The Three Biggest Questions Facing Offline Commerce over The Next Five Years

While we watch the transformation happening all around us we keep reverting to three questions that we think will define the offline world. These three issues seem paramount to understanding every investment, every product strategy, and every major move companies in the space are making.

See if you agree.

Distribution: Direct vs Channel

Let’s just call a spade a spade: companies that are selling directly to offline merchants are outperforming the channel about 100 to 1. That’s sadly not even hyperbole. There will be variances based upon the ACV (annual contract value) of the product, but if you look at a tool like Single Platform, which costs roughly $1,000 a year, each direct sales rep is selling about 400 accounts a year. Ask them how many deals a reseller sells.

Go ahead, we’ll wait.

Or we can look at Heartland’s dealer channel: about 500 deals across 300 dealers. You know how many Toast employees it takes to bring on 500 accounts a year? About 4.

Yea, literally almost a 100:1 sales performance advantage in selling direct.

There are so many reasons for this, but the net result is that 99% of dealers are going away in their current embodiment. Period. These are groups that were supposed to transition to VARs – value added resellers – but they’ve proven that they just can’t do it. Here are a few reasons why, ranked in the order we think most likely:

1. They run lifestyle businesses
2. They don’t know or care to learn new things
3. They view themselves as technical “experts”, not sales people
4. They have no idea what net retention means, why it’s the most important SaaS metric of all time, and are bafflingly unable to revisit accounts in any customer success capacity to drive net retention

So what happens?

For software and systems that can be easily stood up – like a Single Platform – the dealer channel is irrelevant. Maybe a few of them will send in a referral once a decade, but the ISV will both execute the sale and conduct the implementation themselves.

For the more complicated installations, like POS systems, the dealers may become an outsourced services and implementation agent. Laying cables. Plugging in routers. Drilling holes in walls. In fact the earliest days of Boomtown did just this but they found it just wasn’t as scalable as we all hoped it would be.

The problem for dealers is that companies like Toast effectively give the services and installation away for free, convincing the merchant that the value for such services is less and less. With cheap capital expect this to become reality.

The double edged sword is that now any new software entrant targeting offline merchants will be faced with the expensive cost of direct sales, whether that’s really high keyword prices for search and social (even though merchants struggle with self-discovery) or bodies to do direct sales. We’ve seen companies like Slice effectively move direct sales to independent merchants to lower cost geographies (Macedonia specifically in Slice’s case) but not sure how well that will work out in the long term.

In other words, today’s software companies seem to be creating a very compelling moat by pushing resellers out of the market (thus eliminating a viable channel model for upstarts) and establishing brands that will face fewer challengers in the world of online discovery in owning organic search, creating pricing power for direct inbounds.

Product: Best-of-Breed vs All-in-One

We’ve not talked to a single person who can articulate this clearly enough (or at least back up their position sufficiently well) that we know the answer here. The tug of war is between a merchant’s preference to source everything from a single vendor or source the very best from different vendors. The implicit tradeoff is simplified operational complexity in the all-in-one model or higher ROI in the best-of-breed model.

The prevailing wisdom is that smaller merchants prefer all-in-one while larger merchants prefer best-of-breed. Even if we agree to take this at face value, how is a “small merchant” defined? From our own heuristics we see merchants doing a million or so in sales that prefer to source from multiple vendors for the ROI it confers.

To us, then, it seems to be a matter of sophistication. If a person can do a reasonable job understanding the value of their time and back envelop the math on a solution’s benefits, they seem to strongly gravitate towards the best-of-breed category.

For example, let’s say a merchant needs a loyalty solution. The loyalty from their POS provider can do basic stuff like points accrual and what not, but it’s unable to segment users by behavioral patterns and automate campaigns to these cohorts to drive higher lift. In this case the POS loyalty program might cost $50/mo while the stand-alone loyalty might cost $200/mo.

Operator El Cheapo, preferring all-in-one, would do the layman’s math of $200-$50 = $150/mo more for the best-in-breed and determine it’s not worth it.

Operator El Smarto, able to do a bit more math, would realize that segmenting users and running more intelligent campaigns results in a 25% lift for loyalty subscribers. He has 1,000 members in his loyalty program, their average check is $10, and they visit once per month. Now that extra $150/mo yields an extra $2,500 in monthly sales. It takes El Smarto five hours to configure the program and he rationalizes that he doesn’t make $500/hr so it’s a no-brainer to use the best-of-breed provider.

As these things go they’re swinging pendulums, with solutions consolidating and becoming table stakes until some new offshoot of innovation creates a market leader in a category, at which point their competitors copy/acquire them and we’re back in a period of consolidation.

The perversion that we expect to play out – to the detriment of smaller merchants who select the wrong types of ERP or POS systems – are ERP and POS systems that disallow best-of-breed integrations. Why? Because the ERP and POS systems have the transactional data that matters for a number of solutions. And whereas larger merchants can command that their ERP or POS provider do something, smaller merchants hold no such power.

Thus best-of-breed solutions are often unable to serve smaller merchants. Of course it doesn’t help that selling to smaller merchants costs nearly the exact same as selling to mid-market merchants, and payments companies – who often own ERP or POS systems these days – neither invest enough in solutions development nor provide reasonable distribution channels for best-of-breeds.

Verdict? Smaller merchants won’t likely get best-of-breed even if they want it.

Payments Processing: Infinite Cost Ceiling?

This last question is probably the juiciest, and it’s clearly not relegated to online commerce as companies like Shopify get into payments. The question is: do SMB merchants ever learn that payment rates are too high?

It seems to us that every software company is getting into payments (cuz payments = free money, duh) but that they’re using payments as the financial vehicle to support their entire product stack. What it means for merchants is that they’re paying 5, 6, 7% effective rates, which is often more than a merchant’s entire profit margin. In turn the merchants must pass along costs to the consumer or face insolvency, and doing this effectively becomes a tax on the entire population.

We’re going to SWAG some numbers here, but the US GDP is $21T. If cards are used on a quarter of that volume you’re basically tallying up a 3% effective rate on $5T, which is $150B. This $150B goes to support a relatively small number of jobs, and it’s worth asking what value the people in those jobs are providing. If you can transfer money for free on numerous other platforms, why are we spending $150B?

Totally unsustainable.

But in the meantime, at what payments rate do merchants start pushing back? When does the government step in, or when do alternative payment methods (crypto, BNPL, ACH/open banking) take hold? Every basis point in incremental rate is just one more straw on that camel’s back.

This is why we’ve seen the acquisitions and mergers we have in the payments space: there’s no organic growth. There aren’t suddenly 20% more merchants this year as there were last year, nor is consumer spending jumping 20%, so the only way to make 20% more is to 1) charge merchants more for the same commoditized product with shit support or 2) build value add solutions to drive ARPU… Nope, only one answer here for payments bros.

When the hammer does drop merchants will start to realize just how much it costs to build, sell, and support an ERP or POS system (hint: the answer isn’t “free”). We would hope that, like Amazon has done, these companies learn how to leverage data and create real value add solutions that drive down the costs of a POS system, but that certainly hasn’t been the case to-date.

We’re not convinced merchants ever figure this out frankly, and it will become the job of a disruptive agent to catalyze change. We just don’t see any motivation out of even the new POS entrants to overturn this model.

These three questions continue to swirl about and we’re all watching to see where things settle.