Square (SQ 1.09%) has long pointed to its growing ecosystem of services as a way to differentiate its core payments service from a growing set of competitors. Over the last couple of years, Square has built out several new services, acquired a couple, and expanded existing services to cover more verticals and use cases.

That expanding portfolio of services itself doesn't exactly give it a competitive advantage. Square's merchants could put together a nice suite of services from multiple providers that do everything they need and work together just fine. Even the convenience of all of Square's services coming from one provider isn't a huge advantage, especially as it moves upmarket to larger merchants.

Square's competitive advantage stems from the pricing options that having an ecosystem affords it. Square can offer competitive pricing on all of its services for merchants of all sizes because it has several avenues through which to monetize those services.

A customer holding a phone near a Square card reader to pay.

Image source: Square.

Different merchants get different prices

On Square's third-quarter earnings call, outgoing CFO Sarah Friar pointed out that when it comes to charging its customers for products, "we typically try to match it to the place where we think most value is being created on the other side for the customer."

For small merchants, Square creates value by enabling them to take card payments. If that's through an invoice, an online appointment, or some other means, the value is generally derived from being able to take the payment type the customer chooses. As such, Square gives away software for appointments and invoices for free, and it charges sole proprietors a higher rate for payments.

On the flip side, larger merchants have many more options for payments solutions. So, Square gives those merchants a discount on the transaction fees, but it charges a monthly price for access to software like Appointments or Invoices.

The net result should be about even for Square if it priced everything right. It's really a matter of whether the revenue shows up in Square's transaction-based revenue, or its subscription and services-based revenue.

Employees are consumers, too

Adding another layer of differentiation for Square is the increasing popularity of Cash App, its consumer-facing app. Friar has said she wants Cash App to eventually be able to replace a traditional bank account. It's made significant progress over the last couple of years, adding the ability to receive direct deposits and use a linked debit card to spend money in the account or withdraw cash from any ATM.

If a merchant's employees accept their paychecks via the Cash App, Square could give the merchant a price break on its payroll product. Square already incentivizes employees to accept payment via Cash App by offering faster access to their money. Square can then monetize those users through the Cash Card, or perhaps through other value-added banking-type services in the future.

Getting multiple products into merchants' stores

Square can do a lot with pricing when it has the ability to monetize services in multiple ways. So, if a merchant comes to Square and says a competitor is offering a better price for certain services, Square can come back and offer the same price while working with the merchant to monetize its business in other services.

Using a dynamic pricing model depending on how the merchant wants to pay also provides incentive for Square's customers to take multiple services. Square showed last year that offering payment processing discounts while charging for software encourages larger merchants to take multiple products. This year, it's aiming for the opposite, giving away software for free to smaller merchants paying its standard 2.75% for payment processing.

Using pricing as a tool to get merchants to take multiple products is what will lock them into the Square ecosystem and keep them there for a long time.