State of The US Hospitality POS Industry (Part 2)

In part 1 we walked through the status of the major POS players in the US restaurant industry (we defined this as POS companies with greater than 10,000 locations).

At first glance one trend should be abundantly clear:

The merging of POS and payments is real.

We thought we would use this as an opportunity to offer a brief overview for why this is happening. If you’ve been reading for a while you can skip the next six paragraphs.

Payments processing is a very commoditized, zero value add “product”. While the idea of moving money electronically was novel when the first credit card launched in the 1960’s, it’s banal today. That we can move money to friends and family instantly, for free, and securely, from a wide number of service providers demonstrates precisely why merchants categorically hate the legislated taxes they pay to the payments industry.

Because payments processing is so lucrative and so easy to spin up (COGS = $0), one “solution” provider is easily replaced for another; when a merchant notices that their processing rates have crept absurdly high, they switch suppliers. The ease of moving payment providers is a relatively seamless experience.

Point of sale, on the other hand, is the central nervous system of the local merchant. Sales, operations, marketing, and other useful information is stored on the machine. Nearly everyone in the business uses the POS each time they show up for work. It is as embedded into the merchant fabric as any system can get.

POS systems require much more work to sell and support, and it’s not yet a one-size-fits-all product (though we’re reaching a singularity). POS systems also touch payments processing for PCI compliance, so the POS systems are familiar with the the racket that is payments processing.

Yet despite the enormous value engendered by a POS, the industry makes paltry revenues (and profit) in comparison to payments processing. We think this is because merchants must use payments processing and therefore the industry has learned how to gouge merchants but make them feel like they’re getting a great deal.

Knowing that the POS is at the center of a merchant’s environment, much stickier than payments, and far less lucrative than payments processing, payments processors rationalized that they could consume the POS industry and make their product the face of their payments strategy; if the processor could bundle both the POS and the processing together, it would be much harder for the merchant to simply replace the processing.

At this point, at least as far as hospitality is concerned, most of the payment processors of consequence have some sort of POS offering. In alphabetical order:

Bank of America Merchant Services > talech referrals

Chase Paymentech > talech referrals

Elavon > Clover, talech referrals

First Data > Clover

Global Payments > Heartland > Digital Dining, Dinerware, MobileBytes, PC America, Sicom, Xenial, and Xpient

TSYS > Vital POS

Wells Fargo > Clover referrals

Worldpay > random POS referrals

After accounting for the major acquirers there are large ISOs that are jumping on the POS bandwagon as well. Some select examples:

i3 Verticals > Aloha POS resellers

Shift4 > Harbortouch, Future POS, POSitouch, Restaurant Manager

Suffice it to say we only see continued momentum in the merger between POS and payments.

We have to question what major ISOs and processors without a POS of their own are thinking. Does Worldpay believe it can benefit by telling the channel that they’re neutral? Do ISOs feel confident that they can license or resell someone else’s POS and not assume too much strategic risk? The ISOs who previously sold MobileBytes would share that the risks of not owning a POS are quite great.

The next natural question is what happens to POS companies that are neither part of a larger ISO or payments processor – can they remain that independent?

As large payment processors use their balance sheet to pervert the upfront economics of POS with “free POS” the independent POS company needs significant capital to finance sales – at least in SMB where merchants really don’t know how to read fine print. The POS companies that don’t have the benefit of a payments processor’s balance sheet will need to raise significant capital (see Toast), at least if they focus on SMB. By the way, we think this model unsustainable as venture-backed POS companies must eventually earn a profit and merchants wisen up to the economics of “free POS” – not dissimilar to the passing fad of daily deals which proved disastrous for SMB.

Yet because payments offers no value we think they need POS much more than POS needs them. We can easily envision well-run, mid-market POS companies surviving through this industry turmoil (of course few POS companies are run well at all) and winning on value. We don’t see a scenario where ISOs or processors can compete much longer without a POS in their tool belt.

Looking even longer term, we’re not sure POS won’t get spun back out from payments companies. Payments companies only deal with the hassle of POS because it helps them move their payments processing – which is much more lucrative and much less work. Appropriately selling and supporting POS is a massive cultural change for a payments processor and we’re not sure how well they’ll make the transition.

Think about the difference in the sales process.

Payments: any merchant can take it, let’s just talk price.

POS: lots of nuance, not yet a one-size-fits-all solution, integral to business operations.

A poor job defining fit in the sales process only makes for a miserable experience down the road. This is an accelerant for churn and all of a sudden the payments company is sideways.

Then think about support.

Payments: uh, what’s support? But if you put a gun to my head I’ll blame the POS provider.

POS: answer the phone at 2 AM, be on-site by 3 AM, change out equipment so the business can start breakfast shift at 6 AM.

Heartland and Shift4 are trying to bridge the gap through heavy use of channel, but the reality is that 90% of the channel brings massive cost disadvantages (i.e. 9 out of 10 dealers are going bankrupt over the next 5-10 years). Over time, these payments companies will either need to bring POS culture in-house, or risk replacement by an innovator who’s figured it out. It doesn’t help that payments companies spend trivially on R&D and this will not produce a winning strategy for any software business.

And that’s the best case.

Think about how many parties in the payments ecosystem haven’t even figured out how to use a POS channel yet, let alone formalize the cultural changes to bring POS processes internally. Who knows how the hell they’re going to successfully integrate POS into their businesses.

POS might become Peter Pan’s shadow for the payments industry: something to be perpetually chased. If this happens there will be a finite amount of patience and POS will be spun back out to stand on its own again. Which, in its current embodiment, is probably good for the merchant.

The bundling of POS and payments does offer benefits for merchants, however. Since payments is so commoditized, it really is better to receive payments and POS from one single provider. In theory coupling the two should offer tighter integrations so you don’t end up with a situation like NCR has on its hands with Connected Payments. There’s also the benefits of shared data and product opportunities, but those have not manifested themselves meaningfully. Upserve has done the best job at marrying the two data sets in our opinion, but the products it produces are still loss leaders to win the payments processing. Framed from that perspective it’s hard to get excited about the expected pace of innovation on their product front.

But these benefits can disappear entirely if the POS is offering only one payments option. For many payments processors who see the merchant as an endless blood bank, we envision more short-sightedness and fewer processing options on top of the POS systems offered by payments providers.

We don’t think larger merchants will ever choose a POS system with only one payments offering unless they’re given 20-year guarantees on the processing. We say 20 years because larger merchants are known to own their POS systems for that length of time. Then again, we’re watching large, supposedly sophisticated merchants turn over their online brand and customer data to third party ordering/delivery companies, so there’s no amount of stupidity that surprises us in brick and mortar anymore.

To conclude:

1. Payments is going to own nearly all sizable POS assets in short order. There will be stand-alone, mid-market POS companies but they will be in short supply
2. Payments balance sheets/VC money is perverting POS economics in an unsustainable way. This will eventually crash to reality and merchants will realize that they should pay more than $0 for the most valuable platform that runs their entire business (duh)
3. Barring substantial improvement in payments culture, POS will be spun back out

The pace of all this remains to be seen. But we’re skeptical of payments companies changing stripes to become software companies in any sense of the word – no matter what they buy.