How A DSP Model Is Worth Far More Than Payments Residuals

We earlier introduced readers to the idea that the POS will become a DSP, or Demand Side Platform, that facilitates programmatic marketing. This is huge for a few reasons.

1. Merchants struggle to quantify ROI. This is not just limited to marketing. As a result merchants piss away money on things that never deliver on expected promises. Using the POS as a DSP will answer merchants’ ROI question, as least for marketing (though good POS systems are doing this for operations as well)
2. As scale is created among POS providers for a collective DSP, there will be free supplier coop dollars for merchants to use in their marketing campaigns (more on this below)
3. The payments industry, which is subsuming the POS industry, at least in US hospitality, only cares about POS because it reduces churn in their relatively lucrative payments business. Once more money is demonstrated to emanate from the POS than from the payments processing stream the payments industry will be forced to start thinking about value

So how much money is in this whole DSP thing?

The below graphic shows a quick overview for how a $1 in marketing breaks down as it moves across the digital marketing value chain.

We know it’s a little confusing, but demand side networks (not exactly the same as a DSP) take a cut of 5%-15% and ad exchanges can earn 25%-50%. Let’s break down these two numbers first before we go much further.

There are ~650,000 US restaurants racking up ~$700B in annual sales. Over a third of restaurants prefer digital as their advertising channel and collectively the industry budgets $35B, or 5% a year to marketing. In the short term we can say that $11B (30%) goes to digital marketing.

10% (the average of 5%-15%) of that is $1.1B, allocated to the demand side networks. Another cut of 37.5% (average of 25%-50%), or $4.1B, is allocated to the ad exchanges. But there are a couple things that are important to think about before we compare this with that the merchant acquiring industry earns for the same accounts.

First, merchant marketing is going to eventually trend like everyone else and skew towards measurable, digital advertising. No telling how long this takes but given the low margin nature of brick and mortar you’d hope for logic to prevail sooner rather than later. This ultimately means the $1.1B and $4.1B for demand networks and ad exchanges can be expected to grow pretty substantially.

Second, an appropriately-built DSP can swallow the budget for both demand side networks and ad exchanges, effectively commingling the two. So instead of debating between how much of the $1.1B and $4.1B a DSP could potentially capture, you can add the two, ultimately arriving at a much larger opportunity.

Third, the potential marketing budget is not limited to merchant ad dollars: suppliers will gladly add their coop marketing dollars for the right type, and right volume, of data. We’ve talked about this before, but this becomes free money for merchants and a kicker for DSPs who see their potential dollar spend increase. So merchants will still spend their marketing dollars but there are other monies available that are additive to this figure.

Let’s quickly compare this to what merchant acquirers currently earn earn across those same 650K restaurants before we move on to some final thoughts.

Merchant acquirers keep ~0.5% of total processed volume. Multiplying that across $700B in industry spend gets us to $3.5B in annual revenue. (We could discount this by 20% for cash transactions but let’s ignore it for now.) That’s a pretty impressive figure considering the near-zero value add of payments. For context, a merchant will fuss over a $100/mo investment for a product that fixes their problems but seems glad to shell out 4x that amount for little in return. Either way, even if every restaurant purchased some such solution at $100/mo, that would only bring in $780M a year, a meager 22% of what the acquirers currently earn with their processing services.

As interchange rates fall (or are totally eliminated) and processing is increasingly handled through third party ordering providers, bypassing conventional acquirers, the DSP opportunity becomes ever more enticing. And since the $1.1B and $4.1B figures above are being calculated under the assumption of a 30% digital marketing allocation, there’s an opportunity to double or triple these figures as merchants seek marketing channels with higher levels of measurement and accountability (ie digital).

So we are comparing a dwindling $3.5B revenue stream, associated with a low value solution, to a $5.2B revenue stream with demonstrable ROI and a chance to triple.

Hmm.

If this is looking scintillating, there’s one large caveat…

Pulling this off requires cooperation.

In order for suppliers to be interested in putting their coop dollars to work, a nontrivial market share must be presented (generally pegged at 25%, or data from 162,500 restaurant rooftops). To achieve the most commercially favorable rates as a DSP, a certain scale must be achieved. And to suggest the highest ROI marketing campaigns, a large amount of data must be available for machines to learn on.

It’s going to chap payments and POS companies to learn that outside of grocery, brick and mortar is very fragmented. Six phone calls in grocery get you to 60% of the market and data companies IRI and Nielsen have dominated grocery data accordingly.

How do you get to 25% or even 60% market share in the restaurant industry?

Cooperation.

Because this is a case where 1 +1 = 3. In pooling POS data the industry will be able to command serious heft in contract negotiations. If this is still a little confusing just think about the benefits you get with volume purchasing. Walmart, for example, purchases so much Tide they can score great deals from Proctor & Gamble. Similarly aggregated data will allow the POS industry to push back against the advertising complex to find higher margins than they would ever find by working independently. The below example will show what we mean:

• POS Company A represents $50M in annual marketing spend. After conversations with ad networks negotiates 10% margin ($5M).
• POS Company B represents $50M in annual marketing spend. After conversation with ad network negotiates 10% margin ($5M).
• POS Company A & B represent $100M in annual marketing spend. After conversation with ad network negotiates 15% margin ($15M) due to increased volume.

This is why the industry will have to solve their prisoners dilemma. But considering the magnitude of opportunity it presents, perhaps it’s time to call the warden.