By Miguel Helft
August 16, 2012

FORTUNE — The heated battle for mobile payments just got more heated. On Thursday, Square, the pioneer in mobile point of sale systems, announced a new pricing model that gives merchants the option to pay a monthly fee of $275 instead of the current 2.75% fee on every transaction. Merchants who make more than $10,000 per month in business would pay less under the new pricing plan. Jack Dorsey, the CEO of Square, says it is all part of a move to make it easier for consumers and merchants to move away from cash. Dorsey, who just last week announced a deal with Starbucks (SBUX) to process the coffee chain’s credit card transactions, spoke with Fortune’s Miguel Helft about the latest announcements. This is an edited transcript of their conversation.

You are offering fixed pricing to merchants. Why?
If you look at the history of the industry, 1950 was first time that a merchant was charged to accept a credit card. It was 7% per transaction for Diners Club. And that per-transaction fee has not been changed in 62 years, it has not been rethought as a model. Two hundred and seventy-five dollars a month and zero fees is something entirely new. The reason we are doing it, is to make it more approachable. When a merchant has to pay credit card fees, they often don’t know how much it’s going to be.

But your previous pricing plan of 2.75% per transaction was already pretty transparent.
Yes, you know exactly what you are paying. But you still have to calculate that. [Now] you pay $275 per month and everything you swipe is in your bank account the next day.

This is a good deal for merchants who do more than $10,000 a month in transactions. What percentage of existing customers do you think will shift to the new pricing model?
This is designed explicitly for small businesses. A small business is characterized by the IRS as someone who makes under $250,000 a year. There are 27 million small businesses in the United States alone that don’t accept credit cards. This opens the door even further for them to start accepting credit cards.

Every existing merchant who switches to the new pricing model and who exceeds the $10,000 in monthly transactions is going to pay you less.
Yes, but you are probably using the system more. What we care about the most is the experience. We see a massive decline in cash and in payers carrying cash. We see a massive increase of mobile card transactions and mobile payments. The more payments we can enable to accept these forms of payments, the better.

Competition seems to be escalating. Intuit (INTU), PayPal (EBAY), Verifone (PAY), NCR (NCR) and others have mobile point of sale solutions. And they are innovating in price. Verifone, for example, has a plan that combines a monthly fee $9.95 with a per transaction fee of 1.95%. That’s cheaper than your old plans for many merchants, and cheaper than the new plan for merchants that do less than $13,000 or so in monthly business. Is your new pricing plan being driven in part by competition?
Not at all. Our new pricing model is driven entirely by making it easier for merchants to get in the door. We are not going to be reactive.

Is the competition more intense for the bigger merchants, say mid-sized businesses, as opposed to the hairdresser or personal trainer?
We’ve always built the company and the technology with the mindset that we want to be able to carry every single transaction in the world. We are enabling more and more people and more and more classes of businesses to get on. I don’t think there’s significantly more competition in the individuals than in the larger merchants.

What’s this new pricing model going to do for the Square business overall?
We think it is going to grow the merchant base dramatically. That’s good for merchants. And it’s good for payers.

Lets talk about the Starbucks deal. Howard Schultz, the CEO of Starbucks, said the deal will help them lower credit card transactions fees. How is Square able to get better processing fees than a giant retailer like Starbucks?
It’s not their business. Their business is coffee. They should not have to worry about all the payment mechanics.

We are engineers. Most merchants have to go through multiple hops to get through to the end bank. Each one of those hops takes a percentage, takes a fee. We’ve engineered [the system] so we can go direct to the sources and that allows us to get more efficient the transaction costs.

The other thing is that we are effectively one merchant. Starbucks is one merchant. That combined volume is massive and it does afford us some negotiating power in terms of rates.

Third thing, all the cost in credit cards is based from risk and fraud. We have more information than anyone else on risk and fraud, which means that we can minimize risk and fraud, which means that we can minimize the cost better than anyone else.

These three things add up pretty significantly.

So how much will they save?
We are not disclosing that.

You’ve told me before that the Square innovation you are most proud of is the Pay with Square app, and specifically, the fact that it allows you to walk into a store a pay by simply saying your name. You never have to take your phone out of your pocket. This is not coming to Starbucks yet. Why?
We wanted to start small and start simply. They built QR codes on every single counter. If we had to change every single point of sale system, it would be a much longer lead time. We wanted to get started and learn a lot and then figure out how to evolve the hardware. But the reason that Starbucks came to us in the first place was because of the experience Pay with Square afforded.

You’ve always been proud that Square spread itself by word of mouth, that you do not need a sales force to grow the business. Clearly, word of mouth didn’t cause the Starbucks deal. Should we expect Square to continue to court larger retailers?
We are only focused building a utility that can scale from the individual to the larger retailer. This is the first in that class. Absolutely, we want to build a system that any merchant can use.

So this represents a shift, if not of your goal of serving both sides of counter with new technology, but at least in focus for Square?
No. It’s always been merchant based. Small merchants self selected into it. You can imagine many, many retailers enabling Pay with Square.

Are you building a sales force to go after larger retailers?
No. I talk to them to them. But I’m not going out and doing a tour [of major retailers].

As part of the Starbucks deal, they invested $25 million in a Series D round of financing. It’s unusual to announce to a portion of a financing round without disclosing the whole thing. Can you tell us how much you raised and at what valuation?

Was the Starbucks deal necessary to persuade the other investors to get on board?
No. Not at all. This conversation was completely independent. It happened to coincide with a Series D raise and we invited them to invest. Our investors who are leading the round, had no idea that Starbucks was coming when they set a price and when they invested.

There is no user benefit to announcing rounds. My preference is not to. But people care about this and we will announce the round when the time is right.

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