If you’ve been in the POS space long enough you’ll eventually see what I call the Dealer Yo Yo (DYY). Cloud POS has gone through one full DYY cycle already and many of the legacy POS companies have done the dance several times. What is the DYY? It begins with understanding the nature of POS businesses.
Starting a POS company is expensive. You have to procure and ship hardware, build and support software, and then sell it. While hardware and software costs are relatively trivial nowadays, the sale process is more brutal than ever.
Brick and mortar businesses have incredibly long sales cycles for the paltry amount they pay. That’s why, as I’ve argued, it’s impossible for sophisticated investors to get behind endeavors that serve capital inefficient brick and mortar industries. As bad as this was when POS companies were earning tens of thousands when POS first arrived, revenues and margins have flatlined with the introduction of Cloud POS; the POS market is now more crowded and less economically-enticing than it’s ever been.
Throughout the ages, POS companies – referred to as Independent Software Vendors (ISVs) – have been faced with two choices: raise a lot of dilutive capital to sell the product directly, or shift the cost of sales to resellers, who will earn a percentage of the total sale. Since venture capital is a fairly new asset class, and POS companies were started when venture capital was trying to understand its purpose (and have since shifted entirely to growth equity), very few raised any material amount of outside capital.
Thus the majority of legacy POS companies have created reseller/dealer networks. There are all sorts of ways to do this, from the exclusive models that Micros and NCR employ, to the, “anybody and their dog” model employed by Aldelo. But the point of the effort is the same: place the cost of sales on the reseller.
After some amount of operating history, the ISVs came to a conclusion that their resellers were not selling fast enough. In an effort to exert more control over the sales process, the ISVs would buy up willing resellers and start selling directly to merchants. After all, the ISV had already earned enough profit and name recognition to afford these direct efforts.
Well, after months of hiring and training direct sales reps, the ISV would come to a new conclusion: they need local service representation to make sure the customer stays happy. Legacy POS systems are clunky, go down frequently, and have mostly lacked remote access to check system health.
This back and forth of channel expansion and channel consolidation is what we call the Dealer Yo Yo. Depending on the direction of the wind, the ISV would start operating on a plan to reclaim ownership of its channel. Some legacy POS companies eventually found themselves with a hybrid model, maintaining a channel in some markets but local, direct offices in others. In many cases this is the result of a reluctant reseller who didn’t want to part with their business and the ISV felt ballsy enough to establish a competitive office in the reseller’s territory. Fun stuff.
Cloud POS has gone through one full DYY cycle as the result of taking early outside money. Investors demand very, very fast growth, and Cloud is still struggling to figure out how to meet those expectations. Direct sales are too slow and costly; a channel cannot be controlled and delivers even less growth than the direct model; and payments partners cannot sell on value, meaning penetrating larger merchants is a problem.
But this latest Dealer Yo Yo is likely to be the last. Here’s why.
If you remember what I’ve stated previously, legacy POS companies like Micros and NCR earn two thirds of their revenues from “services”. This is a nice explanation for what services encompass. It’s the initial setup, a recurring fee to fix your system, a fee for updates, fees for bolt-ons… and on and on.
What Cloud POS has shown is that service revenues are going to shift. There will be no revenue associated with system updates or everyday support: cloud is much more stable and any updates or remote services are free. In fact cloud is so good that merchants have started questioning resellers pitching monthly cloud support fees as opposed to a break-fix model. Anecdotally, a partner tells us only one cloud install in a sample of 1,000 has gone down in the past 18 months.
We expect service revenues will shift to value-add products (I refer to them frequently as bolt-ons) that become available with access to POS data in the cloud. Some of NCR and Micros’ revenues were already for such services but they had to share those revenues with the channel (think NCR Pulse, their mobile reporting product).
But as Micros and NCR are learning, when the ISV maintains access to the data, they can create (albeit poorly) and sell any additional products directly to the merchant and take the reseller (and associated revenue share) out of the picture.
For instance, NCR has a program called Cloud Connect; it’s their late attempt at an app store, and it’s entirely one-sided in NCR’s favor. The third party developer must pay NCR $15,000 a year to be on the platform, not including additional support that may be needed. NCR also demands 40% of all revenue, and precludes the developer from control of the retailer touch points (in-store, web and mobile), including loyalty programs and reporting/analytics.
Even more damning, considering much of NCR’s hospitality install base comes from channel partners, is that there’s no provision for reseller revenue share in Cloud Connect. Why, you ask? Simple: because with access to data via cloud, NCR can produce (or let third parties produce) products that can be sold directly to the merchant, obviating the need to involve the reseller at all.
Micros (Oracle) has similarly looked toward the future and started alienating their channel. After Micros was purchased by Oracle, it started phasing out all but its 10 largest resellers. That’s exactly why we are seeing stories about small businesses being stranded even after spending tens of thousands on Micros POS systems.
It’s not personal: it’s just business. Micros received the majority of its POS profits and revenue from large retail and hotel accounts. The reseller channel mostly served independents and small chains. It’s really hard to get these accounts to upgrade to cloud and more expensive products. If Oracle sets an annual goal of $1 billion in new revenue from cloud and its derivative products, it’s a fool’s errand to try to meet that $20,000 at a time, especially through a channel you can’t control.
Unfortunately the outcome is that tens of thousands of merchants are finding themselves on POS systems that Oracle is no longer supporting: RES 3700 and e7. Oracle is instead pushing everyone towards the cloud product it designed for Starbucks, Simphony 2.
There are more and more mid-market accounts churning as Micros abandons support for its flagship POS products. Who snaps these up remains to be seen. Our take is that those deals will be won by resellers – the same kind being pushed out at Micros, and undercut at NCR. But if the future of POS revenue comes from bolt-ons, not the initial sale or support, the real question is how quickly other ISVs will follow Micros and NCR to this inevitable future.