This post will cover the history of revenue models for the point of sale (POS) ecosystem with a brief nod to what the industry should expect going forward. We’ve discussed how POS dealers mostly earned their living, and how that model is under attack, but we’ve not spent much time presenting the tangible dollars available to the POS and payments ecosystems as the technology landscape changes. Here we will.
Despite the fact that nearly every POS comes bundled with payments these days, the world wasn’t always so. We’d contend that 25+ years ago, when POS was first making its debut, the idea of bundling the two seemed ludicrous.
- POS was a much more technical product than payments. Payments people wouldn’t bother learning something so technical (remember, this was before the average consumer had a mobile phone and laptop)
- POS was much less stable than it is today. Payments people wouldn’t touch support with a 10-foot pole (and it can be argued they still don’t)
- POS economic benefits were an unknown/unneeded. Payments companies were still earning plenty of money on processing and were thus more interested in getting greater numbers of merchants to accept payments, so there was less infighting
That’s why when POS first arrived the big bucks were in hardware. You have to remember this was before the internet, so hardware prices directly from Asia could not be found online. Hell, Asia wasn’t even a manufacturing powerhouse in the 1980’s anyway: China represented less than 3% of global manufactured output in 1990. This was a much less transparent time and the prices offered by a POS dealer were the only prices a merchant was going to find.
We continue to use the below graphic from the Economist just to show how much hardware margins are declining (this is for TVs); the converse, of course, being that hardware margins were quite rich as short as a few decades ago.
When POS evolved to work on a PC-based operating system (i.e. beyond cash register functionality), POS companies (ISVs) and their channels started charging for software as well. This was another winner, as 40%-50% of the software price was traditionally margin. Software in those days took longer to develop and test, and figuring out how to make do with smaller levels of computing power and memory was a legitimate task. Time carried onward, operating systems and computing hardware got better, and the industry once again evolved…
In 2001, a little company by the name of Mercury Payments figured out payments and POS could be lucratively joined, and the world has looked different ever since. Their timing was impeccable. Asia started beefing up its manufacturing capabilities. The internet was burgeoning. Computing hardware became faster, thus redefining software constraints. And payments became the most lucrative weapon in the merchant portfolio.
Iteration of these variables brings us back to present time, where POS is just a Trojan Horse to capture the payments business. Hardware has been commoditized and if hardware prices are too steep a prospective merchant will just get online and buy the same hardware for less. Software has become easier to build and support, and we’re seeing many POS companies drastically reduce software costs to win the processing business. In essence, it’s all about payments today.
But if you would have asked the POS ecosystem about payments in the early days, none of them would have predicted the collision course we now see.
It’s this last statement that is brimming with irony. Although payments companies disrupted the business model of POS, they haven’t yet realized their own impending business model disruption…
Payments is ultimately a very commoditized industry where everyone is offering the same thing. Outside of supporting and selling the basic payments offerings, payments companies have not produced anything those in Silicon Valley would wow over; the product culture at payments companies just doesn’t exist. As payments companies have purchased POS companies they’ve inherited some product DNA, but you’d be crazy to think anyone on the West coast would fawn over legacy POS products.
Payments companies, to their credit, are trying to make some changes. But don’t think that’s because they have some cohesive product vision. The real answer is much simpler: software companies get a huge valuation premium from Wall Street relative to payment processing companies. While processing companies trade at 1x revenues, software companies trade at ~5x revenues. If a payments company can convince Wall Street that they’re a software company, employees get a 5x payday. Not bad, eh?
Well, that’s easier said than done. To pull this off a payments company will need a material percentage of their revenues emanating from software. And since very few software people currently work, or are attracted to payments companies, that’s a big hill to climb.
But we’d challenge payments companies to think one step further. Amazon gets a lot of leeway (and an even more fantastic earnings multiple) by being a constant innovator. Do payment companies understand just how much optionality exists in the POS data? What’s possible with consistent innovation on top of that data? Are they aware of what they’re really purchasing with the POS?
We thought we would use this as the segue into the future business model of payments and POS. We will limit our discussion to revenues these companies can earn from merchants because few can think much beyond this. We hope this changes, but even so this by itself is a captivating number.
Merchants spend around 5% of gross sales on marketing. Many franchise agreements will actually stipulate this amount specifically, with the mean falling between 3% and 6%. If we take an industry like the US restaurant industry, that does $700B in sales, 5% of that figure is $35B. That number is frankly too large to be relatable, so we’ll show you what it tangibly means to a POS or payments company.
For the purposes of simple math, let’s say we have a merchant who earns $1MM annually. They’re going to allocate 5% of those gross sales for marketing expenditures, so that’s $50,000 a year. Before we go any further, can you think of anything a POS or payments company can do that earns them $50,000 a year from a merchant?
Exactly, so read on.
To be in the hunt for this money a POS/payments provider needs to offer something unique and measurable. In other words, they’re going to need to offer some piece of software that can assist the merchant in both running marketing campaigns and measuring the results. (For those who are unaware, merchants struggle to measure ROI with just about everything – though some of this can be blamed on their current providers.)
Our take is that this marketing inevitability is a partnership of advertising networks (think Google and Facebook) tied into the POS, where all transactional data (not just card swipes) can be measured and reported upon. We fully expect prescriptive marketing (also called programmatic marketing) to take hold; that is, machine learning is used to process data across tens of thousands of merchants and billions of data points from Google, Facebook and other sources to choose the right promotions for the right people at the right time. The output would be something that looks like this, generated directly within the POS user interface:
Over the next 14 days we recommend running this campaign. We will automatically adjust messaging and pricing for your customers and report on the success of the campaign. We estimate spending $2,000 will yield $7,481 in new revenue over the next 30 days. Click here to run it.
Pulling this off will not only take a number of partnerships (inevitably splitting up that $50,000 pie… sort of), but also some data chops… which is a serious problem for POS/payments companies today.
Payments companies aren’t climbing the first rung to becoming software company any time soon. First Data, as an example, bought Clover POS and then said, “You know what? We’re just going to double down on this hardware and payments game… software makes our heads hurt.” It really makes you wonder if First Data’s data sharing partnership with Google isn’t just a bunch of First Data execs happy about collecting a small check while Google is over there playing chess and netting all the long term benefits of the data.
Regardless, executing on the marketing opportunity we describe means POS/payments companies will need to step above the first rung of software and onto the second rung of data. This presents an entirely new set of cultural challenges for POS/payments companies who are struggling to attract talent to climb the first rung; forget that the second run is that much higher.
The good news in all of this is that the juice is worth the squeeze: tapping into merchant marketing dollars will be a 10x opportunity over anything else the POS and payments industries have in front of them. And we intentionally didn’t mention the tens of billions in unused co-op marketing dollars that suppliers could use to further increase these revenues. Nor did we talk about the myriad of other possibilities with the data – utilities, real estate, finance, et. al. – because the industry just isn’t ready for that.
All you need to takeaway is this: there’s a lot more value in the POS data than you realize, and it’s much larger than the payments stack you see parties fighting over today. The payments era will pass and we will look back with the same amazement as the POS industry now has towards Mercury’s success.
“How did no one see it coming?”
Hopefully now you do.
Spot. On.