Jim McKelvey, who co-founded Square with his pal Jack Dorsey, hasn’t been content to merely create a hugely successful innovator in card payments and survive a competitive attack by Amazon, he wanted to understand what had made it successful. And he wanted to see if Square had developed principles or skills that could be applicable to other companies.
So he spent three years researching the book which has recently come out, The Innovation Stack. He probably didn’t write it for the money; Square, now named Block, has a market cap around $56 billion.
Pretty impressive for a company started after he lost a sale in his St. Louis glassblowing business because he couldn’t take American Express. His research into the card industry uncovered mind-numbing complexity— 50-page contracts, fees that added up at the end of the month so a merchant didn’t know how much she would be paying out, clumsy and expensive card readers.
Then he came across a mundane report from the Federal Reserve Bank of Philadelphia which showed, if you could read the graphics, that small merchants were paying 45X as much on card transaction as large merchants.
“There were 5.2 million small merchants who desperately needed help. They were getting hosed by the established processing companies,” wrote McKelvey.
The Square team didn’t set out to build an innovation stack, they were just trying to solve problems that arose as they created hardware and software that would allow small businesses to accept credit and debit cards. After just one year Square had millions of customers and payment volume was increasing by an average of 10% per week, and that continued for almost three years.
This wasn’t business taken away from Visa and Mastercard, this was business they never pursued, McKelvey writes.
“At some point, the market just ends. There’s also the point where entrepreneurship begins. The end of a market is like a border that nobody is able to cross. Beyond this area is also uncontested ground, which is quite strange. Every other part of a market has cutthroat competition. And any inch of ground, abandoned by one company, is immediately seized by another, but just past the bottom of the market prices are so low that nobody fights for this turf.”
The border was about $10,000 in annual sales. Any merchant who sold less than that was effectively excluded from taking credit cards — the costs of cards was too high for small business to be profitable.
But Square did not remain unchallenged, and the threat was real, because it was from Amazon.
“Then the door bell rang and Jeff Bezos delivered a severed horse head free via two-day shipping. Amazon had copied our hardware (albeit as a black rectangle) and had undercut our price by 30 percent and was offering live customer support.”
Square needed a response, fast, but it could find no example of any company which had successfully fended off Amazon.
The board decided to do nothing different. Square continued to do what it had been doing, focused on customers rather than on competitors.
“We didn’t now how insanely powerful our innovation stack would be against the competition. We didn’t even know we had one.”
It was only after Amazon withdrew from the field that McKelvey began examining what had made it successful, against some significant odds.
“An innovation stack isn’t simply a list of independent changes to an existing business model,” McKelvey wrote. It is integrated, and each block in the stack only works in conjunction with all the others. This is what makes it so hard to copy.”
Square’s key ingredients, and the list, shows how they are related and interdependent:
1. Simplicity, starting with a known price, a percentage of the transaction, no hidden fees, no transaction fee even though Square was paying a transaction fee to the card networks.
2. Free Sign-Up. “Our pricing model could only work if we grew rapidly, so to create a fast and frictionless experience we made sign-up free — another industry first. This allowed millions of merchants who might be curious about Square to give it a try. Free is a magic price: you never have to explain free.”
3. Cheap hardware. The cheapest portable credit card reader on the market cost $950. The original Square reader cost 97¢ to build. When Square sold the reader through Best Buy and the Apple Store, it included a processing credit equal to the retail cost.
4. No Contracts. “Since we weren’t trying to lock customers into some long-term deal, we didn’t have to add any fine print to our user agreement.”
5. No Live Support. Email customer support only. “It was not just a way to keep our costs down, it forced us to develop more innovation to further reduce the need for customers to contact us.”
6. Beautiful Software. “Our users became our sales force. The Square experience, from the hardware to the software to our website, was so beautiful that people started talking.”
7. Beautiful Hardware. “We then took our 97¢ reader and packaged it in a $2 box. The effect was like receiving a piece of jewelry.”
8. Fast Settlement. Payments moved same day or next day, breaking all speed records in the industry. “Speed…delighted our customers and kept our growth humming, but more important it eliminated all those ‘Where’s my money?’ support calls.”
9. Net Settlement. “Our simple pricing allowed us to know what amount to send to the merchant, which we did daily.”
10. Low Price. Most small merchants were paying 4%, Square’s charge of 2.75% “spread through the small business community like a cold in a kindergarten class.”
11. No Advertising. “Square grew 10% every week for two years without advertising.”
12. Online Sign-Up. No paperwork, no credit check.
13. New Fraud Modeling. Square had so much data it could use data science and game theory to fight fraud, although banks didn’t believe it and wouldn’t take the risk.
14. Balance Sheet Accountability. By using excellent fraud modeling, Square could move the credit risk from a merchant business onto its own balance sheet. “We eventually welcomed over two million new merchants onto our balance sheets and into a new base of the credit card pyramid.”
Working together these components made up an innovation stack that was difficult for a traditional player to copy.
After failing to find much innovation in his survey of contemporary businesses, McKelvey looked to history and found some examples — Bank of America when it began as Bank of Italy, Southwest Airlines and IKEA.
“The Bank of Italy created an innovation stack so so powerful that it became the largest bank in the world…it opened the world of finance to hundreds of millions of people and built much of the Western United States of America.”
All three companies focused on their customers Only IKEA has stuck with a low-price model. McKelvey detailed its Innovation Stack.
1. Catalog showrooms
2. Overseas Manufacturing
3. Efficient Factories
4. Self-Assembled Furniture
5. Custom Design
6. Interchangeable Parts
7. Global Supply Chain
8. Warehouse Showrooms
9. Winding Paths
10. Food and Child Care
11. Low prices
The Innovation Stack is an enjoyable read with amusing anecdotes and digressions, and an inside look at how Square was developed.