Square’s Cofounder on Discovering — and Defending — Innovations

CURT NICKISCH:  Welcome to the HBR IdeaCast from Harvard Business Review. I’m Curt Nickisch.

One day, a woman walked into Jim McKelvey’s glass-blowing studio and wanted to buy one of his art pieces. But he couldn’t take her credit card. It was American Express – his studio accepted only Visa or Mastercard. She left without buying anything.

Afterward, McKelvey looked down at his phone, and wondered to himself: If an iPhone can be a book and a TV and a map and a jukebox, why can’t it be a credit card reader?

That’s where the mobile payment company Square was born. McKelvey’s not just a glass blower, he’s an engineer too. He designed and hand-built a small credit card reader that plugged into the iPhone’s headphone jack. Today, Square is a publicly-traded company based in San Francisco with billions of dollars in revenue.

McKelvey says there are lessons in building that business – and others he’s been involved in — that any entrepreneur can learn from. Starting with how we even understand words like innovation, disruption, and entrepreneur.

He’s our guest today. Jim McKelvey is a cofounder of Square and the author of the new book The Innovation Stack: Building an Unbeatable Business One Crazy Idea at a Time.

Jim, thanks for coming on the show.

JIM MCKELVEY: Curt, so happy to be here.

CURT NICKISCH:  So, what is wrong with that word “entrepreneur”?  What do people get wrong about entrepreneurship?

JIM MCKELVEY: Well, it used to be a great word that was used to describe something other than business.  Because when Joseph Schumpeter, the economist who originally started using it, he was using it to differentiate entrepreneurs from businesspeople, because businesspeople were rational, they built businesses that had typically been done before, they had business plans, they had structures.

And entrepreneurs were people who built companies, but built companies that had never existed before.  And in the last 150 years, what’s happened is the word entrepreneur has come to mean businessperson.  We just use the terms interchangeably, and because of that we no longer have this word just dedicated to crazy folks doing stuff that hasn’t been done before.

CURT NICKISCH:  And what is special to that word besides the sense of something new, like really new?

JIM MCKELVEY: The process of doing something that hasn’t been done before is different, and it’s messier, and it’s harder to discuss.  One of the things that I’m trying to do in this book is to cleave off all of business, and just talk about that part of commerce that is creation of new, and where you can’t copy something.  Because copying is the most powerful force in the world, it is the thing that gets it done, and as I look around the room that I’m sitting in right now, everything that I see is a copy of something else that has proven itself worthy of being copied.  So, I’m looking at a power strip, and I can guarantee you that that power strip has a grandfather and grandmother power strip that preceded it.  Most of the things that work are copies of other things.

CURT NICKISCH:  Yeah.  Defend copying for a moment because you do write in your book about how it has a ton of value, but it’s also so conforming, it’s also so normative that it also limits us.

JIM MCKELVEY: Yes, so look, no disrespect for copying.  I think copying is the most powerful force in the universe, and it’s the thing that I always try to do.  If I have a problem, the first thing I do is try to find some other precedent for solving that problem.

CURT NICKISCH:  It’s productive and efficient, right?

JIM MCKELVEY: It’s productive, it’s efficient, it’s what the educational system does.  So, I’m sending my kids to school right now, and you know what they’re doing?  They’re copying the knowledge that other people have.  And they can go all the way through master’s degrees, up until their PhD, and get nothing but recycled information.  And that’s good, like, that’s great, that’s how we learn, that’s how things work.  But it doesn’t give us new.

CURT NICKISCH:  How rare is entrepreneurship then?  How rare is wanting something new?

JIM MCKELVEY: It’s actually very rare. If you actually look at new, there are kind of two types of new.  One is this sort of evolutionary new where you’ve got a group of companies all making basically similar things, and one company comes up with a little innovation.  So, like in a car, cars used to start with turning keys, and now you start most cars with pushing a button.  And the first company that said, oh, our car’s going to start with a push button had something new, but then all the other companies copied that, and now we all kind of start our cars with push buttons.

And so, there’s that type of evolutionary innovation that is not what I’m interested in.  What I’m looking at is revolutionary innovation.  This is a case where you do so many things differently, so many new things at once, that you end up creating something wholly different.

CURT NICKISCH:  When you started Square, were you this kind of entrepreneur?

JIM MCKELVEY: I was, but I didn’t realize it. I have always tended to do things that have not been done before.  So, opening up a glass studio in St. Louis that was a giant teaching studio, it had never been done, it just had never been done in the United States.

CURT NICKISCH:  You wrote a textbook when you were a freshman in high school.

JIM MCKELVEY: I wrote a textbook, a computer science textbook when I had never studied computer science as a freshman in college.  And I don’t know where it came from in my case, I can’t really trace it back to too much in my childhood except to say that I’ve always been able to do things where I have not had somebody to copy, and I got used to that.  I got used to that level of discomfort.  I am always uncomfortable when I do something new.

And this is the thing that I see.  I see brilliant people all around who have great ideas of how they could potentially solve problems that plague us all.  And often from the most brilliant people what I hear is this excuse saying, well, I’m not qualified to do that.  And you know what, they’re right, they’re not qualified to do it, but the fact is if you’re doing something new, by definition you are not qualified.  Nobody is qualified to do something that has not been done before.

Qualifications only come after we know what the solution is.  Like you want to be a pilot?  Guess what, you got to go get qualified for that, you’ve got to go get trained, and type rated, and there’s a lot of training before they’ll let you fly an airplane.  But the first person to fly an airplane was not qualified, but they flew it anyway.  And it’s a different process.

CURT NICKISCH:  Did you have a clear motivation with Square that made you feel like you really wanted to stick to doing something new that had never been done before?  Or was it just the fact that you had had success doing this in the past that made you feel more comfortable about not taking the road well-traveled?

JIM MCKELVEY: It was trying to solve a problem, but it turned out in this case Jack and I chose a problem that had not been solved before.

CURT NICKISCH:  And this is Jack Dorsey.

JIM MCKELVEY: This is Jack Dorsey.

CURT NICKISCH:  He’s somebody that you had worked with when he was a teenager in St. Louis where you lived at a company that you owned.  He later went on to co-found Twitter, was forced out of Twitter, and that’s when you two decided to start Square together.

JIM MCKELVEY: Yeah, yeah, Jack had some time.  And he actually suggested that we start a company together.  And I said, great, what do you want to do, and he was like, I don’t know, what do you want to do?  And so, we kicked around some ideas, and we actually even hired our first employee to start working before we came up with the idea for Square.  And where Square sort of happened was I was trying to sell a piece of glass in my studio, and lost a sale because I couldn’t take an AmEx card.  And I was upset.  And then I realized that that frustration that I felt was something that I personally cared about, and so that provides a lot of motivation.  So, I called up Jack, and I was like Jack, man, I am really frustrated, I just lost this sale. I said, I think we should fix this, not that other thing that we were talking about doing.  And Jack was like, well, that’s interesting.  That’s how he says stuff, well, that’s very interesting.  So, for the next couple weeks we kicked it around, and that’s what became Square.

CURT NICKISCH:  Now some people might have gone to credit card companies, or point-of-sale providers, and they must have been wondering about this kind of thing too, and just tried to partner with an existing provider, and just create a hardware solution that they needed.  But you actually avoided even hiring people who had experience in the credit card industry.  Why did you feel so strongly about taking a path that kind of runs counter to the normal way of doing business?

JIM MCKELVEY: Yeah, we actually did consult with a former executive for MasterCard, and what we found was all his advice was either of the form of you can’t do that – Yeah, that message doesn’t resonate really well with me.  But the other message he gave was here’s some clunky, ugly, too expensive solution to do it.  And we were looking at this stuff, and it was like oh, this guy’s just feeding us what he knows from the industry, and it was largely useless.  As a matter of fact, in a lot of ways we just took what he suggested and did the opposite. It was at that point that we just kind of decided that we weren’t going to pull anybody in with relevant experience until we got a product out that we loved.

CURT NICKISCH:  Jim, you ended up building a company a lot like that, figuring out your own solutions to things as you went along, making choices, and then putting systems around the sort of company that you wanted to build, basically because you saw that for instance it would be too expensive to do live customer support, so you just went with email support only, knowing that that was what you had to do to grow.  And you created a whole company sort of looking at the scenario and making decisions, rather than following an existing playbook?

JIM MCKELVEY: Yeah.  So, we didn’t really have anything we could copy.  All of the inventions from the hardware, to the software, to the way we underwrote, and the way we signed up merchants, and the way we promoted ourselves, that was all unique.  And it wasn’t that we were trying to be unique. I mean, Jack and I didn’t sit there and say, we have to do things different.  What we did is we looked for solutions, and then we couldn’t find solutions to copy, so we had to invent.

And the problem with inventing a new solution is that it usually causes other problems.  So, for instance, the way we allowed merchants to sign up was this one-click experience, it was beautiful.  Forget a 42-page contract, you could just click a button and boom, you were set.  But now, we’ve got this weird contract that nobody else in the industry will respect because we’re not doing it the way everybody else does it.  So, now we have to have our own underwriting.  Okay, now you’re in the underwriting business, which means you need all these other systems to mitigate risk, so we had to invent those.

And it just kept going again, and again, and again.  And we fell into this pattern where you solve one problem, you create two more.  And it creates this web of solutions that altogether create a thing that I call the innovation stack.  And it’s this phenomenal business resource because it allows you to essentially dominate an entire history.

CURT NICKISCH:  Essentially by creating a company without looking to other solutions to copy, you created a company that was hard to copy, and made it possible for you to defend your business against Amazon when Amazon tried to copy it?

JIM MCKELVEY: Absolutely.  That is what happened.

CURT NICKISCH:  What is striking to me is that when Amazon attacked you, and came up with its own card reader with lower fees, you as a company decided not to do anything differently than you were already doing.  You were not going to make any move in response to Amazon.

JIM MCKELVEY: Yeah, so we were terrified.  We looked at Amazon, we looked at what they had done to other companies, and we looked at what they were going to try to do to us, and we said, how do we respond to this?  And we looked at all the things we were doing, and couldn’t come up with anything that we would do differently.  Including lowering our price, which was the amazing thing.

Amazon came in with this low-ball price, and we did not match it.  We did not start a price war.  And we looked at other stuff that we could do, Amazon had customer service, live customer service, at the time Square didn’t.  Now, we were trying to add it, but we couldn’t add it any faster than we were already adding it.  So, we’re like okay, we’re doing that anyway.  And we looked at all this other stuff, potential responses, and we came up with this shocking conclusion.

We weren’t going to do anything differently.  We were just going to keep being Square, and essentially ignore Amazon.  And I say ignore in actively ignore, in other words, you know that there is this giant monster outside your house, but you can’t do anything differently than what you’re already doing, so you just do what you do.

CURT NICKISCH:  Because you had good reasons for doing what you were doing.

JIM MCKELVEY: We had good reasons.  Look, it did force some introspection.  I was terrified, I was nervous.  The odds of surviving an attack by Amazon are pretty slim. There are a lot of bodies on that pile.

CURT NICKISCH:  This innovation stack, it’s essentially a collection of all the innovations and decisions that you made as a company to do the things the way that you did.  And you write in the book that while Amazon could have maybe copied one of them, or beaten you on price, or done some other things, it was just really difficult to copy all of the interlocking pieces the right way to have it work.  And that is what made Square so defensible?

JIM MCKELVEY:  Yes, it’s possible to do two or three innovations at the same time.  You can do two or three things differently. It’s hard to do 12 or 14 or 20 things differently simultaneously and get them all right.  So, if you look at the way an innovation stack evolves, the company that’s inventing it is able to iterate very quickly and evolve this thing that eventually has 14 components.  The company that’s copying those 14 components has to copy all 14 components, and that’s a totally different thing to do.

CURT NICKISCH:  Or have good reasons for not having to copy a few of them because they already have it or whatever.

JIM MCKELVEY: Yeah. And the other thing is if you’re copying, you don’t necessarily know what you’re copying, and why.  So, the company that creates this innovation is keenly aware of why they’re doing what they’re doing.  But a company that’s copying something was not privy to that inside information, so they’re just saying, well, those guys do this, so we should do this too.  And maybe they’re doing it for some stupid reason that’s only relevant because of their geography, and you don’t need to copy that thing.  But then you do it sort of unintentionally, well, I’m sorry, you did it intentionally, but incorrectly.  So, copying if you’re doing too much of it is really difficult.

CURT NICKISCH:  In your book you go back and you find some other companies that had similar innovation stacks as you see it.  The Bank of Italy, in the United States, Ikea, the furniture company, and also Southwest.  You ended up talking to Southwest founder Herb Kelleher before he passed away to talk about kind of how he put the company together.  Can you just talk about Southwest, and why you think that company had an innovation stack, and that explains how it was so successful?

JIM MCKELVEY: So, yeah, I had a great conversation with Herb, and I really miss him.

CURT NICKISCH:  Apparently, he was one of a kind, yeah.

JIM MCKELVEY: Oh my god, fantastic guy, fantastic guy, I’ve still got a pack of his cigarettes.  But he – so, I wasn’t interested in talking to Herb, or Southwest, okay, what I was interested in was the fact that the airline industry is the most commoditized, worst industry to compete in that you can imagine.  As a matter of fact, Herb, when I was talking to him, quoted a study that he had that said, of all industries, airlines were dead last, they were the worst.

And here in this terrible industry, Southwest comes and just crushes everybody.  And Southwest was the number one performing stock, not just of airline stocks, but of all stocks, for like 20 years.  They crushed it in this industry that everyone said well, there’s no way to be different because we all fly the same planes, we all have the same rules, we all have the same airport access, it’s just this completely commoditized thing.  And yet Southwest came up with this massive differentiating innovation stack.

And so, I talked to Herb about this, and I was like Herb, what did you do, and how did you do it?  And it turns out that what Herb and Southwest did 30 years before we started Square was the same pattern.

Well, I was lucky enough to reach Herb.  And he was so gracious with his time, we spent a whole afternoon together, which is Herb time is two and a half packs of Kool menthols.  And he is awesome.  I’m sorry, he was awesome.  No, you know, he is, I’ll use the present tense, because his spirit is still there.  And what he and the team at Southwest developed in those early years is still partially driving that company.  And it is miraculous to see in an industry as homogenized at air travel, a company like Southwest that just crushes everybody using the power of an innovation stack.

CURT NICKISCH:  And the other thing that kind of drives your point home is that Southwest was very successful, it was a legendary business case, anybody’s who’s done an MBA has learned about the trade-offs, and the choices, and just the very strategic thinking that went into coming up with a low cost competitor in a very high fixed cost industry.  But, to underscore your point, Southwest also fended off copycats like United came out with Ted, other airlines came out with low cost competitors to go up against Southwest, and most of them folded.  Ted is gone now.

JIM MCKELVEY: Ted stood for the end of United.

CURT NICKISCH:  And that’s because they could not copy Southwest.

JIM MCKELVEY: Right.  Amazingly, United, biggest carrier in the world, studies Southwest for 30 years.  So, it wasn’t like they didn’t know what they were doing.  And they come out with Ted, which either stands for the end of United, or United without U and I onboard, and it became this joke in the industry.

And here is the most competent potential competitor, the best airline there is, trying to copy this little upstart, and they can’t do it.  And why can’t do they do it?  And so, that’s what I go through in the book.  Okay, here’s why that failed.  And that wasn’t the only one that failed.  There were dozens of other companies that tried to copy Southwest and failed, and failed, and failed, and failed.

CURT NICKISCH:  I want to ask you about a few things I’ve heard you say, or read in the book that kind of struck me.  You write that the most interesting part of any market is its end.  What do you mean by that?

JIM MCKELVEY: So, the interesting part of the market is where it stops.  In other words, if you look at any market – take the market for automobiles, okay, now I’m talking new cars right now, forget used cars, but let’s say brand new cars, that stops at around $15,000.  Like if you have $15,000 you can barely buy a crummy new car, and if you have less than that you’re going to buy a used car, or no car at all.  So, the question is well, why couldn’t a car cost $1000 or $500 or $2000.  It turns out markets end at this low level where people assume nobody wants to participate anymore.

So, when I was talking to Herb Kelleher, what he found was the government did a study of airline travelers, and they concluded that only rich people and business people wanted to fly.  The rich and the people with corporate expense accounts, that was it.  This was a government study, and Herb quoted this to me, and he’s like, that’s insane.  You’re telling me that somebody doesn’t want to fly just because they’re poor?  No, it’s because they can’t afford it.  So, let’s make it affordable and see how many people want to fly.

When I look at markets, my most, the focus of my attention when I look at a market is where that market ends, where do we start excluding people?  So, in Square’s case, it was about $10,000.  If you didn’t sell about $10,000 of stuff in a year, you did not except credit cards.  There was just no way to do it economically, the costs were too great.  And if you look at flying, Southwest was not taking people from the other airlines, they were taking people from Greyhound and Trailways buses.  The interesting part of the market is where it ends because that’s where all the potential lies.  If you can figure out a way to expand that market, you will create tremendous good for the world.  And that’s usually where the innovation stack comes in, because almost always the tools that the market has evolved, will only serve up to that border.  And if you’re going to go beyond that border, you have to invent.

CURT NICKISCH:  Besides entrepreneurship, you also are not a fan of the term disrupt, and you argue that disruption needs to be disrupted.  Can you explain that?

JIM MCKELVEY: We use the term disruption a lot out in Silicon Valley, and it’s now popular elsewhere.  And this idea that young companies disrupt the complacent incumbents.  And it’s just the wrong focus.  Like if you’re starting something to disrupt something else, it’s bad energy.  And the reason I don’t like the focus of disruption is that it forces you to look at the thing that you’re trying to overthrow, and that’s not where you should be looking.  You should be looking at the customer who has been excluded, the person who would happily buy a new car, but they can’t afford a new car, the person who would love to have an apartment by themselves, but they can’t afford it, or the person who would love a new pair of shoes, but can’t get a new pair of shoes. Look at the person who’s been excluded and try to serve that person as opposed to disrupting the incumbent.

And I actually did a little research on this, and I traced the history of disruption, and it wasn’t called disruption.  In the beginning, Clayton Christensen wrote this book called The Innovator’s Dilemma, which most of your listeners have read.  And if you read that book, it’s called disruptive innovation.  That’s what he, but disruptive innovation is too many syllables so they used to just shorten it to disruption.  And it’s changed the focus.  And I dislike it.  I don’t like being called a disrupter of industries because look, by the way, Square did not disrupt most of the other credit card processors.  When we entered the industry, we just made the industry bigger.  And by the way, Southwest didn’t disrupt the other airlines.

CURT NICKISCH:  Besides looking for the end of the market, when you have young entrepreneurs come to you looking for advice, what else do you tell them to do?  How else do you tell them to think about creating this kind of company?

JIM MCKELVEY: So, look, I don’t talk about creating companies, I talk about solving problems.  And if I’m talking to young people or old people, or anybody that has a problem they care about, what I’m going to tell them is this, look, if your problem’s already been solved, copy the solution from somebody who’s done it.  But if it hasn’t, you have the potential to solve that problem if you’re willing to do things that have not been done before.  And when you start doing stuff like that, you’re going to feel really uncomfortable.  Any human feels uncomfortable.  I feel uncomfortable every time I do something new.  Every time I lose the protection of the herd and I can’t look around me and see five other people doing the same thing I’m doing, I feel weird.  And it’s going to feel weird and scary.

And the reason I wrote this book is to sort of hold the hand of the person who has that potential to do something but is fearful.  And I’m just saying look, yeah, you’re supposed to be afraid at this point because that’s a rational reaction, but there is a solution, and there are people who’ve done it before you.  And I profile four companies in the book that have done it, but there are thousands of examples I could have chosen, and it’s all basically the same pattern.  You start solving a problem that nobody’s solved before, so you can’t copy the solution.

Now you’re on a level playing field with the rest of humanity.  There are no experts in the new.  So, what are you going to do?  You’re going to quit?  Okay.  But if you’re going to try anyway, here are people who have been in your situation before and have made it, and here’s somethings that maybe they’ve learned that we can share with you.

CURT NICKISCH:  You also had advice in the book about finding the perfect problem for you, something that you cared enough about that would take you through the dark days.

JIM MCKELVEY: Yeah, so the perfect problem is this concept of something that I got actually from rehab.  So, from the 12-step programs, they all use the Serenity Prayer.  The interesting thing about the Serenity Prayer, and the reason I love it, is because if you scale it up, and apply it to everything in the world, problems sort themselves into three piles.  The first is things you can’t change, and the second pile is things you can change.

CURT NICKISCH: And the wisdom to know the difference.

JIM MCKELVEY:  Yes, that is the serenity prayer. And if you look at that slice of things you can change, there is a subsection of things you can change by copying the solution, and things you have to invent.  So, to me the perfect problem is something that’s a problem that you can solve that nobody else has ever solved.  And to me, that’s where the focus should be, on those things that will make the world a better place.  So, 100 years from now, when somebody has the same problem you’re having now, they’re going to copy your solution, and that’s where I think the greatest good can be done.

And I want to give people a guide, sort of a lens to sort these problems, because we have so many things that are wrong, and need to be fixed, and we have so many people, good people, who disqualify themselves because they don’t feel qualified.  And I’m just saying to them, look, none of us are qualified when we’re doing something new, but you can still do it anyway.

CURT NICKISCH:  Jim, this has been great.  Thanks so much for coming on the show to talk about this.

JIM MCKELVEY: Cool, well, Curt, it’s been super fun.

CURT NICKISCH:  That’s Jim McKelvey, he’s a co-founder of Square, and the author of The Innovation Stack: Building an Unbeatable Business One Crazy Idea at a Time.

This episode was produced by Mary Dooe.  We get technical help from Rob Eckhardt, Adam Buchholz is our audio product manager.  Thanks for listening to the HBR IdeaCast, I’m Curt Nickisch.