Square (NYSE:SQ) recently introduced Square Terminal, a portable all-in-one payment processing device designed to replace keypad-based credit card machines. The wireless, Wi-Fi-enabled device processes payments from traditional cards and NFC platforms like Apple Pay and Alphabet's Google Pay, and it uses a built-in printer to print receipts.
Square will charge a transaction fee of 2.6% plus $0.10 per payment on Terminal, which is comparable to the rates on its other hardware devices, which charge fees between 2.5% and 2.75% plus $0.10 per transaction. The Square Terminal costs $399, but it comes with a $300 credit for merchants.
Square's hardware strategy
Square's first hardware product was the Square Reader, a credit card reading dongle that could be plugged into a smartphone. The device was later updated into a stand-alone Reader that could also accept NFC (i.e. contactless) payments. Square also launched the Square Stand, which converted iPads into point-of-sale systems, and the Square Register, which evolved the concept into an all-in-one system without the iPad.
The Square Terminal shrinks down the Register into a portable form factor, which frees merchants from checkout counters -- which is ideal for certain employees, like hairdressers. All these products tether merchants to Square's expanding ecosystem of services, which includes payments, customer relationship management tools, payroll services, HR and inventory management tools, e-commerce and web design tools, instant deposits, small business loans, and even food deliveries via Caviar.
Square's primary strategy is to lock in merchants by cross-selling more of those services, which could turn it into an "one-stop shop" for digitizing a business. Doing so would widen its moat against PayPal (NASDAQ:PYPL), and help it challenge other "one-stop" digital shops like Shopify and Grubhub.
Square's hardware revenue rose 78% annually to $18.4 million last quarter, fueled by strong demand for its Reader, Stand, and Register devices. However, that total accounted for less than 5% of Square's total adjusted revenues. Most of Square's revenues came from its payment fees and subscriptions for its add-on services.
That's why Square sells its hardware devices at a loss. Last quarter its hardware costs rose 80% annually to $25.5 million, and exceeded the unit's revenues by 37%. That loss-leading strategy will continue with the Terminal, which technically only costs $99 net of $300 in credit. That makes it much cheaper than the Stand and Register, which cost $169 and $999, respectively.
Understanding the competition
Square's main competitor in the space is PayPal, which offers four types of hardware: the Chip and Swipe Reader, the Chip and Tap Reader, the Chip Card Reader, and the Mobile Card Reader. PayPal's first two Readers compete against Square's Contactless and Chip Reader, while its Mobile Card Reader competes against Square's classic dongle-based Reader.
Meanwhile, Square's Terminal seems "squarely" aimed at PayPal's Chip Card Reader, which offers similar features but uses a physical keypad and lacks an onboard printer. These two key differences could win over merchants, since the Terminal can display more information on its full-color touchscreen and doesn't need to be tethered to a receipt printer.
PayPal's Chip Card Reader only costs $100, but Square likely thinks that the Terminal's bundled credit could make it a compelling alternative.
The bottom line
Square sees a chance to disrupt the market for keypad-based credit card processing systems with Terminal, and its bet could pay off over the long term. However, investors should note that Square is probably incurring losses for every device sold, and that its ultimate goal is to generate higher subscription and service revenues from merchants instead of making money from hardware sales.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Apple, Grubhub, and Square. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, PayPal Holdings, Shopify, and Square. The Motley Fool has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, short January 2019 $82 calls on PayPal Holdings, and short January 2019 $80 calls on Square. The Motley Fool has a disclosure policy.