As the POS industry finds itself at the doorstep of another transformation (it’s not the payments transformation you might be thinking of), we thought it would serve readers well to have a visual for the evolution of the POS business model. While we had shown some visuals to this general opportunity last year, we spent more time ruminating about the revenue potential per merchant. Thusly we’re using an example $1M/year merchant to calculate the annual costs in the graphics below.
Phase I, commonplace in the 1990’s, was a business model predicated on hardware margin. Asia and global competition hadn’t yet found its way into brick and mortar. There was margin on POS software, but the business was mostly about the high fees associated with servicing hardware. If merchants wanted a POS there was no Google or Amazon to shop prices either. So the dealer channel had a nice monopoly as merchants were paying for their installation and support markup whether they wanted to or not.
Phase I POS was a perpetual ownership model, meaning one could buy everything up front and simply pay an ongoing maintenance/service fee (that was nonetheless pricey in comparison to today’s standards). Over 60% of Micros’ revenues came from the service category, by the way.
Phase II introduced the idea of “free POS” in exchange for an ongoing payments residual. This model has cropped up over the past five years and is growing in popularity. Global competition – and the internet – has brought pricing transparency to hardware, driving down costs substantially. Software has transitioned from a perpetual model to a license model as the latter provides higher cash flows and valuations. Included in the licensed POS software are forever-updates and often Level 1 support at a minimum. Phase II POS systems are more reliant on the internet to deliver value and accordingly can do much in the way of remote diagnostics to bring down support costs.
The transition to SaaS in Phase II has made it difficult for POS resellers whose business models were built on large cash infusions from each new purchase. Now there are smaller, recurring payments for software, and many dealers don’t have the mindset necessary to make their businesses work under this economic construct.
Phase III, something that’s already commenced but will be gaining serious traction over the next 2-3 years, shows a real break from the POS model of earlier phases. Hardware and POS software are even cheaper, and in many cases given away for free. But not in exchange for payments, as was common in Phase II…
Viewing the POS as the hub, Phase III enables the POS provider to offer an array of services on top of the POS; collectively these new opportunities are more lucrative than the POS software, hardware, or payments residuals. It is under this model the Phase III positioning might become “free POS” in exchange for the transaction data as it proves to be the lifeblood of these new products and associated revenues (think of Google and Facebook as analogues, who offer a free core product but make money hand-over-fist on the backend).
Meanwhile the reseller channel consolidates into a smaller number of larger players. Imagine a franchise dealer model where each dealer is given a formula for success: CRM (customer relationship management), remote diagnostics, network security, PSA (professional services automation – ticketing, agreements, collections, quoting, timekeeping, payroll), and training to become a true managed service provider. This means that 95% of dealers rightfully disappear but the ones that remain will be more financially successful than ever before.
The biggest difference between the three phases is the amount of recurring revenue. In Phase I overpriced services were recurring to the tune of a few thousand dollars a year. This services revenue was manually earned too, meaning that it required a lot of man power and had margins of maybe 20%.
In Phase II that recurring revenue number grew to around $7,000 per year (software + payments residuals). POS software has gross margins of ~70%, and payments revenue is 95% operating profit since the underlying product is super easy to deliver.
In Phase III the recurring number jumps again, this time to around $17,000 per year (you can read here to understand one category that will deliver a lot of this revenue). Achieving this, however, requires the POS seller (reseller or otherwise) to have a broad awareness of industry solutions so they might fix merchant problems with the best possible product. Nothing makes a seller look more out of touch than offering a shitty, old solution when a quick Google search shows much better available products.
It may seem that Phase II and Phase III revenues are lower than Phase I, but that’s only nominal. Remember, a business is worth 1x non-recurring revenues and 5x recurring revenues (software is actually getting a 8x revenue multiple as of this writing). Phase I revenues were earned upfront but very little carried forward. So when applying this multiple valuation technique to a Phase I and Phase III business, the latter is worth 10x more than the former.
That’s simply the power of recurring revenue.
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