Over the past decade POS startups have been pitching investors on the idea that they will verticalize the merchant stack and generate high annual revenues per merchant (termed ARPU in startup parlance). So not only will a merchant get POS from the POS company, but also lending, payroll, payment processing, etc. (the list of possible solutions is very long.)
And up until recently the pitch was easy to buy into: incumbent POS providers had comparatively shitty solutions; retailers are getting more tech savvy and therefore more demanding of good/modern product.; bundling products simplifies life for the merchant; if nothing else a venture associate has a spreadsheet which says the math for verticalization is fan-freggin-tastic.
But these days may very well be over.
We’ll begin by defining the merchant stack visually so you can understand why all this commercial interest exists.
Businesses have a number of needs and brick and mortar merchants are no different. Collectively we estimate that retailers spend between 5% and 8% of gross revenues on solutions to solve these needs. While the below list is certainly not exhaustive it will serve well enough for our analysis.
The merchant in our example does $1M in annual revenues; we chose this number because it makes the math neat. You’ll notice that there’s a stacked red bar with a 3% value in the following graphic. This is money that the merchant loses to the payments ecosystem for processing, which delivers no ROI for the massive expense. Just wanted to make sure to point that out.
The 7% green stacked bar is what merchants will spend on solutions that fall into two categories: Operations and Marketing. Underneath each of these categories is a bulleted list of possible expenditures. We limited Operations spend to 2% of revenues since Hospitality Technology’s survey consistently show this as the spend ceiling for restaurant merchants.
Now we’ll do the math. For this $1M merchant that 7% translates to $70,000 of annual opportunity for someone. But whom?
Well the POS company hasn’t historically earned very much. Let’s assume this $1M a year operator has 4 POS terminals at market prices of $80/mo per terminal. Over the course of the year that’s only a meager $3,840 per year. That means theres’s more than $66,000 still sitting there, and since POS companies typically have the tightest relationship with the merchant (being equivalent to the nerve center and all) you can understand why POS companies are expanding their offerings to capture those idle dollars.
POS companies also rationalized that they had access to merchant transaction data, which would serve as a very real leg up in building solutions to capture dollars in the stack. Of course POS companies also failed at basic self-awareness: they’re greedy and have not been very good product builders. POS is a very complicated solution and building much beyond that nears impossibility.
POS entities weren’t the only merchant solution providers who noticed the massive opportunity sitting there, of course. If a third party solution provider could generate material distribution and gain access to the POS data, a number of solution opportunities would become possible. This is why you’ve seen non-POS solution providers making inroads to the POS data.
First let’s look at the consumer packaged goods (CPG) suppliers in the industry. In grocery, suppliers access POS data and then spend billions of dollars using that data to run marketing and develop new products. Outside of grocery the data markets are a clusterfuck, and gaining a material view of the market is basically impossible; for the US restaurant industry statistical confidence starts happening around 160,000 merchants, which no POS company can claim. This is why Anheuser Busch developed a POS app called Trayz. Trayz is a Trojan Horse to extract POS data so Anheuser Busch can gather the relevant insights it needs for on-premises product placement, removing any middle man (and revenue stream potential from POS companies).
Next there’s Omnivore. Omnivore is a middleware agent that sucks up data from over 5,000 restaurant POS systems. It would appear that Omnivore is now monetizing that data with the suppliers mentioned in the first point through a partnership with CGA, a subsidiary of Nielsen. If successful this again removes part of the data opportunities from the stack.
Lastly is the largest beneficiary of POS incompetence: third party delivery (3PD). These companies have distribution conquered, with DoorDash and UberEats each claiming more than a quarter million direct merchant relationships in North America. They also have access to some POS data already, and now just need to extract the rest of the POS data off the systems of their current customers. Doing so would open up the product stack to them in a very meaningful way.
The 3PDs have already started stack expansion and have been in the marketing budget since inception. Think about it: if our sample operator does 10% of his revenues through a 3PD (that’s $100K in revenues) then his commission fees of 30% are coming right out of his marketing allocation. 3PD rationalized that they should keep going after marketing spend because that’s where most of the stack dollars fall. GrubHub made the argument that its value to restaurants lies in its potential as an online advertising partner, and that delivery services are really just a vehicle for generating ad sales. UberEats has gone full bore and formally launched its ad product. Additionally POS companies have probably realized that the POS is a lot of work for very little gain – POS requires a lot of features and a lot of support. Who needs to bother with that hassle if you can extract the POS data and build all of the other relevant stack solutions instead?
Brick and mortar has effectively become a battle for merchant POS data – the requisite to building stack products – that can be demonstrated with the below graphic.
The POS is already embedded with the merchant and has the requisite data but POS companies are too dumb and greedy to figure out how to execute what’s needed – this is especially true of the payments companies who own most of the US hospitality POS systems today. The 3PDs don’t have the necessary POS data yet, but they do have merchant relationships at massive scale and a very, very strong product culture. All they need is a POS integration at their existing customers – the same kind that back office providers have had for over two decades – and they’ll get the POS data they need to build the rest of the solution stack.
Perhaps the most fascinating question is how the merchant deals with the opposing sales pitches, so to speak. On one side you have a POS company who hasn’t done shit for your business in years and can barely fix your current problems. On the other you have a third party that has perversed your economics but does build really good products. Oh the dilemma…
What happens then?
We think 2020 will be the make-or-break year in the battle for the stack. It’s really hard to bet against product companies like Uber and DoorDash when POS assets are owned by payments bros that appear so myopically focused on attaching – and ratcheting – payments that they can’t be bothered to invest in R&D and build any products worth a damn. Especially when all that’s preventing the 3PDs from stack domination is a relatively trivial POS integration (they’ve already solved the hardest part of the equation – distribution).
If you’re asking for our opinion we’d say the following POS companies are at highest risk:
- NCR. NCR still lacks a viable, modern replacement for Aloha POS and they’ve been publicly prioritizing financial engineering over product enhancements. That and they still have one of it not the highest integration tolls in the industry (who said walled gardens are dead?). Also, their merchants’ POS data is available on local servers so the 3PDs don’t have to negotiate for API access.
- The POS assets owned by Global Payments (Digital Dining, Dinerware, HRPOS/MobileBytes, and PC America). Global is not investing nearly enough in R&D, lacks a true product culture (Christopher Sebes – the head of their POS division – leaving the company is a huge red flag), and looks more focused on payments than making even mediocre strategic moves. Their data also persists on local servers.
- Toast, whose business model is burning so much cash ($100M in 2019 according to insiders) that the entry of a stack competitor could prove lethal. Although it will be really interesting to watch how the 3PDs handle mass API access with POS companies that want to charge for every possible solution; we’d expect litigation.
- Patchwork of smaller legacy POS companies who are dead but just don’t know it yet.
(Note: if you notice Micros missing from this list that’s because they’re actually investing in moving things the right way.)
Disruption often comes from the fringes and incumbents never see it coming; whalers thought they were competing against peers with faster ships and sharper spears but they ended up competing with a bunch of Pennsylvanians drilling holes in the earth.
POS companies have come to prioritize payments processing, not product and certainly not value. The unforeseen (and existential) disruption from the 3PDs could finally put the payments bros to death, and that alone would be good for merchants.
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