Square (SQ -0.20%) has seen the payback period on its marketing spend decline considerably over the last few years. Management used to say it recoups its investment in marketing within five quarters of signing up a new seller account. More recently, that number's fallen to between three and four quarters.
That might sound great to a lot of investors. More efficient marketing means more profits.
But the financial services and mobile payments company sees a massive long-term opportunity to capture more of the $3 trillion in credit and debit card gross payment volume processed by small and medium-sized businesses in the United States. It accounted for less than $100 billion in payment volume over the last four quarters.
"We think some of the payback, some of the ROI we're seeing in our seller business actually tells us we've over-indexed to efficiency," CFO Amrita Ahuja said at a recent investor conference. "We want to continue to grow the business for the long term."
Here's how Square plans to manage its marketing for growth instead of efficiency going forward.
Increased brand awareness
Square launched a brand awareness ad campaign in April, and management has been pleased with the results. The campaign was meant to expand knowledge of the company's offerings beyond just the square-shaped credit card reader that plugs into smartphones and tablets. As most investors know, Square offers a suite of products and services that all work together.
Following the launch of the campaign in April, Square saw a double-digit increase in seller activations over the next three months, according to Ahuja. As a result, Ahuja said the company is investing more in brand campaigns ahead of the holiday season when merchants make more of their sales, expecting it to have an even bigger impact on acquisition.
Interestingly, increased brand awareness could make Square's marketing even more efficient. The impact of such investments is notable in Square's international markets. "We have been investing in brand campaigns in the U.K., and this has driven efficient customer acquisition with the costs to acquire new sellers down by over 50% compared to prior year," CEO Jack Dorsey said on the company's second-quarter earnings call. Ahuja mentioned that Square's typical performance marketing may see benefits from increased brand awareness as well.
Lower hardware pricing
Square doesn't sell its hardware to make a profit like some of its competitors. Instead, it tries to lose as little as possible on the hardware sale in order to bring on a new merchant or grab a larger share of an existing merchant's payment volume. Last quarter, hardware costs exceeded hardware revenue by about 50%. That's up from 39% the year prior.
Square has been experimenting with lower prices, particularly on its high-end hardware that's likely to attract larger sellers. Ahuja says a 25% reduction in hardware prices for devices like Square Register and Square Terminal resulted in an increase of activations of 30% to 40%.
And those are high-quality merchant activations that will produce a considerable amount of payment volume and adjusted revenue for Square for years to come. Additionally, those merchants are likely to use other Square services, especially if the company continues to brand campaigns and makes them aware of everything it offers. The biggest benefit of Square's ecosystem of services is that it allows for it to be more flexible with its pricing. Square is extending that strategy to its hardware.
Ahuja says the payback period on those lower-priced hardware sales is two to three quarters. It's not clear if that's just for the loss on the hardware sales or if it includes Square's other marketing. Even in the latter case, Square is back to its five-quarter payback period with a much larger base of merchants and payment volume.
A stronger marketing mix
Square's new marketing strategy ought to lead to a considerable increase in merchant acquisition. The more familiar merchants are with Square's product offering from a brand campaign, the more likely they are to respond to a more traditional direct-response advertisement. And if that merchant finds Square's hardware is priced lower than they expected, the more likely they are to adopt Square's products.
Investors should expect Square's marketing expense and hardware losses to climb considerably, but it's only taken a tiny portion of its market opportunity so far. Management can focus on marketing efficiency and profitability later.