What the Starbucks Square deal really means

By now, you’ve probably heard that Starbucks is going to be investing $25 million in Square, the San Francisco-based mobile payments company. As part of the deal, Starbucks will switch its credit and debit card processing to Square in the United States. But once you get past the headline, what does this really mean?

For starters, don’t expect to see Square dongles at Starbucks locations. They’re just too inefficient and flimsy for the kind of volume that Starbucks does. Line speed is among the top 5 things Starbucks cares about, if not the top thing. Having the Square reader at each register would slow down the lines too much. But if they’re not going to have the Square dongle, how is Square handling all of Starbucks’ credit and debit card transactions?

I asked Square PR if Starbucks was going to use the reader at retail or just have its existing infrastructure and readers point to Square’s processing system. “The latter,” replied Aaron Zamost.

If there are no dongles, how can Square improve the Starbucks experience?

Pay with Square is one possibility. I am a regular user of PWS. Is it a magical experience? It can be. Every Saturday that I’m in town, I go to the ferry building for an empanada at El Porteno. After a few weeks, Alex, the guy behind the counter got to know my face. He would hand me my emapanada and I’d just walk away. I didn’t even have to say my name, making it even easier than advertised. Or it can be a pain in the ass. The last time I went to El Porteno, there was a new guy who hadn’t heard of PWS. It would have been much faster to pay with my credit card.

Whether you’re paying by name or paying by tapping (as Google is trying to get people to do), it’s hard to change consumer behavior. And paying with a swipe is so simple it’s hard to improve on that experience. There’s a reason for this: Credit card companies make money with each payment, so they have made paying as easy as possible.

To the extent that any company can get people to change the way they pay, it’s Starbucks. (Apple would be the other leading contender.) Starbucks’ ubiquity and frequency means it has the ability to drive consumer behavior. It already has with the Starbucks Mobile apps on iPhone and Android. According to the New York Times, Starbucks handles 1 million transactions a week through its mobile apps. That system uses bar codes that display on a phone’s screen. (Starbucks deployed special bar code readers for its stores.) In my experience, the Starbucks app is faster than Pay with Square. (It’s even faster if you don’t use the app and just print the bar code and stick it to your phone.)

That app is not going away.

The biggest win for Square (aside from the glowing press it will get for the next few days) would come from getting people to download and use the Pay with Square app. This will be entirely dependent on the extent to which Starbucks puts a marketing push behind this. If PWS is just another option that Starbucks accepts for the few people who know about it, it’s irrelevant. But if it pushes PWS downloads, that creates more value for all of the merchants who accept Square.

Another benefit to Square from this deal is that it provides social proof. It can tout that small businesses can use the same processor that Starbucks does. While this may turn off some independent coffee shops, it does have value. That is going to hurt startups trying to get into mobile payments as well as companies like Groupon that are trying to diversify their businesses. (Starbucks CEO left Groupon’s board earlier this year. As part of the Square deal, he will be joining Square’s board.) And it certainly trumps the partnerships PayPal has rolled out with Home Depot, Jos. A. Bank, and Abercrombie & Fitch.

Although $25 million is a big number, lets put it into context for Starbucks. In its fiscal 2011, Starbucks recognized $46.9 million in revenue on unredeemed stored value card balances. Those are just the leftovers that Starbucks expects people won’t use up on their gift cards. Essentially, Starbucks earned twice its investment in Square just by scrounging in its couch cushions.

Stored value cards are a big business for Starbucks. As of the most recent quarter, it had $521 million in deferred revenue — money that it had collected from customers but hasn’t yet earned.

Starbucks Cards are also essential to Starbucks in another way: They’re how Starbucks manages its loyalty program in the United States. The press release doesn’t address stored value cards, and neither Starbucks nor Square responded to a request for clarification.

The other big question is how much Starbucks is paying for transactions. The announcement says that Starbucks will save money on credit card processing as part of the deal. Zamost declined to comment on whether Starbucks will be paying Square the same 2.75% that regular merchants pay. “We’re not disclosing the terms of the agreement,” Zamost said.

With its volume, Starbucks is already getting some of the best rates available. The most likely way that Square can improve processing economics is to eat some of the cost.

Regardless, this is a big deal that will reverberate throughout the emerging mobile payments ecosystem. Exactly how big it is will depend on the details of the implementation and marketing, which we’ll see as it rolls out over the next few months.

(Full disclosure, given that I mention Groupon above: I have puts and several wagers against the company.)

[Top image credit: markyeg/Shutterstock]