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The Crucial New Business Unit Hiding in Square's IPO Filing

It's the profit margins, stupid.

Square

Square’s second-smallest business unit could be the one to watch the closest.

The payments company, which filed IPO documents on Wednesday, generates the vast majority of its revenue by charging merchants a fee when a shopper swipes a card in their stores. But a new, though tiny, business unit may be the key to whether Square becomes just another big payments company or the transformational force that CEO Jack Dorsey has billed it as.

The division, dubbed “software and data products,” consists of a variety of new products that aren’t tied directly to Square’s credit card processing business. There’s Square Capital, a cash advance business that fronts merchants cash in exchange for a cut of their future receipts. There are software products like Square Payroll and Square Appointments, which Square sells to merchants for a monthly fee. And there’s Caviar, a food-delivery business that Square acquired to offer to restaurants that want to outsource their delivery.

Altogether, this group of businesses generated $21 million in revenue in the first half of this year, or just 4 percent of Square’s total revenue, up from 1 percent a year earlier. Still, that’s a tiny number; how can it be so important? Because the included businesses are much more profitable combined than the core payments business, which comes with the meh profit margins of many payments processors. And if Square can boost its margins well above its payments peers, it can command a higher value from investors along the way.

The numbers spell it out nicely. Square’s gross profit margin for its core payments business, after stripping out its soon-to-end Starbucks relationship, is a little above 36 percent. As for the new business line? Sixty-five percent.

“To the extent we are able to increase the proportion of our total net revenue that is derived from sale of these software and data products, we expect our overall gross margin will be positively affected,” the company said.

Update: Smart people on Twitter have pointed out another reason why these new products are important: they’re retention tools. While Square’s core processing business is essentially a commodity service, these new products aren’t and could provide the lock-in that keeps merchants from changing processors.

This article originally appeared on Recode.net.

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