean one other thing that I noticed is that not only is it now Square Block is not a payments business, but it’s almost a marketing business and a discovery for consumers, discovery for Merchants, it’s marketing, which is just bringing it even that much more important for

Hamish (00:52:58):

Each. Exactly. That’s right. And the further you go up the funnel, the more economics you get in the more mature markets for Afterpay, many consumers are starting their shopping journey with Afterpay. So the vision is every Cash app consumer starts their shopping journey with Cash App more often.

Jesse (00:53:17):

Are there any other acquisitions you think are worth highlighting that maybe they seem not obvious at first title or really game changing for them? Like Afterpay?

Hamish (00:53:25):

I’d say they’re the two most interesting. I mean, square bought Weebly, which was an online business. If there was a criticism of Square dating back a few years, it was that they were slow to online and they’re really strong in offline. They were really, again, it goes back to that focus. They were really, really focused on that, and somewhat of that weakness was exposed when we went into this global pandemic and it really became pedal to the metal on delivering more online capability. I mean, they had it before they were delivering it. They’re building on that Weebly transaction. But now I’d say that they are much stronger in online now. They’re much more of an omni-channel payments player than they once were.

Jesse (00:54:07):

We’ve gotten close to the end here and we haven’t talked about something which I’m glad, which is crypto, and I sort of wanted it that way on purpose. We talked about this huge business they have, but they’ve just changed the name to block, which is a great double or triple entendre. Jack is very public about Bitcoin and being kind of the future. What’s view on it? What’s the business’s view on it? What are they building around it? Just help us understand how does this all play into the business of

Hamish (00:54:31):

Block? Yeah, sure thing. Let’s put it into context first. So there is a huge line item in the PML, which is the Bitcoin revenue. So that’s a gross revenue number, which is really just a pass through block is just taking a clip. So in the Cash app business, allowing Cash App users to buy and sell Bitcoin Block is just really taking a 2% clip of that total number. So the Bitcoin revenue is a little bit distorting. It’s not what I would say really block revenue. It’s just the 2% clip that is a real net revenue take. There’s no question that Jack and Now Block is passionate about furthering the cause of Bitcoin. And just going through the timeline, this dates back to building in Bitcoin, trading into Cash app, which was originally a hack week project with Jack, which Jack was a part of a few years ago.

That actually was a really successful product. It drew a heap of engagement into Cash app and since then they have put a few hundred million dollars worth of Bitcoin on the balance sheet, which again, putting into context, it’s less than 1% of the EV and less than 5% of the outstanding cash. So it’s a small amount, but it is a stake in the ground. And more recently, they’ve introduced a few key elements of their Bitcoin strategy, which is TBD, spiral, Bitcoin Wallet, and a Bitcoin mining hardware. But where all this comes from, again, goes back to the mission access and economic empowerment. So the mantra for Block is that Bitcoin should be the native currency of the internet, and if it becomes a native currency of the internet, it’s going to unlock a huge amount of opportunity for people all over the world. It becomes a truly global currency.

It reduces friction for smaller businesses, individuals, all over the world to participate in the economy. And it is not a huge unlock for the customer base, but could potentially become an unlock for the block business. So for example, instead of block setting up a different regulatory business in every single geography, they expand into if the internet has a native currency, they can start launching products globally, which is unique, which you can’t effectively do in financial services at the moment without a native currency. The key elements are Spiral, which is purely a team of developers, Bitcoin specialist developers that have been put together to build open source projects to further the cause of Bitcoin. They’re paid in Bitcoin, they get no stock in Block. There is no economic benefit at all for Block. They’re just there to further the Bitcoin effort.

Jesse (00:57:30):

I guess the bet is from your perspective, or for someone who betting on it, is that if it doesn’t become the reserve currency, they will effectively become the Reserve merchant service and consumer service provider on both sides of that.

Hamish (00:57:42):

That could be an element, but I think it’s really about creating the domain expertise. So again, what’s the secret source with Block? I think one of the things they’ve done really well is they’ve got one mission and one platform to deliver it. And that one platform allows them to share capabilities, to share the main expertise, to share talent, to share payments rails, to share all these services and IP across the different ecosystems. So whilst they might benefit from Spiral directly, it does really deepen themselves in the Bitcoin ecosystem and it gives some real authenticity and again, enables ’em to build more trust. I mean, this is area where you really have to build trust with the participants, with the developer community, and that’s what they’re trying to do with Spiral.

Jesse (00:58:32):

Looking forward, when you think about the business block in the next five, 10 years, if it grows beyond your wildest dreams, your wildest imagination, what did they get right in terms of their specific business betts and what happened in the macro environment?

Hamish (00:58:48):

Firstly, they maintain the culture and that comes from leadership. So again, one of the awesome things that Jack has done and the other leaders is that the leadership of the organisation has been incredibly consistent. They have had absolute gangsters in every single key position in the business, and their tenure has been unbelievable, especially in the world of software. So if you look at Jess Doka, who came from Apple runs the hardware business still there, you look at Alyssa Henry has taken the seller business from call it a hundred million gross profit to over 2 billion. She’s been there for almost 10 years. There’s a number of these key players in the business that are still there running key parts of the business and maintaining the culture. So maintaining the focus, maintaining the speed of innovation. It’s those elements that are key in terms of delivering the ultimate outcome.

When you get big, you don’t want to get slow, and that’s something that they’ve delivered on to date and they need to continue to deliver on. The second component is can they really drive this two-sided network effects? Why have MasterCard, visa, Amex been such powerful business models? It’s because those two-sided network effects at a very high level between consumers and merchants are so powerful, can block drive those two-sided network effects within their business. And I’d say they’ve got the added benefit of they’ve actually got peer-to-peer got direct network effects on the consumer side of things. So creating really more powerful network effects within the business. Can they use the data and the richness of that data to create a better customer experience? Can they maintain the authenticity of the brand and the mission? I mean, these are all execution and leadership issues, but I’d say these are the key things that will ultimately determine whether they’re that trillion dollar financial services business or not.

Jesse (01:00:49):

And what about the flip side of it? If it doesn’t go to plan, if it goes down, the market cap goes down in the next five or 10 years, what did they get wrong or what happened? And then what maybe in the macro environment could have driven it?

Hamish (01:00:59):

The key thing and the key risk is around trust. When you’re building a business that businesses of all sizes are depending on to run their business every day to grow their business, to accept payments, but that is hallowed ground. And so trust is a huge element of that. Likewise, on the consumer side of things, that ecosystem is built all around trust. The biggest risk in my view, this business is that trust is corrupted in some form, in some way. That is number one. Number two, I’d say there’s always a regulatory component. I’m less concerned about regulatory risk. I would say that whatever regulatory change there is, I mean there’s always an X factor there. It doesn’t always make sense, but Square is I’d say the friend of the consumer and the friend of the business at this stage, and they have the ability and they have the margin to be able to adapt to whatever those changes are. When I think about the regulatory side of things, my bigger concern is as they grow into a more financial services led business with things like cash app borrow and square loans continuing, and the introduction of Afterpay, does that regulatory burden bog them down and do they become slow and does that change the culture? So I’d say they’re the two key risks in my mind.

Jesse (01:02:22):

Just because we talked about the Bitcoin and obviously they changed the name to block. If for some reason they’re just wrong, the dollar becomes the Internet’s reserve currency. How does that affect their business from your

Hamish (01:02:33):

Perspective? At this stage? I don’t think it affects the business in a material way. I think it probably reduces the opportunity for the business they’re investing in Bitcoin specifically, probably 2% or less of the opex of the business in those initiatives in aggregate. So I don’t think there’s certainly a lot of financial risk at this stage, but clearly they’re going all in on that. And Jack is, I think, really starting to craft the business around Bitcoin. So whilst it is smaller on a financial basis, I think in terms of the Headspace it takes up, I think it is much more significant than that.

Jesse (01:03:12):

The last three questions we ask everyone on this show are the same. So it’s lessons for builders, lessons for investors, and then places for further study for those listening who want to learn more. So let’s just take ’em one at a time. If you’re an entrepreneur or executive, you’re someone who builds businesses, what’s the big lesson from Block?

Hamish (01:03:29):

There are a hell of a lot of lessons, whether you are running a more mature business or whether you’re starting a business, and the ones that come to mind are the mission matters. You’ve got to give a shit about your mission, you’ve got to be passionate about it, and it actually has to articulate what the strategy of the business is because that’s what’s going to attract talent. That’s what’s going to help you focus. That’s what’s going to help you have the courage to make the key strategic moves. And I think that piece, there’s no better exemplar than block for that one. I think the second piece is to is that customer empathy piece. Spend time with your customers, promote bottoms up innovation, really get close to the customers, really understand what their pain points are, understand what the jobs to be done there, and go deep and empower decision-making and innovation throughout the organisation because it’s usually those people out in the organisation that are spending time with the customers that know what needs to be done to serve them better. And probably the final thing that comes to mind is just have outstanding players in the key positions. It’s an obvious thing to say, but that is something that Block has done exceptionally well. And empower them. Empower them with decision-making autonomy and make sure their culture carries.

Jesse (01:04:53):

Yeah, and I mean obviously all those things go really well together. What about on the other side for investors? What’s the big lesson?

Hamish (01:05:00):

The big lesson that I’ve taken out of the block story is take Tam with a grain of salt. The more important determinant of growth opportunity is the level of innovation within the business, the dedication to the mission, the customer empathy, all of those kind of things. And especially when you talk about financial services or big markets with big incumbent players and real concentration in the industry, that usually creates an environment where there’s big opportunity, even if you’re just starting out with a small wedge to go after that market. And that’s what Block has done over and over again exceptionally well.

Jesse (01:05:42):

Yeah, that’s such a cool story. Where would you encourage others listening that want to learn more about Block and Payments and all these things broadly to go?

Hamish (01:05:50):

Well, there are a couple of awesome business breakdowns on the payments industry, Adian, the Alex Ramel Visa business breakdown. I would encourage anyone to listen to some of the square related podcasts that Jack has done. If you really want to get an insight into the DNA of the company. Both Jim McKelvy and Jack have done some podcasts specifically on Square that are a really good starting place. Cool.

Jesse (01:06:18):

Well, Hamish, this was an amazing episode. Excited for people to listen to it. Thanks so much.

Hamish (01:06:21):

Thanks so much family. Jess.

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