Why Square Acquired Afterpay For $29 Billion: Merchant And CashApp User Acquisition

OBSERVATIONS FROM THE FINTECH SNARK TANK

Payments fintech Square announced its intention to acquire Buy Now, Pay Later (BNPL) firm Afterpay for $29 billion in an all stock transaction. Square’s press release quotes Square CEO Jack Dorsey as saying:

“Square and Afterpay have a shared purpose. We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles.”

OK, whatever you say Jack.

The real reason was contained in Dorsey’s next comment:

“Together, we can better connect our Cash App and Seller ecosystems to deliver even more compelling products and services for merchants and consumers.”

Buy Now, Pay Later is a Hot Space...

The BNPL space has generated a ton of press over the past year as consumer purchases around the world have moved online and consumers look for ways to make it easier to buy what they want without incurring more debt on credit cards.

In the first quarter of its 2021 fiscal year, Afterpay generated $4.1 billion in sales from 11.2 million active customers, who purchased from 63,800 active merchants.

With 3.4 million customers in the ANZ region, Afterpay has penetrated roughly 14% of the market.

In the US, Afterpay’s market penetration is just 2.5%, despite having nearly twice as many customers as there are in ANZ. In the UK, Afterpay counts 2.2% of US adults as customers.

Average sales per customer is more than twice as high in ANZ as it is in either the US or UK.

Low customer penetration and lower average sales in the US and UK are the result of slower evolution of BNPL in those countries, not underperformance on the part of Afterpay.

In the US, Cornerstone Advisors estimated that $24 billion worth of goods were purchased with BNPL programs in 2020, and that in 2021, that amount will nearly quadruple to roughly $100 billion.

In the US, since the beginning of 2020, roughly four in 10 Gen Zers and Millennials, and three in 10 Gen Xers, have made a buy now, pay later purchase.

...But The Square-Afterpay Deal Isn’t About Buy Now, Pay Later

Although the idea of incorporating a BNPL service into Square’s services is appealing, Square didn’t need to spend $29 billion to deploy buy now, pay later services.

(Square isn’t really “spending” anything, actually, since this is an all stock deal. Square’s stock price is trading around $274, up about four-fold from its price at the beginning of 2020.)

What the deal is really about is bringing AfterPay’s merchant relationships into Square’s seller ecosystem and converting AfterPay’s existing customer base into Cash App users.

Square is a platform, and it would be helpful to review what a platform is (since it’s an overused—and misused—term). According to Platform Strategy, a platform is:

“A plug-and-play business model that allows multiple participants (producers and consumers) to connect to it, interact with each other, and create and exchange value.”

There are three elements to a successful platform strategy:

1. Be a magnet. A platform must attract the right providers—those with the most desirable products and services) and the right consumers (those who the providers want to do business with).
2. Act as a matchmaker. A platform requires a mechanism for matching consumers to the right providers, and for enabling providers to reach the right consumers who come to the platform.
3. Provide a toolkit. The toolkit is what enables providers to easily plug into (and out of) the platform, and to integrate with consumers.

While Square has done a great job at #1—attracting buyers and sellers, it has a lot of room for improvement. According to Cornerstone’s research, just 13% of Square Cash App users earn more than $100,000 a year. In contrast, 31% of BNPL users (who are still predominantly Gen Zers and Millennials) have more than $100k in income.

Square wants—and needs—those higher income consumers in order to keep attracting (and holding on to) new merchants to the platform.

In addition, Square needs to bolster its seller ecossytem. According to Seeking Alpha:

“Over the last year, Square's Cash App has taken the spotlight while the Seller ecosystem has struggled.”

The Small Business Platform War

All of the major platforms—PayPal, Shopify, Intuit—are engaged in an arms race to win the payments war, and each are racing to fill the gaps in their offerings.

PayPal’s acquisition of Honey helped the payment company add marketing and sales capabilities. At the time of the acquisition, TechCrunch commented:

“PayPal’s network of 24 million merchant partners will gain the ability to offer targeted and more personalized promotions to consumers as a means of acquiring new business and driving increased sales. PayPal Credit may also be integrated into Honey to help finance larger purchases.”

PayPal highlighted its merchant value chain capabilities in its February 2021 investor presentation with a slide titled “We’re building a comprehensive platform to power the global digital economyGreat companies solve real problems.”

In addition, Intuit launched a card reader for small businesses to boost its payment processing business and take Square on.

If Square is successful at converting Afterpay’s customers and merchants to its ecosystems, it will likely prove to be well worth the $29 billion in stock the company is giving up.