How Merchants Shoot Themselves By Avoiding “Startup” Vendors

There’s an old adage that nobody ever got fired for buying IBM. The phrase started about 30 years ago with the implied logic that IBM was a large, established provider and therefore a safe bet as a supplier. Except that if anyone chose – and staid with – IBM cloud services over the past decade their company probably collapsed and they lost their job in spite of choosing IBM. Even Watson, IBM’s attempt at “Big Data” has failed spectacularly in many use cases.

The moral of the story? Things change. And fast. Two gems to consider:

• In 1965, the average tenure of companies on the S&P 500 was 33 years. By 1990, it was 20 years. It’s forecast to shrink to 14 years by 2026.
• About 50 percent of the S&P 500 will be replaced over the next 10 years, if Innosight’s forecasted churn rate holds. 

Established incumbents often lack the innovator’s gene. That’s because these organizations are looking to protect what’s already working and have little interest in disrupting revenues and cash flows. It’s the same observation we made about NCR’s products years ago and despite management changes NCR has only seemingly moved more aggressively in the anti-innovation direction (if there is such a thing) by erecting the industry’s most costly and cumbersome integration program, in addition to prioritizing financially engineering their antiquated product set without fixing the core problems. This is not just our opinion but the belief of Aloha’s largest customers.

So when an innovator comes along to save merchants from themselves, merchants incorrectly ask: is this company IBM? Is it a company with 300,000-some employees, a market cap of $120B, and I won’t get fired for choosing them (but I’ll ignore that the share price has been in steep decline over the past 5 years?)

That’s the wrong question. The question set needs to be reframed.

Is this a company that is going to solve my problems today? What happens if my problems change tomorrow? Are they investing in R&D to meet the challenges of the future?

This is why we laugh when merchants argue about features. Features are a function of time. Features don’t tell you:

• The CEO’s priority
• The quality of customer support
• The R&D investments and roadmap of the product
• The speed of innovation
• The company execution
• The transparency and culture of accountability

All of these are drastically more important characteristics for a potential vendor than motherf*ing features. Let’s deconstruct two industry actions as we see them to infer company priorities.

Company: Global Payments

• Action: Increases payments rates without demonstrating any increase in value. Meanwhile Heartland Analytics, their lightweight software product, appears unchanged despite being in market for two years.
• Inference: Global prioritizes payments, not products.
• Our take: Woe is the merchant using an actual product from Global Payments.

Company: NCR

• Action: Takes existing, antiquated restaurant products, bundles them as SaaS, tries to convince merchants to pay the highest POS SaaS price in the US restaurant industry.
• Inference: NCR leadership cares about financial engineering a win for their personal stock portfolio as opposed to solving customer problems.
• Our take: It’s a tough time to be an NCR merchant and the writing on the wall says it will only get worse.

We also think merchants need to consider another side of this coin as well: financial reality.

In a merchant’s mind if a company is losing money it’s likely to go bankrupt. Sure, that was probably a reasonable assumption in the 1960’s, but the advent of private equity has changed the game. There’s so. much. money available in the private markets ($2.5T) that companies which would have gone belly up a half century earlier are thriving with private dollars funding their growth. You need to remember Amazon was barely breaking even for years, aggressively reinvesting in growth and innovation.

Not only that but business models have changed; investors strongly prefer recurring revenue software businesses over perpetual license businesses regardless of the number of customers. Below we’ll put this math into a tangible example.

Company A sells marketing software to brick and mortar merchants. They price their software as a one-time fee of $10,000 and some ancillary set-up (i.e. services) revenues. Over the past 20 years they’ve sold 10,000 licenses, earning $100M in revenues.

Company B sells marketing software to brick and mortar merchants. They price their software on a recurring basis at $3,000 per year. They currently have 1,000 customers.

The economy falters and no merchants buy any marketing software this year. What’s each company worth?

Company A is worth balance sheet + intangibles (IP, customer accounts).

Company B is worth balance sheet + intangibles (IP, customer accounts) AND 8x recurring annual revenues, which would be 8x $3M, or $24M as a starting point.

This is how a legacy POS company, like Digital Dining, could be bought for $15M with 20,000+ customers (thought it’s anyone’s guess how many of those customers are active since there’s no remote monitoring) while a new POS company like Mobilebytes had to be acquired for $23M despite having only 1,300 customers.

Sure, Digital Dining would be the “safer” bet based upon years-in-market and the number of customers, but if times got rocky which company would a financier put money in? Hint: it’s the company with higher market value!

Recurring revenue software companies with happy customers and a growing client list don’t just disappear if they run out of money anymore: there’s too much capital in the private markets to let that happen.

If you’re honest in your search and you discover that your problems will only solved by one of these “high risk” startups, know that they might be in a better financial position than your existing service provider, even if they’re losing money. The financial markets have a very rational way for rewarding actual value, which is why Watson has not saved IBM yet.