PayPal and Square, who can stand out in the "trillion-dollar choice" of payment

As an online retailer, or any industry that completes transactions, payment is the missing link in Dolphin's research and coverage of medium- to long-term targets. Therefore, in order to fill this gap and compare domestic payment companies that may go public across markets, this article will focus on the U.S. payment industry to explain the basic business logic and profit avenues. It will also analyze the competitive landscape in the U.S. payment market and the strengths and weaknesses of different companies in various payment scenarios. Ultimately, it will attempt to determine which companies are most likely to stand out and become winners in the vast payment industry. At the same time, through cross-market comparisons, it will help understand the situation of the domestic payment industry.

The following is the main text:

I. Digital Payments in the United States: "Old Money" Banks Still Dominant

Although the United States is a leader in the technology field, with the largest market value of internet companies mostly originating from the U.S., its development in fintech areas such as digital payments still lags behind China, similar to how the U.S. lags behind China in the e-commerce field. In China, digital payment methods such as Alipay and WeChat Pay can be used in almost any payment scenario and are the preferred payment methods for Chinese residents. In the United States, however, traditional bank cards are still the absolute mainstream payment method.

According to data from the Federal Reserve, in 2018, the total number of non-cash payments in the United States reached 174 billion, with a total payment amount of 94 trillion U.S. dollars (the data for 2019-2020 in the following chart is estimated). In terms of payment volume, bank card payments accounted for over 75%, followed by ACH (Automated Clearing House, similar to bank transfers) and checks, while mobile wallet payments accounted for only 2.4%.

In terms of payment amount, ACH and checks accounted for a combined 93%, bank cards accounted for approximately 7%, and mobile wallets can be ignored. Based on the above data, we can draw the following scenarios: In daily small-value payments, bank cards are the absolute first choice for U.S. residents, while bank transfers and checks are the main methods for large-value payments. P2P and mobile wallets are only used in a few small-value payment scenarios.

So, how is the usage rate of digital payments in the United States in different scenarios? In offline scenarios that favor physical card payments, the proportion of U.S. electronic wallets is only 11%, compared to over half in China. Even in online scenarios that favor digital payments, bank card payments still dominate in the United States, with credit and debit cards accounting for 51% and electronic wallet payments accounting for only 30%. Therefore, whether offline or online, using bank cards for payment is the preferred method for U.S. residents, and the popularity and user habits of electronic wallets are far from mature. In contrast, domestic electronic wallets not only dominate the online scene but also account for over half of the offline scene. Compared to China, the digital payment industry in the United States is still in its infancy and has a lot of room for development.

So what are the reasons behind China's leading position in the digital payment industry compared to the United States? Dolphin believes there are two main reasons:

Before the rise of digital payments, the penetration rate of bank cards in the United States far exceeded that of China, and offline bank card payments were already well-established. Therefore, when China made a leap from cash payments to digital payments, there was a noticeable improvement in the payment experience for residents. However, the improvement in digital payments compared to bank card payments was relatively limited, so there was not enough motivation for residents in the United States to widely switch from bank cards to digital payments.

The development of e-commerce, especially mobile e-commerce, plays an important role in promoting mobile payments. One of the reasons for the success of Alipay and WeChat Pay is that they have stable online payment scenes under their respective platforms, such as JD.com, Taobao, and Tmall, which gradually penetrate into offline scenes.

On the other hand, the proportion of online sales in the United States is already low, and the penetration rate of mobile e-commerce is only in single digits. Most online consumption is done through PCs, so the usage scenario for digital wallets is not high. Even Amazon, which has a market share of over 40%, does not support third-party companies like PayPal in the United States, further reducing the frequency of digital wallet usage. Therefore, if electronic wallets cannot dominate online payments, it is even more difficult for them to penetrate offline.

Although bank cards are still the absolute mainstream for payment among the American people, it does not mean that third-party payment companies have no role to play in the payment process in the United States. In addition to banks and card organizations (Visa, UnionPay, etc.), third-party payment institutions (including acquirers, payment service providers, etc.) also play different roles in the entire payment process. In the following sections, we will briefly describe the payment process and business models of payment institutions from the perspective of third-party payment institutions (Square, PayPal, Alipay), based on both the four-party payment process based on bank cards and the three-party payment scenario based on electronic wallets. First of all, in the bank card-based four-party C2B payment process, the role played by third-party payment institutions is mainly that of the acquirer, which means they gather payment requests from end consumers and transmit the payment demands to the bank backend through card organizations/clearing institutions to complete the payment. Generally, the costs incurred by the payment are borne by the merchants. For example, if a US consumer pays $100 with a credit card, the acquirer will charge the merchant an overall merchant discount rate (MDR) of about 2.5%. At the same time, the acquirer institution will pay a commission of about 0.25% to the clearing institution and about 1.5% to the bank. The net cost rate charged by the acquirer is about 1%.

In comparison to China, due to the fact that domestic regulations view payment as a basic service rather than a commercial profit-making activity, the overall payment rate in China is generally around 0.68%. After excluding the commission of banks and clearing institutions, the net cost rate charged by the acquirer is about 0.2%.

In a horizontal comparison, the monetization rate of US payment institutions is much higher than that of China, indicating higher profit potential for payment companies. However, from the perspective of profit distribution, both in China and the US, banks account for 50% to 60% of the total payment fees, while third-party payments can receive 30% to 40%. From a business logic perspective, the current payment process is still built on top of bank cards or accounts, allowing banks to capture the majority of the revenue. This also means that if third-party payment companies can bypass bank clearing, their profitability will greatly increase.

In addition to the above payment process, there is also a self-clearing model that allows third-party payment institutions to generate more profits. In this model, funds are directly transferred from consumers' digital wallet accounts to merchants' digital wallet accounts through third-party payment institutions, without involving consumers' and merchants' bank accounts, as well as interbank clearing institutions. Therefore, digital wallet payment institutions can monopolize about 2.6% to 2.7% of the payment fees, which is significantly higher than the four-party clearing model. However, the prerequisite for the establishment of the self-clearing model is that consumers and merchants use digital wallets under the same brand. Therefore, only when third-party payment institutions have a large number of C-end and B-end users can they seize greater profits through the self-clearing model. Currently, there are no third-party payment institutions in the US that can meet this requirement.

Overall, in the US payment ecosystem, the banking system still occupies a dominant position, with low penetration of digital payments and limited bargaining power for third-party payment companies. However, the US payment industry has a market size close to trillions of dollars and a payment rate of nearly 3%, indicating that the market size of the US payment industry is at least in the hundreds of billions of dollars (excluding bank transfers and checks). Therefore, the current low penetration rate and market concentration of digital payments also imply that future winners can achieve tremendous growth prospects.

Second, there are many players in the field, and Square has a unique dual-engine driving force for offline 2B+2C businesses.

Although the digital payment industry in the United States is not mature, its huge potential scale and high payment fees and profit margins have attracted numerous payment companies with different backgrounds to compete with each other. Depending on their backgrounds, players in the payment industry can be mainly divided into four categories:

Native payment companies: Companies whose main business is payment, such as PayPal, Square, Stripe, etc. These companies have advantages in payment know-how and a large number of merchant resources.
2C internet companies: Companies that enter the payment field through 2C businesses, such as Apple Pay, Google Pay, Amazon Pay, etc. These companies have advantages in a large number of C-end user resources and the huge funds and technological advantages of group companies.
Bank/card organization-related companies: Payment brands launched jointly or individually by banks to defend against competition from third-party payment companies, such as Zelle (P2P payment), Citi Mobile/Chase Mobile, etc. These companies have advantages in having a large number of adapted merchants and cardholders, but their disadvantages lie in technology and online operational capabilities.
Consumer lending companies (Buy Now Pay Later): Payment companies that primarily focus on online shopping installment payments and consumer loans, such as Afterpay, Affirm, Klarna, etc. Their disadvantage is that they have a relatively narrow range of applicable scenarios.

Among the above players, we will focus on Square (the current company name has been changed to Block) as the main research object among native payment companies, and explore Square's competitive landscape and advantages in the payment industry through comparisons with other players.

First, let's briefly introduce the business composition of Square to better understand the following content. In brief, Square's business lines consist of two major segments:

The 2B business line, which is centered around the POS hardware and software services for offline merchant payments, mainly provides offline payment services for small and medium-sized businesses in the United States. It also includes SaaS services such as customer management, store management, online appointments, as well as financial services such as short-term business loans for merchants.
The 2C business line, which revolves around Cash App, a personal electronic wallet, focuses on P2P transfer functions and extends to services such as stock/crypto investment services and offline payments.

1. Square 2B Business Ecosystem

Among the many third-party payment companies, Square is one of the few companies that started with offline merchant payments. When Square was founded in 2009, there were a large number (over 20 million) of small and medium-sized merchants in the United States who were unable to obtain approval to use bank POS systems or afford the high costs associated with them, making it difficult for them to accept mainstream card payments. In response to the pain points and payment needs of these small and medium-sized merchants, Square entered the offline B-side payment market with low application thresholds, affordable prices, and easy-to-use card readers.

According to industry statistics, 95% of merchants can be approved to use Square's services, compared to a pass rate of only 30-40% for traditional POS service providers. In addition, the approval process for Square merchants is automated by the system and takes only 1-2 days, while traditional service providers require several weeks for approval and debugging.

In terms of hardware, take the initial simple headphone jack card reader as an example. Merchants only need to connect the card reader to their phone or computer and install the Square Point of Sale software on the device to easily accept card payments. Subsequently, Square also launched more feature-rich and expensive card terminals to provide a better payment experience and generate more profits for the company.

As only around 30% of the over 30 million merchants in the United States accept credit card payments, Square has successfully gained a significant market share and merchant resources in the offline C2B payment market by filling the vast gap in payment acquiring services for small and micro merchants. According to the company's disclosure, the number of offline merchants using Square had exceeded 2 million by 2017.

2. Cash App C-side Ecosystem

Outside of the 2B business system centered around offline POS payments, since the launch of Cash App in 2013, Square has gradually built a 2C payment ecosystem around this application. At its inception, Cash App mainly served as a platform for personal peer-to-peer payments or transfers, with relatively limited functionality. However, the company subsequently introduced the following features: ① Cash Card (a debit card issued in partnership with banks) with added C2B payment capabilities; ② In-app stock and cryptocurrency trading; ③ Small cash loans with limits ranging from $20 to $200, without the need for review. And by acquiring "BuyNow PayLater" service provider Afterpay in 2021, Cash App further integrated online payment and installment consumption functions. At this point, the C-end payment ecosystem centered around Cash App has been initially established.

With the gradual enrichment of Cash App's functions, the frequency and stickiness of users using the app have also increased, and the company's revenue sources have continued to expand. The average revenue contribution per Cash App user has grown from less than $30 in 2018 to $280 in 2021.

III. What are the advantages and disadvantages of Square compared to its peers?

From the above discussion, it can be seen that the development of digital payments in the United States is still immature, with different backgrounds and different focuses. There are many third-party payment companies, so which companies are more likely to stand out from the current "chaotic stage," and what are the core competitive points of payment companies? Dolphin believes that the core competitive points lie in payment scenarios, user scale and habits, product iteration speed, and payment rates.

First of all, in terms of payment transaction fees, which are the most intuitively perceived by users, a horizontal comparison shows that the fees charged by various payment companies are basically the same, with only PayPal charging slightly higher fees. Specifically, the fees for online payments are generally around 2.9% of the total payment amount, while offline payments are around 2.7%. It can be seen that engaging in a price war on payment transaction fees is not the main competitive means for these companies.

From the perspective of user scale, it can be seen that the user scale of the two major P2P payment apps, Venmo and Cash App, is leading, both reaching around 70 million by mid-2021. The user numbers of bank-owned apps (such as Chase Mobile and Zelle) and 2C internet company-owned payment brands like Apple Pay are in the second tier, with approximately 40 million users each. The user scale of "BuyNow PayLater" companies is currently the smallest, with leading companies having around 10-20 million users. Therefore, in terms of user breadth and usage habits, PayPal and Square, as the leading companies, hold a dominant position.

In terms of payment scenarios, they can be roughly divided into three categories: ① Online payment: such as online shopping, hotel booking, ticket purchase, etc.; ② Offline payment: payment at offline stores and restaurants; ③ P2P payment: direct transfer between individuals, such as sending red envelopes, splitting bills for meals, etc. For different scenarios, payment companies have also launched corresponding products or services (see the figure below for details).

After summarizing, PayPal's advantage lies in online payment; Square excels in offline B2B business; Apple/Google Pay and others dominate in offline B2C business; banks firmly occupy the leading position in traditional payment field, but lag behind significantly in digital wallet field. As for the P2P field, it is dominated by PayPal and Square.

1. Square has a keen eye and leads in offline B2B business

As one of the few digital payment companies focusing on offline business, Square has a clear advantage in this field. According to Nilson's estimation, although Square's market share is still relatively low compared to traditional offline acquirers, accounting for about 1.5% in 2018, it is already the eighth largest service provider in the United States.

Although other digital payment companies have also launched their own offline payment brands and hardware, such as Zettle (formerly known as PayPal Here) under PayPal, they have not been able to shake Square's leading position in the offline payment field. Square's market share is far ahead of Zettle, Stripe, Shopify, and others.

2. PayPal's stronghold is online payment

Unlike Square's focus on offline, PayPal's advantage lies more in online payment. Acquired by the leading e-commerce platform eBay in its early days, PayPal gained a stable online payment scenario. However, PayPal's online payment business has expanded beyond eBay to the global market. As of 2021, PayPal has over 390 million C-end users and 3,400 merchant users worldwide. According to research, about 75% of the top 1000 online merchants in the United States accept PayPal payments. However, according to Dolphin's investigation, among the top platforms, the largest player in the US e-commerce market with a market share of up to 40%, Amazon, does not accept PayPal payments, possibly due to competition. However, other platforms such as Walmart, eBay, Mercado Libre, Expedia, and Airbnb all accept PayPal. Therefore, PayPal undoubtedly has the widest range of use cases and user base in the online B2B payment field.

In comparison, Square's online payment scene is relatively limited, generally requiring the use of its Cash Card co-branded debit card to complete online payments through card organization channels. However, after the acquisition of Afterpay, the applicable online stores have also been integrated into Square's Cash App, partially addressing the issue of the lack of online payment scenarios. Currently, Afterpay's applicable scenarios are mainly limited to independent websites of product brands and are not widely available.

3. P2P personal wallets, the forefront of fierce competition

In addition to the aforementioned online/offline C2B payment scenarios, the P2P payment scene can be said to be the most fiercely competitive and potentially promising payment scene in the United States. Cash App, Venmo, and bank-backed Zelle are all strong competitors in this field, with user bases numbering in the tens of millions.

Each of the three P2P wallets has its own advantages. Cash App stands out for its wider range of functions, not only for payments but also for investments. Venmo's advantage lies in its embedded social features, allowing direct communication with friends. In addition, as a PayPal subsidiary, Venmo can be used directly for online payments in more scenarios. Zelle's advantage lies in its reliance on banks, making it more attractive to users who prioritize fund security and more suitable for larger P2P transfers.

However, based on recent download data and daily active user numbers, Cash App, which was born later, has surpassed Venmo in terms of growth momentum. Dolphin believes that there are three main reasons behind this:

Cash App's target user group is more focused on young people or low-income groups who have little or no access to banking services. For this user group, Cash App serves as a primary payment and financial management tool, while Venmo and Zelle are additional payment tools outside of traditional banking services for their user groups. ( The search popularity of Cash App in the figure below corresponds to the density of the population in the United States lacking banking services )

Cash App makes better use of social platforms such as Facebook, Tiktok, and Twitter for promotion, so it spreads more widely among young people.

Cash App iterates its product features faster, enabling it to quickly grasp the needs of the target audience and provide richer functionality, thereby increasing user dependence. Although Venmo has also introduced co-branded debit cards and virtual currency trading services, its pace has always lagged behind Cash App.

IV. Based on advanced domestic experience, which payment players can stand out?

Referring to the success of Alipay and WeChat Pay in the domestic digital payment field, Dolphin believes that there are mainly two paths for digital payment tools to stand out and even surpass the dominant bank card payment in the United States.

① Starting from controlling the payment scenario, similar to the path of Alipay, it relies on online platforms with a large amount of traffic and C-end users in its ecosystem to establish the basic foundation of the payment scenario. It gradually diverts users from e-commerce platforms to payment tools and then tries to break out of the circle and occupy payment scenarios outside the system. When the number of payment users outside the system significantly increases, it reversely diverts users back to the e-commerce platform within the system, forming a positive cycle. With the exclusivity of payment channels within the system, it further consolidates the basic foundation of the payment scenario and consumer habits.

From this perspective, PayPal once developed into the largest online payment tool in Europe and the United States through this logic. However, the core flaw of PayPal is that after being sold by eBay, it does not have its own e-commerce platform as the basic foundation. Amazon does not accept PayPal payments, and eBay has changed its main online payment service provider to Adyen, which reflects the flaw of PayPal in this logic. Due to the lack of an in-system platform, PayPal still needs to rely on third parties, so its negotiation and bargaining power will not be high, let alone replacing the position of bank card payments.

For e-commerce platforms, payment is also an important part of completing their transaction loop. Therefore, when online platforms reach a certain scale and have the motivation to launch their own payment tools, such as Amazon Pay, JD White Bar, Meituan Pay, etc. In this case, the status of third-party payment tools such as PayPal is bound to be affected. For Square, its control over the payment scene is relatively stronger due to its ownership of in-store merchant payment resources. For example, for merchants using Square services, the company can promote its own payment tool (Cash App) through rate discounts and other means, and even replace bank cards as the main payment channel. However, the prerequisite is that Square must cover a sufficient number of B-end and C-end users to ensure the applicability of its own payment tool. Currently, there is still a considerable distance to go.

The second approach is to leverage the huge advantage in C-end user scale and control over user habits and frequency to cultivate the habit of using payment tools among users, and then use the advantage of scale to compel merchants to accept such payment tools. WeChat Pay has successfully adopted this logic. From this perspective, both Cash App and Venmo, the two major P2P payment tools, have the potential to stand out using this logic.

At the same time, Apple Pay and Google Pay may also stand out by virtue of their large number of mobile and other terminal users. However, as of now, Apple Pay and Google Pay mainly simulate bank cards for payment and have not yet established independent digital wallets separate from bank cards. Therefore, Cash App and Venmo are still the most promising contenders.

Summary: In this article, we mainly analyze the business models and profit paths of the payment industry, using Square and PayPal as examples, and discuss the current competitive landscape of payment companies with different backgrounds. We also examine the strengths and weaknesses of various payment players in different payment scenarios, and identify which companies are most likely to stand out like Alipay and WeChat Pay.

In the next article, we will select a target company and conduct a more detailed analysis of its revenue sources and composition, as well as explore the additional growth opportunities for payment companies in merchant SaaS services and 2B/2C financial services beyond payments. Finally, we will assess the TAM market size and growth potential of payment companies, and provide our valuation judgment and recommendations based on the current market environment.

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