Starbucks and Square: This One’s About the Bankers

8/8/12Follow @curtwoodward

Updated 1:40 pm Pacific, see below
Starbucks surprised the retail and tech worlds today with news that it will start using mobile-payments startup Square to process credit- and debit-card payments at U.S. coffee shops. And while a lot of the initial reaction has focused on the gee-whiz features possible with Square’s consumer smartphone app, the fundamental reason for this partnership is much simpler: Competition for the bankers.

Mobile payments may not be mainstream yet, but they’re coming fast. Starbucks itself says it’s now processing 60 million mobile payments each week at its stores around the world through its own smartphone applications. Those apps rely on consumers to display a scannable code on their phone’s screen, which cash-register workers can use to deduct money from a Starbucks card account.

That won’t change—Starbucks is keeping its loyalty card apps in force while adding the ability for customers to pay with Square’s app. And yes, that app has the ability to do interesting things like automatically detect when a customer enters the store and upload their photo on the register’s screen, so the customer can pay just by verifying their name at the register.

But in interviews with reporters today, Starbucks CEO Howard Schultz said that kind of magic wasn’t in the cards just yet. And the corner coffee bar won’t suddenly start sprouting iPads with a white plastic card reader plugged into the headphone jack, which is the Square payments setup typically seen at small businesses. Starbucks, after all, just rolled out a new point-of-sale system during the last fiscal year and a mobile-app scanning system at the drive-thru windows just a few months ago.

The real action is behind the scenes, where Square will become Starbucks’ vendor for processing digital payments. Starbucks CEO Howard Schultz wouldn’t say how much he’s paying Square for the service, but it’s less than Starbucks is paying now, and almost certainly less than the startup’s standard 2.75 percent charge.

That matters for two reasons. First, companies from several industries are all racing to plant themselves in the consumers’ mind as the go-to system for smartphone-based payments. That includes smartphone operating system providers like Google and Apple, online payment veteran PayPal, the wireless carriers, countless startups, and the existing credit card networks.

That competition is concentrated at the consumer level because the two dominant credit-card processing companies, Visa and MasterCard, have essentially won the battle to control the fund-transfers layer. Wireless carriers had been hoping to set up a rival system with their Isis initiative, but regulatory changes passed last year by Congress made that competition no longer profitable because it limited the processing fees that merchants have to pay to the banks.

With that piece of the battlefield set, industry insiders now see the race for mobile payment dominance mostly as a competition between the big four of Google, Apple, Amazon, and PayPal.

Now, you might add Starbucks and Square to the mix. Even with a high-profile CEO in Jack Dorsey (who is also one of Twitter’s founders) and a ton of venture financing, Square has mostly been an interesting case for early adopters. As of today, the small San Francisco company has access to what Schultz called “the largest retail mobile payment platform in the U.S.”

The deal also gives Starbucks a stake in Square’s success: A $25 million equity investment from the company, which includes a Square board seat for Schultz—it’s significant that Starbucks itself is making this investment, and not Schultz’s private venture fund, Maveron. Update: As an illustration of just how complicated this competition has become in a very short time, it’s also important to note that Visa made an investment of undisclosed size in Square last spring (thanks to Dan Toffey for pointing this out).

More competition is a good thing—particularly if the bank-based processing networks already have the payment infrastructure slice to themselves. In Starbucks’ statement, Schultz and company specifically called out “the expensive interchange fees associated with payment processing” as a barrier to getting more retailers to accept digital payments.

“As an entrepreneur, I understand how critical it is for new businesses to have easy and affordable access to card processing while also giving customers a choice in how they pay,” Schultz said in a news release.

Curt Woodward is a senior editor for Xconomy based in Boston. Email: cwoodward@xconomy.com Follow @curtwoodward

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