REAL Data Proves Restaurant Software TAM Is Infinitesimal: A Must Read for All Vendors

It’s hilarious when reading some of the revenue projections from technology companies that serve restaurant operators.

“Restaurants spend 2-3% of revenues on technology solutions…”

No. They. Don’t.

The only way we could possibly get this number to rationalize is if it’s inclusive of the ~2% interchange fees that restaurants pay.

You basically have three segments of merchants in the restaurant industry.

SMB

These are merchants using Square or Clover or Lightspeed and earning < $500K in annual revenues. For these merchants any expenditure is large as a percentage of their total revenue because their total revenue is small are there are simply minimum costs to buying anything. Here’s Square’s merchant segmentation for reference:

Keep in mind that inflation has reset the expectation of $500K in revenue: today $650K might really be the $500K of old.

In absolute dollars these merchants spend nothing on technology.

They use a POS and that’s the end of it.

They’re not out actively looking for solutions to solve their problems, and even if they were they’re not paying more than free for said solution.

Go ask Clover what percentage of their merchants actually download other applications in their app store and you’ll see precisely that these merchant don’t give a shit about life.

Remember: these people are “artists”, not business professionals who understand the meaning of ROI.

A POS system ranges from “free” (in exchange for a steep payments rate, of course) to roughly $89/mo, or $1,000 annually with a modestly-lower payments take rate.

Note that we CANNOT honestly include payments margins as “software spend” because the merchant 1) doesn’t believe they’re paying any margins for payments (they’re all the world’s best super-genius-negotiators), and 2) would NOT spend said payment margins on software if it was explicit.

By this we mean that Square might make 100 bps ($5,000 on $500K in merchant revenue) in payment processing margin in addition to the $1,000 in software fees for their POS, but there’s NO WAY IN HELL that same merchant would hand Square $6,000 for that POS and pay $0 in payments margin.

$1,000 (the upper end) in annual software spend on $250K (median of a small SMB’s revenue) in revenue is 40 basis points of revenue spent on software.

Quick comment: for a technology vendor to sell to these SMBs they’re going to need an ARPU of at least $2,500. Maybe after the last few years of inflation that number has crept up to $3,500. That’s because these merchants do NOT self-discover (there is no such thing as product-led growth for retailers) so you need an active outbound motion.

To cover the cost of direct sales – and make it so your sales people can actually hit an OTE that affords them beans and rice for at least 2 meals daily – you need a higher sales price.

Or you need insanely high volume.

We don’t want to derail the article here, but you probably have an aggregate OTE for a BDR and AE that’s $170K in today’s SMB market. That means that this team of 2 people needs to generate ~4x their OTE, or $680K, in annual revenues. At $3,500 in ARPU that’s 20 deals per year.

But you know what? That SMB will never pay $300/mo for whatever this sales team is peddling: that’s “more” than the merchant pays for their POS (except it’s not when you consider payment margins but remember that the merchant doesn’t and can’t comprehend this). And clearly the sales team can’t make OTE by selling a free product (the literal upper limit that most of these merchants are willing to pay for anything) so the technology vendor would HAVE to bundle in their solution with the POS and hope to grab some payments revenue… except that the POS will just clone the vendor’s product with all the payments revenue.

Now you see why SMB technology vendors that don’t own the payments stream have gone the way of the dodo.

Mid Market

This is the classic Toast customer. More than a million in revenue per site, often with 5-20 locations, these merchants give up a ton of money in payment processing on both an absolute and relative basis (at least if they’re using Toast), AND they pay rack software rates for POS.

For example, Toast is juicing these merchants for 55 basis points (that’s $5,500 on $1M in processing volume per location) in addition to grabbing another ~$5,000 in software fees (it’s actually a bit higher since Toast’s latest ARPU is above $12,000). This is 2.6x more than these merchants were previously paying for their POS systems, by the way.

This segment of merchants will start to consider additional softwares – loyalty, labor, payroll, inventory, analytics – but they won’t pay much for them.

And this is Toast’s theory, in a nutshell:

Restaurants are cheap. And dumb. Let’s build them a lot of different software modules – mostly by ripping the product off our “partners” – and offer them to our merchants for “great deals”, and we’ll take what we’re really owed out of the payments stream.

Toast’s thesis on life

As some interesting fodder, we’ve actually seen Toast offer merchants these additional software modules for “free” for an introductory period, knowing full well that the merchant would forget to turn them off and Toast would be the beneficiary when the auto-payment commenced in a few months .

Regardless, Toast says that 43% of their merchants are taking 6+ software modules from Toast, exclusive of POS and payments.

But notice that it’s plateaued.

We expect this to hold pretty consistent: merchants just refuse to explicitly pay for software.

Now, Toast could get this number to 10+ software modules if they gave them away for “free” and recouped the revenue by cranking up the payment fees.

But that’s not what we’re writing about here.

Instead, we’re going to point out something else:

Toast is collecting $629M in annualized software revenues from 106,000 restaurants doing $135B in processing volume. That software spend represents 0.47% of those restaurants’ payment revenues, and Toast is often discussed as being “too expensive”.

You can probably increase the $135B by 10-15% since some amount of restaurant sales volume will be cash, meaning that these restaurants are likely spending ~40 bps of their revenues on software.

Again, this is with Toast very aggressively pushing additional software modules and, in some cases, likely charging the merchant for software that the merchant doesn’t even know they’re paying for.

And Toast is “all-in-one”, making it likely that their customers aren’t sourcing software from anyone else.

In other words, this is the upper limit for what this segment of merchants will spend on software… And merchants think 40 bps is “expensive”.

Enterprise

Oh, enterprise: the part of the market that forces their vendors to customize everything and lose money serving them.

It’s like Arby’s – whose average store sees $1.25M in revenues – getting POS for $600 per store per year, or 4.8 bps or revenue, and still bitching that it’s overpriced.

We’ve gone through 10Ks at pubic restaurant companies to demonstrate that enterprise restaurants only allocate 10-20 bps of revenue to software because they view it as an expense, not as an investment.

Restaurant people categorically cannot understand the definition of ROI.

But since nobody believes us, below is the ACTUAL 2022 operating budget for an enterprise restaurant chain that clocked $4.5B in annual sales.

Their software spend?

$8.627M.

That’s 19 bps of revenue.

The lower spend as a percentage of revenue makes sense for enterprise merchants for two reasons.

First, they have larger revenues per unit. When spend is fixed, the percentage decreases.

Second, restaurants get massive boners when their vendors lose money. It’s like a competition among restaurant operators to see who can put their vendors – who are often providing mission-critical services to the restaurant, mind you – out of business first. Enterprise merchants leverage their heft to beat vendors into the dirt.

But don’t worry: restaurants are all “spending 2-3% of revenues on technology”.

This lie is dangerous.

It’s the most lethal lie peddled in all of retail.

And it should be criminal, frankly.

Because what it does is induce well-meaning innovators and entrepreneurs into believing that they have a chance to make returns by serving otherwise apathetic and ignorant restaurant operators.

Oh wow, 2-3% of the ~$1T in US restaurant sales means there’s a $20-30B software market. That’s enough for 200-300 companies making $100M of ARR. My research shows that there are fewer than 10 restaurant software vendors that earn more than $100M of ARR… so there’s clearly a huge opportunity!

Wishful founder

Lying like this has deluded – and will continue to delude – founders into wasting precious, unrecoverable years trying to assist people that, like we said earlier, don’t give a sh*t about f*ck.

Instead, the following graphic is what NEEDS to be promulgated:

The restaurant industry lacks any self-awareness.

You know who doesn’t?

Investors.

They’re in the business of making returns.

Look at the software TAM promulgated by an investment bank and how closely it matches our numbers:

As of 2024, they’re projecting restaurant software spend to be $1.9B out of $1T of total sales, or…

19 mother f*cking basis points.

Stop the lies.

Stop the misinformation.

Stop penalizing founders with effective prison sentences by inducing them into serving retailers.

Let them affect change in industries that actually want to improve.

Society would be in a much better place if founders never wasted time trying to help retailers ever again.