It’s no secret that POS companies – especially of the cloud variety – have been investing relatively obscene amounts of money in marketing directly to merchants. Without argument this is the most expensive distribution model available, so one needs to have a high conviction that merchants will pay tens of thousands of dollars to recoup such costs (current estimates show Toast’s direct customer acquisition costs [CAC] hovering around $6,000-$7,000 per site).
Earning a return on direct distribution, however, comes from three possibilities:
Larger merchants
Larger merchants who can afford to buy a number of subpar, homegrown products from the POS company, therefore increasing ARPU for the POS company. This is when the POS builds loyalty, analytics, labor, reservations, etc. The bolt-on products are all but guaranteed to be total shit for the merchant but it takes the merchant a while to figure it out, and by then it’s hard to switch POS systems (investors are betting on this behavior and intend to get their returns before merchants wake up).
In the case of the largest of the large – i.e. enterprise merchants – the POS company can make enough money from POS alone to justify the costs of direct distribution without needing to bother building shitty bolt-ons (see Brink, Revel, and Qu)… but we’ll be damned if this hasn’t kept some POS companies from trying (NCR and to a lesser extent Micros). But this is hard because building products takes at least some work. So instead, POS companies reach for what’s closest…
Payments Savagery
The easier and tried-n-true method is just to take advantage of the payments processing revenue stream, where merchants have no idea what a fair price is and where transparency doesn’t exist. Because the POS company can lift their revenue straight from the top line the merchant has no idea what they’re paying: they just see $10,000 in their bank account but are oblivious to the notion that the POS might have skimmed $3,000 for himself first.
There’s the added benefit that COGS for payments is zero, meaning every dollar is immediately accretive, and it’s how payments founders have been able to build large businesses without any outside capital. That’s just not possible in software businesses, where good engineers cost $250,000, product can take several years to build, and you have to earn your place with product-market fit. In payments, everyone has to take the product, there are essentially no bugs to deal with, and innovation is not required.
Product Partnerships
The last category is a bit of a halfway house and is still not entirely proven out. But, in theory, it should work. Instead of trying to build entire product suites themselves, POS companies strike partnerships for their bolt-ons and recognize the partner revenue share as pure EBITDA. This takes less work than building solutions yourself and the solutions you do offer end up having real staying power because there’s an entire team whose sole focus is to keep improving the product.
However, this requires POS companies to be thoughtful and, as anyone at a venture-funded POS company would tell you, admit “defeat”. Because there’s so much money in private markets investors have huge checks to write and that means there’s a plethora of dollars to throw at building shoddy bolt-ons to juice the top line. Unfortunately it usually comes down to a Revel-type correction before the POS company realizes that chasing everything is an unsustainable model.
Hindsight is 20/20, eh?
But all of these models ignore a larger macro trend, and it’s what we’re here to really discuss.
With so much money sloshing around everyone has the same tactic: buy digital advertising to put merchant leads into the top of the funnel. Well, if there’s literally hundreds of millions of dollars chasing marketing spend for a small market of POS, that advertising gets to be expensive.
The easiest way to understand this is to look at keyword prices. On Google Adwords an advertiser pays when someone clicks their ad. The more in-demand the keyword they use, the more they pay. If you’re selling basketballs, as an example, the keyword “basketball” might be competitive and therefore relatively expensive.
Certain keywords are always high in demand, like credit cards and insurance, since those are very lucrative industries with lots of competition. Fringe keywords that nobody cares about are conversely very cheap.
Here’s a sample list of costs per clicks (CPCs) of those very expensive keywords for context.
Now you ready for the crazy part? Look how expensive keywords related to POS have become…
But it’s even worse in Canada, the country that Lightspeed, Shopify, and Touchbistro call home. According to Chris Silvestre, analyst at Veritas Investment Research,
Google lists the keyword “Insurance”, which is known to have high competition due to the value of securing a new customer relationship, as having an estimated cost per click (CPC) in Canada of $4.37 – $16.63. The keyword “POS”, by comparison, has an estimated CPC of $8.80 – $25.36.
Chris Silvestre, Veritas
The point here is that these keyword prices are insanely high. Now, maybe they’re justifiably high if the POS companies think that POS becomes as lucrative as insurance and credit cards, but it puts pressure on the economics today. And a further consideration is that as POS companies add revenue streams like loyalty, analytics, etc to their stack, they become increasingly comfortable in spending more money on direct marketing as the lifetime value (LTV) of their customer goes up.
Remember the 3:1 rule: the LTV of a customer should be 3x the CAC. If you increase LTV you can increase the CAC by a third and still maintain this ratio. But in a perfectly competitive market, everyone else will increase spending too, eroding the perceived value of increased spend as higher priced keywords become table stakes. In a pretty short period of time POS companies that can’t figure out how to juice ARPU will be unable to compete on Adwords and, in essence, direct distribution. Look at what Lightspeed’s leadership even commented on the matter in their Q3 2020 earning call:
This means that we will be able to double-down on the CAC because the LTV is going to be higher as these customers adopt Payments, and we’ll do the same as we also over time, deploy Payments throughout all of the geographies.
Lightspeed management, Q3 2020
Now we draw ourselves the contrast: Vend POS.
Vend POS is a leading cloud retail POS company. They’re global in focus, and do have an inbound sales engine. But they’ve also invested a ton of money in a channel program, especially relative to other venture-funded POS companies, and over the past 18 months would you believe that 40% of Vend’s revenue now comes through their partner channel?
Believe it.
Jake West, Vend’s director of business development, told us the story of how and why Vend grew their partner program.
Historically speaking, Vend didn’t have much success with a traditional reseller channel. I think we found what a lot of folks find when it comes to resellers: they’re great technical resources but are fearful of being labeled as salesmen so their sales numbers are usually very light. Coming from the payments world I knew that the payments channels could manifest the volume that would make sense for the partner program since POS and payments are closer together than ever.
Jake West, Vend
As Vend marched down this path they faced a profound decision that we see every POS company navigating: do I become a PayFac / ISO and sell my own processing? The upside is that payments revenue = pure EBITDA, but the downside is that it kneecaps your payment channel distribution for the obvious conflicts it engenders.
When we looked across the market we saw that a lot of cloud POS companies were becoming their own processors. This left many payments entities with few sellable options for their POS product line. Sure, some of the larger acquirers were buying POS companies but that didn’t mean their ISOs and agents felt it was best POS solution for their customers.
Jake West, Vend
Jake and his team doubled down on the channel model to make it as seamless as possible for a (candidly often technophobic – the label ours) payments partner to onboard a Vend account. “We’ve invested in our partners instead of just dumping more money into adwords. We’re now continuing to invest in the partner model to serve any type of reseller. Whether they want to light up merchants without speaking to Vend, or want Vend to handle the entire demo process while pitching their payments solution, our focus is being the best partner-led POS company in the market. If we succeed we make the onboarding process as simple as possible so the partner can get back to doing what they do best,” says Jake.
Economically, Vend found that it was cheaper to both revenue share their monthly SaaS and spiff their partners than it was to run on the Adwords treadmill. “Sure, we still have an inbound game, but we see a lot of potential in the partner model because it’s much more sustainable.” Vend views their partner model as a means of giving their partners a path to software, complete with an API that allows partners to build custom solutions on top of their technology stack. “It’s no secret that payments alone won’t win deals anymore, so we’ve been flexible in helping our payments partners built their own IP on top of our POS. We’re giving traditional payments models a means to survive.”
There’s a lot of wisdom in Jake’s comments. Despite the much-touted death of the ISO, the distribution model is proving rather resilient. It may be compressing, but it’s not gone to zero. And all the traditional acquirers buying POS systems as a means for survival? It’s just a matter of time until they screw the pooch: the cultures are fundamentally misaligned.
Vend’s position of being a partner-led company might be the best move in the long run.
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