Describing Stripe’s business as a payments n00b

At the end of one of my Harvard Business School courses last semester (“Strategy & Technology”), I was faced with a team paper to write. Given that the topic was fairly open-ended, I was faced with the questions of not only which topic to select, but which criteria to use to select the topic. Should I:

1. Choose a topic I knew a ton about already (and therefore was likely to be get the best grade on)?
2. Choose a topic that would offer me useful opportunities for networking?
3. Choose a topic that would would lead me to learn something useful as I wrote it?

My teammates and I (my classmates Neha Rambhia [https://twitter.com/neharambhia] and Aishwarya Ramakrishnan) chose to focus on 3. above. We wrote our paper on Stripe, as all three of us had a passing familiarity with the popularity of its product among developers, but no clear idea of why this was the case. We wanted to remedy this gap in our knowledge.

Some of this paper is focused around a hypothetical strategic question facing Stripe, which may or may not be useful to other readers, but hopefully much of this paper is helpful to others in laying out what Stripe is, why its latest product releases are important, and the type of opportunity it has in front of it.

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Executive Summary

Stripe, a payments startup recently valued at $5B, started in 2011 as an extremely easy-to-implement payments platform targeted at web software developers. Notably, and unlike PayPal and many other ‘fin-tech’ startups, Stripe works with and improves the existing credit cards payments infrastructure rather than supplanting it. Stripe has built a unique set of products, platforms, and services on top of its core transactions product ‘Stripe Checkout’, including ‘Stripe Connect’ (which powers payments in modern multi-sided platforms) and ‘Stripe Relay’ (which enables mobile in-app transactions). Stripe has reached a point in its evolution where critical questions have been raised about its best strategic options for growth: should Stripe “stay the course” and continue executing on its current strategy, or should it move to more directly compete with PayPal and strive to disintermediate its existing credit card payments ecosystem partners as a “closed-loop payments network”?

This paper argues that due to the incremental costs, economic risk, and likely loss of support from partners associated with a shift to a closed-loop strategy, Stripe should “stay the course” and focus instead on international expansion. Stripe should extend and expand its set of products, services, and platforms that sit on top of core transactions, and build out new and deeper partnerships with ecosystem players to deliver more value to customers and increase the company’s defensibility.

What is Stripe?

Stripe is a financial technology startup founded in 2011 valued at $5B as of July 2015[1]. Stripe’s initial value proposition was focused on three primary tenets. First, Stripe developed a payments platform with extremely quick, streamlined setup focused on fulfilling the needs of developers of internet services. Developers using Stripe were often able to accept credit card payments within minutes, compared to the arduous processes required to set up a merchant account and negotiate with credit card associations in legacy models. Second, Stripe implemented an extremely simple pricing model for its service. Stripe charged a simple 2.9% of each transaction plus $0.30 per transaction[2]. Incumbent pricing models were typically significantly more complicated, and often required negotiation on the part of developers (which was both confusing and time-consuming). Third, Stripe focused on complementing existing payments infrastructure, while many payments startups of a similar vintage were focused on supplanting or circumventing incumbent ecosystem players.

Stripe’s initial value proposition resonated with startup developers, which has resulted in significant growth for Stripe. Stripe in late 2015 continues to offer streamlined setup and simple fees, but as Stripe CEO Patrick Collison has stated, “The transaction is just the start.”[3] Stripe offers a set of services designed to supplement its core transactions processing product, Stripe Checkout. Stripe Connect, launched in October 2012, is a platform designed to cater to the needs of the swelling ranks of would-be multi-sided marketplace startups like Lyft, Instacart, and others. Connect allows these startups to not only accept payments from consumers, but also set up and verify contractors, streamline and carefully control payments to contractors, and easily expand to any of the 23 countries Stripe is available in.[4] Stripe Relay, a platform launched in September 2015, was designed to remedy the fact that 60% of internet browsing, but only 15% of transactions occur on mobile. Relay allows for extremely quick (2-click) ordering of the products offered by a merchant from within social platforms like Twitter[5]. Stripe today is focused on being the easiest way for developers to receive payments from their customers, wherever they are.

Market Context

The payments ecosystem is a notoriously complex web of interlocking pieces that operate between merchants and consumers. Several different categories of companies exist in this space, each playing a nuanced role within the ecosystem. Credit card associations, such as VISA, Mastercard, or American Express, create & manage policies for their cards, monitor processing activity, and take care of clearing and settling transactions. Acquirers for these associations such as Chase and Bank of America traditionally provide merchants with merchant accounts and lines of credit. Point-of-sale technology companies such as MagTek and ID Tech offer equipment for retail establishments to track and charge customers for their purchases, while companies like Square offer point-of-sale equipment and software for mobile computing devices like mobile phones and tablets (among other things). Stripe operates within this ecosystem in two primary roles: as a ‘3rd-party processor’ and as an ‘e-commerce payment provider’. (See Exhibit 1 for a graphical ecosystem landscape.)

Exhibit 1: Map of the consumer ecosystem

Source: https://www.payfirma.com/blog/the-payments-ecosystem/

One alternative to this ecosystem is a ‘closed loop system’, or a system that independently manages all of the steps of the transaction between consumer and merchant. PayPal is such a system, as is transacting via BitCoin. PayPal is a company that independently manages fraud and transfer of funds without the participation of other intermediaries (though it can connect to other systems), and BitCoin is a protocol that accomplishes the same goal. Importantly, closed-loop systems are both business-to-business and business-to-consumer in nature, which can be a tricky balancing act for growing companies to navigate.

PayPal acquired Braintree, Stripe’s most significant competitor, in September 2013 for $800M.[6] Braintree historically had slightly different focus areas than Stripe, but recently has responded to Stripe by launching an extremely streamlined software development kit (SDK) for its services designed to replicate Stripe’s ease of use.[7]

The payments ecosystem is hot, and many view it as ripe for further innovation. 2015 is on track for ~$3.7B in VC fundraising as of December, up from ~$2.4B in 2014.[8] (See Exhibit 2) However, many view this funding as over-exuberant. Some view Square’s recent IPO at a ‘down-round’ to its previous round of private funding as proof of this. Stripe is growing, hot, and the apple of many a venture capitalist’s eye, but long-term success is far from certain, and murky decisions loom around every corner.

Exhibit 2: Global Payments Financing History [22]

Source: https://www.cbinsights.com/blog/payments-tech-funding-statistics-and-growth/

Key Strategic Decisions

Clear vision for the future

Stripe’s co-founders, the Collison brothers, looked to the future in 2011 and had a huge vision for the company: “To increase the GDP of the internet.”[9] Even today, only 2–3% of global credit card transactions and ~10% of US credit card transactions are done over the internet.[10] More and more offline transactions are likely to move online, especially towards mobile transactions. Reasoning back, the Collison brothers saw an opportunity to change the architecture and landscape of the financial industry by offering a set of products and services to dramatically improve the stale payments ecosystem. With globalization and progress in technology, it was critical to create a mechanism for seamless payments across geographies via both mobile and desktop interfaces. Stripe is focused on building out the infrastructure needed to accelerate and enable this shift. They believed that focusing on the developers and solving a key pain point i.e. building a simple payment processing system that will integrate easily with software developers’ online businesses, will lead to quick adoption and more online and mobile transactions from end consumers.

Build platforms and ecosystems

While Stripe started out describing themselves as a ‘Suite of APIs’, it was soon evident that they were on a larger mission: to build not just a product but a platform. Stripe has been very nimble in shifting from an initial product and set of services (Checkout) to the development of multi-sided platforms fostering ecosystems of partners that depend on Stripe to run their businesses across geographies (Connect and Relay).

Stripe initially focused on delivering a robust, easy-to-use product (Checkout) to help developers accept payments. It could be easy to confuse Checkout for a multi-sided platform, as it enables flows of payments that involve not only consumers and merchants, but credit card associations as well. However, Stripe is more precisely characterized as a bundler/ reseller of the services of credit card associations. It abstracts away any need for merchants to directly engage with acquirers and credit card associations and does not truly have any affiliation with consumers, who are unaware they’re using Stripe.

Stripe Connect is a multi-sided platform. Connect is similar to Checkout except for one key difference: freelancers / contractors for companies like Instacart or Lyft also create Stripe accounts, and can be paid through these accounts. Stripe fosters a direct interaction between the two parties through these accounts and technological integration, and is affiliated with both parties, albeit a weaker affiliation on the contractor side.

Stripe Relay fosters the development of a multi-sided platform between merchants and mobile apps (e.g., Twitter, Shopstyle, etc.) with even stronger affiliation than Connect. Relay enables merchants to post links to purchase goods on Twitter and allows consumers to quickly and easily purchase those goods within Twitter. Consumers are not aware that this is powered by Stripe. Twitter is not currently charging a percentage of sales or a referral fee for direct purchases via Relay, but instead hopes that merchants will buy Twitter ads to promote Relay links.[11] Relay enables direct interactions between merchants and mobile apps, and both of these parties are affiliated with Stripe via technology integrations and partnerships (See Exhibit 3 for graphical depiction of Checkout, Connect and Relay).

Exhibit 3: Evolution of Stripe Products and MSPs

Stripe Checkout

Stripe Connect

Stripe Relay

Build a product that you would use

The Collison brothers, Patrick and John, shaped Stripe around their personal anchors: technology, their love for programming, and their sympathies for the difficulties facing software developers and entrepreneurs in getting their businesses off the ground. Stripe was designed to solve problems they themselves faced. Patrick and John dropped out of MIT and Harvard, respectively, to start up Auctomatic, which was sold for $5M. A year later, their learnings from this experience helped them set Stripe up for success. At Stripe, they’re building technology for businesses and are operating in spaces where the solution lies in machine learning.[12] They do not spend any money on marketing. Instead, they’ve gained traction among the developer community through Reddit, Hackernews and word-of-mouth publicity. They kept the culture at Stripe friendly and egalitarian, in line with their own personalities. “We were the first people to work on Stripe, and chronologically that’s interesting but so much of the great work that we do now, we’re a piece of it but we’re not the most important piece of it,” says Patrick.[13] Their web homepage does not list a hierarchy of employees but features a grid of headshots that is reshuffled randomly with every page reload. The brothers’ own descriptions do not mention the fact that they were the founders.

Strategic alternatives

Stripe has created a strong strategic positioning and recently extended in to building multisided platforms to complement its core Checkout product. Looking forward, Stripe could potentially be the preferred payment processor on any card-not-present transaction. Working back to this position, there are two potential paths Stripe could take: (1) stay the course — continue to excel as a 3rd-party payment processor with value-added services, or (2) extend to become a closed loop network — compete head-to-head with PayPal. (Exhibit 4 shows what both these future MSPs could look like.)

Exhibit 4: Future Strategic Options — MSPs and Key Implications

Option 1: Stay the course

“Staying the course” in Stripe’s case means playing the game they are good at. The growth opportunities they focus on in this option are three pronged: 1) continued international expansion, 2) building innovative new products and platforms and 3) strengthening current products and platforms/ MSPs. They have built out products that are platforms themselves. The future for them is building out and strengthening their current ecosystem.

Stripe is well-positioned to capture e-commerce and other transaction volume growth in international markets, particularly as consumers shift their behaviors to mobile transactions. Stripe’s partnerships with VISA and AMEX are serving them well, particularly with developing local banking partners in international markets.

Continuing to build developer-friendly products and integrating with new applications helps them capture early startups looking at new business models. This helps build a first mover advantage in innovative internet businesses and helps them build features to target these models, as they did working with Lyft to help the drivers get paid instantly through Stripe Connect.[14]

Additionally, continuing to strengthen MSPs that Stripe has built in Connect and Relay (and developing new MSPs/ network effects with yet-to-be-released products) is crucial to developing a sustainable advantage for Stripe. Currently the number of transactions through Stripe is directly proportional to the number of merchants in their customer base. Through key app partnerships like Twitter, the transaction flow for the same merchants can increase significantly. This strong indirect network effect will be magnified as more apps and social platforms come on board with Connect and Relay. Helping merchants access more channels and sell in the same place they market also helps the social platform partner monetize their ad inventory in a more profitable way.

Option 2: Develop a closed-loop payment network

A second clear option for Stripe to continue its growth is to compete head-on with PayPal in the closed-loop system segment. In doing so, Stripe need not abandon its existing services in the credit card ecosystem. It could offer closed-loop services in addition to its current tools. This would enable consumers to, for example, pay Instacart through their Stripe account. This Stripe account could be linked to their bank account or credit card, or could be funded through other means (e.g., deposited from work as a Lyft driver). The importance of the card association is definitely lower in this ecosystem. This MSP could potentially be 4 sided — merchants, apps, customers and (where applicable) contractors. There would likely be indirect network effects: customers would appreciate the service available across as many apps and merchants as possible, while apps would appreciate more merchants, and merchants would desire greater consumer reach.

If Stripe can successfully offer a closed-loop system, they can offer a service with many advantages. These advantages include the ability to more fully control costs (lowering them below 2.9% if they see fit, due to lack of pass-through to credit cards, or raising fees if possible), an ability to potentially put cash from transactions in the pockets of merchants more quickly (currently 2 days),[15] and potentially do this while extracting a more meaningful margin from these transactions.

However, all of these potential advantages are tempered by meaningful downside. Stripe would have a more meaningful responsibility to manage fraud, which can be expensive and distracting. PayPal struggled with this in its early days as a closed loop system. Building up a multi-sided platform of merchants and consumers, especially on the consumer side, could be difficult and/ or expensive. PayPal solved this problem with referral fees paid to consumers, a tactic which Uber is famous for in this era (both for its consumer appeal, and the mountains of VC cash this tactic consumes). Finally, one of Stripe’s current advantages is that it is well-regarded by the credit-card associations and other incumbent players as a company that enhances the offerings of existing tools — Stripe would almost certainly lose this trust and support if it were to launch a closed-loop system that could potentially circumvent credit cards and other players.

Recommendation

Stripe should focus on staying the course over the next 5 years by building out its core products and growing and innovating on the ecosystem it has built. It is not feasible that Stripe could build a closed-loop system in the near future. This tactic may work for Stripe far down the road if it reaches a (much) more meaningful scale, but if it were to attempt such an aggressive maneuver now it would likely be disastrous.

The economics of building a consumer facing platform are not attractive. Developing a new leg of a multi-sided platform for consumers would be expensive, time-consuming, and risky. Many current multi-sided platforms rely on paid customer acquisition programs (e.g., Uber free rides), which would require significant additional fundraising for Stripe. Unit economics would become significantly less attractive in the near term due to higher customer acquisition costs and a significantly increased cost of maintaining the network.

Strategically, following this course would invite large-scale retaliation by Stripe’s large partners (especially credit card associations and acquiring banks) and competitors (especially PayPal). Stripe would need to strengthen their risk and fraud management functions and build a new consumer growth function all while reassuring current customers that their service won’t be interrupted, and they’d need to do so without the support of their best current allies. Executing on this shift could be extremely difficult. Even small interruptions in service for major merchant customers could be disastrous, and significantly erode their trust in Stripe. Continuing to build strong MSPs may prove more difficult, as Stripe’s consumer relationships may be overly complex or suspicious for partners like Twitter to want to deal with. Many key competitors in this space would all have meaningful scale advantages over Stripe: PayPal has its sheer scale and long experience, Amazon’s closed-loop system need only exist alongside its e-commerce and infrastructure businesses, and Bitcoin manages to operate as a stand-alone algorithm with decentralized trust mechanisms (and therefore a potentially much lower transaction cost structure). It is tempting to look at these players and notice that, while there are many big companies in this place, there is no clear “winner” yet, and therefore perceive this as an attractive market. The idea of that launching a high quality integrated system could help the market tip is powerful and seductive. However, Stripe has nowhere near the scale and influence globally, nor the competitive position to engage in a “payments war”. This maneuver, if it is ever attractive or feasible, will be a long way down the road. A frontal assault on PayPal and the rest will have to wait.

In contrast, “staying the course” offers a much rosier outlook. Stripe has carved out an attractive niche in the credit card payments ecosystem. Economically, though they’ll always keep a relatively smaller slice of the fees they charge compared to the potential in a closed-loop system, it’ll be a smaller slice of what is almost certainly a much larger pie. Their funding requirements will be much more limited, and applied primarily to international growth and infrastructure development and innovation. Strategically, their card association partners are willing to help them grow internationally, Stripe has a customer base that’s enthusiastic about the products and services it offers that “sit on top” of the core transaction, and Stripe has begun to build strong defensive positions with its MSPs built on top of its Connect and Relay products. It should continue to refine these approaches and build around them.

Stripe will still have to deal with competition on this path, but they’re better prepared for it in their current strategy. PayPal acquired Braintree in large part to take control of Venmo[16] but has begun retaliating against Stripe through tactics that only a scaled player can execute. PayPal has invested in innovation in recent years, enough that Braintree’s product is considered competitive and comparable to Stripe Checkout in its current state. [17] By leveraging its brand, network, and larger transaction volume, PayPal has helped Braintree acquire large customers, as well. Braintree and its moves will be a crucial competitive consideration as Stripe determines its strategy going forward.

Fortunately, Stripe has proven itself adept in the use of “scrappier” competitive tactics. Stripe avoided a direct fight with PayPal or the credit card associations. Stripe has targeted small businesses and startups while PayPal has continued to focus its efforts on larger merchants and consumers, and positioned Stripe as a way to grow credit card association transactions by making it easier for these new businesses to ramp their transaction volumes. As they build their business internationally, its important that Stripe continue to avoid these head to head battles, as they’re ones Stripe will find it difficult to win.

A second tactic that Stripe should continue applying is to carefully define their competitive space in an area that PayPal has been weak — developer friendly products, user interface and payment experience. Stripe made it simple for businesses to set up and accept payments within minutes with a significantly better user experience, while PayPal had been bemoaned for years as being a horrific ordeal to set up payments on. Also, Stripe chose to serve the most nimble customers in rapidly changing environments: developers in startups. This was ideal in two ways. First, startup developers are early adopters of new technology and were excited about Stripe’s elegant new solutions. Second, startups are typically cash-poor. Stripe’s lack of upfront or setup fees and transparent and simple pricing model instantly appealed to startup developers. Going forward, Stripe needs continue to support its key startup developer customers, but also gradually climb up the ladder to support its earlier customers as they scale, and eventually broaden its appeal to larger organizations.

Stripe has engaged with potential rivals and turned them into partners through strategic investments. Early on, PayPal founders Peter Thiel, Max Levchin and Elon Musk were Stripe’s first major angel investors, mentors, and advisors and continued to invest in subsequent rounds.[18] While card associations could be competitors, Visa and AMEX are also strategic investors in Stripe.[19] Patrick Collison has noted that “(Existing payments ecosystem players) were a bit surprised we were coming to them… It’s about knowing which level of the stack you’re competing in. Stripe is not competing at the financial plumbing level. A lot of those problems have been solved to a large degree. We’re competing at the technology, the API, the infrastructure level to figure out how we can go above and beyond these super basic transactions and enable that next generation of transactions for these businesses (card associations)”[20] Stripe can also accept Alipay and Bitcoin, which allows Stripe to increase affiliation to the platform and access to customers across geographies, including China. These carefully reasoned steps were instrumental in the success of Stripe. Looking forward, Stripe needs to carefully consider how feasible these partnerships with potential rivals are: it may not be able to continue to build these partnerships with would-be competitors for long.

Stripe has effectively managed to avoid tit-for-tat retaliation to date. PayPal is cheaper for high value transactions, as they drop their fee to 2.5% and then 2.2%.[21] While Stripe could have done the same and engaged in a price war with PayPal, they instead focused on increasing the number of card associations on the platform, improving customer experience and developer convenience to command a higher value. While Stripe may be more expensive in some cases, if its slick consumer experience increases customer conversion rates at the key payment stage of the funnel, it could easily make up that difference. Slack, a high-profile messaging startup, moved from PayPal to Stripe recently due to Stripe’s support of ACH and Netsuite. Focusing on key leverage points like these, and overall value rather than straight fee percentages, are a crucial tool for Stripe. Stripe has many advantages compared to its competitors; its most dangerous potential pitfall is allowing its competitors to draw them in to their games.

Citations

[1] Jon Russell, “Stripe Lands New Funding At $5B Valuation And Partnership With Visa”, Techcrunch.com. 28 July 2015 <http://techcrunch.com/2015/07/28/stripe-5-billion.

[2] “Pricing,” Stripe website. <https://stripe.com/us/pricing>

[3] “Keynote: Patrick Collison (Stripe) & Vinod Khosla (Khosla Ventures),” Money20/20.tv Youtube Channel. <https://www.youtube.com/watch?v=SDvF1oVbqLw>

[4] “Stripe Connect,” Stripe website. <https://stripe.com/blog/stripe-connect>

[5] “Stripe Relay,” Stripe website. <https://stripe.com/blog/relay>

[6] Leeno Rao, “eBay’s PayPal Acquires Payments Gateway Braintree for $800M In Cash,” Techcrunch.com 26 September 2013 <http://techcrunch.com/2013/09/26/paypal-acquires-payments-gateway-braintree-for-800m-in-cash>

[7] Michael Carney, “Oh hai, developers: Braintree may have just won the payments war with its new ridiculously simple SDK,” Pando.com. 9 July 2014 <https://pando.com/2014/07/09/oh-hai-developers-braintree-may-have-just-won-the-payments-war-with-its-new-ridiculously-simple-sdk/>

[8] “Financing To Payments Startups On Track For A Second-Straight Record Year” CB Insights Blog. 1 December 2015 <https://www.cbinsights.com/blog/payments-tech-funding-statistics-and-growth/>

[9] Tom Simonite, “Increasing the GDP of the Internet,” MIT Technology Review. 26 January 2015 <http://www.technologyreview.com/news/533996/increasing-the-gdp-of-the-internet/>

[10] “Keynote: Patrick Collison (Stripe) & Vinod Khosla (Khosla Ventures),” Money20/20.tv Youtube Channel. <https://www.youtube.com/watch?v=SDvF1oVbqLw>

[11] Adam Levy, “Twitter Inc. Wants You to Shop for Everything in Its App,” The Motley Fool. 10 October 2015 <http://www.fool.com/investing/general/2015/10/10/twitter-inc-wants-you-to-shop-for-everything-in-it.aspx>

[12] “Keynote: Patrick Collison (Stripe) & Vinod Khosla (Khosla Ventures),” Money20/20.tv Youtube Channel. <https://www.youtube.com/watch?v=SDvF1oVbqLw>

[13] Sarah Mishkin, “The Collison brothers and $1.75bn online payments start-up Stripe,” Financial Times. 17 April 2014 < http://www.ft.com/cms/s/2/9c8d9f7c-c000-11e3-9513-00144feabdc0.html>

[14] “Our Commitment to Always Treat You Better,” Stripe Website. <http://blog.lyft.com/posts/wetreatyoubetter>

[15] “Getting Paid,” Stripe Website <https://stripe.com/help/transfers>

[16] Leeno Rao, “eBay’s PayPal Acquires Payments Gateway Braintree for $800M In Cash,” Techcrunch.com 26 September 2013 <http://techcrunch.com/2013/09/26/paypal-acquires-payments-gateway-braintree-for-800m-in-cash>

[17] Aboli, “Braintree vs Stripe: Facts and User views,” letstalkpayments.com. 23 September 2015 <http://letstalkpayments.com/15824-2/>

[18] “Patrick and John Collison of Stripe at Fortune’s Brainstorm Tech” Fortune Magazine Youtube Channel. < https://www.youtube.com/watch?v=1iBcCBm8Hk4>

[19] Leena Rao, “Stripe’s new funding makes it a $5 billion company,” fortune.com. 28 July 2015 <http://fortune.com/2015/07/28/stripe-visa/>

[20] “Keynote: Patrick Collison (Stripe) & Vinod Khosla (Khosla Ventures),” Money20/20.tv Youtube Channel. <https://www.youtube.com/watch?v=SDvF1oVbqLw>

[21] Justin, “Did Balanced just (inadvertently?) kick off a price war with Stripe?” Spreedly Blog. 14 January 2014 <http://blog.spreedly.com/2014/01/14/did-balanced-just-inadvertently-kick-off-a-price-war-with-stripe/#.VmPW0d-rQ_U>

[22] “Financing To Payments Startups On Track For A Second-Straight Record Year” CB Insights Blog. 1 December 2015 <https://www.cbinsights.com/blog/payments-tech-funding-statistics-and-growth/>