Archive | May, 2016

POS App Stores Don’t Work, so Shut Up

23 May

Since the wild success of Apple and Google’s efforts, everybody and their dog wants an app store. It’s totally understandable – after all, Apple earns $6B from its app store. But there a lot of necessary ingredients to successfully pull it off.

First you need a process to accept, vet and support third party developers. Without the procedures to keep good apps in and bad apps out, the quality of your efforts will be seriously questioned. It’s not an easy task, and it’s why Apple gobbles 30% of app store revenue.

Second, you must be attractive to developers. Apple and Google have literal billions of users (i.e. prospective customers) between them. As a developer, even if I get a fraction of those users to convert, it’s serious money – whether it’s a paid app or in-app advertising in a free app is moot. I must be lured by the possibility of a (relatively) large outcome for my development efforts.

If you can’t provide a good process for third party onboarding and don’t offer a clear business proposition, why would I sign up? Yet this is where the majority of POS companies find themselves.

POS is a highly fragmented business. High levels of customer churn (25% annually), wide segmentation and very low barriers to entry mean there are tens of thousands of POS systems across multiple verticals. By its very nature this means that each POS company has a small number of merchants on its platform. Even a larger platform, like First Data’s Clover, or Poynt, has upwards of 50,000 very small merchants (i.e. their merchants won’t pay for much) but that’s still exponentially smaller than the user bases of Apple or Google. For tangible numbers, the Android user base is 30,000 times larger than that of Clover or Poynt.

Given their smaller footprints you’d expect POS companies to be more flexible in making their app stores work. Nope. NCR takes 40% of the revenue, 10% more than Apple. NCR also asks for $15,ooo per year just to participate, and charges additional fees for any extra work on their end.

The biggest distinction, however, is that businesses do not do self-discovery. At least not yet. I was in the same camp as everyone else: “App stores work great for consumers, why not businesses?” Turns out there’s a huge behavioral difference. As a consumer, I can peruse an app store in my underwear while watching college football on the couch. I’m not in a rush or on the clock. While at work something seems to change.

No POS company has accounted for this reality to help their third party developers sell their products. POS companies will not provide third parties with a list of their customers, nor will they actively sell third party products to their merchant base. At least Apple and Google have developed app store SEO and found ways to promote good apps. A healthy app store not only yields increased revenue for Apple and Google, it also means customers find increased value in buying an Apple or Google device. It’s a great cycle of fulfillment.

Unfortunately, POS companies expect developers to build apps for their app stores and pray something happens. I know numerous products that went through the trouble of participating in POS app stores only to still be sorely disappointed a full 12 months later.

My advice for all developers is to steer clear of POS app stores. Until the POS companies are honest with themselves and desire win-win partnerships, you’re drawing the short straw.

Micros and NCR are Alienating Resellers. Who’s next?

23 May

If you’ve been in the POS space long enough you’ll eventually see what I call the Dealer Yo Yo (DYY). Cloud POS has gone through one full DYY cycle already and many of the legacy POS companies have done the dance several times. What is the DYY? It begins with understanding the nature of POS businesses.

Starting a POS company is expensive. You have to procure and ship hardware, build and support software, and then sell it. While hardware and software costs are relatively trivial nowadays, the sale process is more brutal than ever.

Brick and mortar businesses have incredibly long sales cycles for the paltry amount they pay. That’s why, as I’ve argued, it’s impossible for sophisticated investors to get behind endeavors that serve capital inefficient brick and mortar industries. As bad as this was when POS companies were earning tens of thousands when POS first arrived, revenues and margins have flatlined with the introduction of Cloud POS; the POS market is now more crowded and less economically-enticing than it’s ever been.

Throughout the ages, POS companies – referred to as Independent Software Vendors (ISVs) – have been faced with two choices: raise a lot of dilutive capital to sell the product directly, or shift the cost of sales to resellers, who will earn a percentage of the total sale. Since venture capital is a fairly new asset class, and POS companies were started when venture capital was trying to understand its purpose (and have since shifted entirely to growth equity), very few raised any material amount of outside capital.

Thus the majority of legacy POS companies have created reseller/dealer networks. There are all sorts of ways to do this, from the exclusive models that Micros and NCR employ, to the, “anybody and their dog” model employed by Aldelo. But the point of the effort is the same: place the cost of sales on the reseller.

After some amount of operating history, the ISVs came to a conclusion that their resellers were not selling fast enough. In an effort to exert more control over the sales process, the ISVs would buy up willing resellers and start selling directly to merchants. After all, the ISV had already earned enough profit and name recognition to afford these direct efforts.

Well, after months of hiring and training direct sales reps, the ISV would come to a new conclusion: they need local service representation to make sure the customer stays happy. Legacy POS systems are clunky, go down frequently, and have mostly lacked remote access to check system health.

This back and forth of channel expansion and channel consolidation is what we call the Dealer Yo Yo. Depending on the direction of the wind, the ISV would start operating on a plan to reclaim ownership of its channel. Some legacy POS companies eventually found themselves with a hybrid model, maintaining a channel in some markets but local, direct offices in others. In many cases this is the result of a reluctant reseller who didn’t want to part with their business and the ISV felt ballsy enough to establish a competitive office in the reseller’s territory. Fun stuff.

Cloud POS has gone through one full DYY cycle as the result of taking early outside money. Investors demand very, very fast growth, and Cloud is still struggling to figure out how to meet those expectations. Direct sales are too slow and costly; a channel cannot be controlled and delivers even less growth than the direct model; and payments partners cannot sell on value, meaning penetrating larger merchants is a problem.

But this latest Dealer Yo Yo is likely to be the lastHere’s why.

If you remember what I’ve stated previously, legacy POS companies like Micros and NCR earn two thirds of their revenues from “services”. This is a nice explanation for what services encompass. It’s the initial setup, a recurring fee to fix your system, a fee for updates, fees for bolt-ons… and on and on.

What Cloud POS has shown is that service revenues are going to shift. There will be no revenue associated with system updates or everyday support: cloud is much more stable and any updates or remote services are free. In fact cloud is so good that merchants have started questioning resellers pitching monthly cloud support fees as opposed to a break-fix model. Anecdotally, a partner tells us only one cloud install in a sample of 1,000 has gone down in the past 18 months.

We expect service revenues will shift to value-add products (I refer to them frequently as bolt-ons) that become available with access to POS data in the cloud. Some of NCR and Micros’ revenues were already for such services but they had to share those revenues with the channel (think NCR Pulse, their mobile reporting product).

But as Micros and NCR are learning, when the ISV maintains access to the data, they can create (albeit poorly) and sell any additional products directly to the merchant and take the reseller (and associated revenue share) out of the picture.

For instance, NCR has a program called Cloud Connect; it’s their late attempt at an app store, and it’s entirely one-sided in NCR’s favor. The third party developer must pay NCR $15,000 a year to be on the platform, not including additional support that may be needed. NCR also demands 40% of all revenue, and precludes the developer from control of the retailer touch points (in-store, web and mobile), including loyalty programs and reporting/analytics.

Even more damning, considering much of NCR’s hospitality install base comes from channel partners, is that there’s no provision for reseller revenue share in Cloud Connect. Why, you ask? Simple: because with access to data via cloud, NCR can produce (or let third parties produce) products that can be sold directly to the merchant, obviating the need to involve the reseller at all.

Micros (Oracle) has similarly looked toward the future and started alienating their channel. After Micros was purchased by Oracle, it started phasing out all but its 10 largest resellers. That’s exactly why we are seeing stories about small businesses being stranded even after spending tens of thousands on Micros POS systems.

It’s not personal: it’s just business. Micros received the majority of its POS profits and revenue from large retail and hotel accounts. The reseller channel mostly served independents and small chains. It’s really hard to get these accounts to upgrade to cloud and more expensive products. If Oracle sets an annual goal of $1 billion in new revenue from cloud and its derivative products, it’s a fool’s errand to try to meet that $20,000 at a time, especially through a channel you can’t control.

Unfortunately the outcome is that tens of thousands of merchants are finding themselves on POS systems that Oracle is no longer supporting: RES 3700 and e7. Oracle is instead pushing everyone towards the cloud product it designed for Starbucks, Simphony 2.

There are more and more mid-market accounts churning as Micros abandons support for its flagship POS products. Who snaps these up remains to be seen. Our take is that those deals will be won by resellers – the same kind being pushed out at Micros, and undercut at NCR. But if the future of POS revenue comes from bolt-ons, not the initial sale or support, the real question is how quickly other ISVs will follow Micros and NCR to this inevitable future.

Note: I don’t accept random Linkedin connections. You can write me at Jordan [at] whatsbusy [dot] com if you need to reach me – thanks!

EMV Chargebacks. Ouch

23 May

He strolls into your club and sits at a VIP table. Your server asks for his ID to sit among the plutocrats. He orders bottle after bottle of your top shelf liquor. At the end of the night your server hands him his tab. He wasn’t dressed particularly well, so she’s worried he will start a fight over the bill.

Without hesitation he flops his card on the table. Your server swipes his card and hands him the receipt. He snakes the pen across the bottom of the page, gives the server a wink, and walks out.

A week later you learn that his $8,000 bill is being refuted. “It was fraud,” Visa explains. But you have his signature, a copy of his license and video of him imbibing heavily on camera. Unfortunately your only recourse is to take it to small claims court. Such is the nature of the EMV chargeback.

Starting October of last year all merchants who processed credit cards without using the inconvenient chip method were liable for 100% of any fraud. Previously fraud was swallowed by the banks and credit card networks. No longer.

Assuming the merchant had the discretionary funds to invest in new hardware that accepted EMV payments, this is an easy fix, right? Wrong. Even if merchants had complaint hardware, their point of sale software might not be approved.

When PCI (payment card industry) pushed through the rules in October, they didn’t expect so many POS companies to be so far behind. To be EMV certified, the POS providers had to go through certification via third party. Well there are a limited number of certifiers and a large number of parties needing certification. A giant backlog accumulated.

Studies estimate that 50% of merchants will have EMV enabled at the end of 2016. Until then a large number of chargebacks will accumulate on hapless merchants.

The Evolution of Data Solutions

23 May

To borrow from IBM,

“Every day, we create 2.5 quintillion bytes of data — so much that 90% of the data in the world today has been created in the last two years alone. This data comes from everywhere: sensors used to gather climate information, posts to social media sites, digital pictures and videos, purchase transaction records, and cell phone GPS signals to name a few.” In fact, we’re producing so much data that experts estimate 2016 will be the year when humans produce more data than we’re capable of storing.

With all this data being produced there’s an amazing opportunity to capture and analyze it for massively useful solutions. Solutions like tracking and curing diseases; delivering resources, products and solutions faster – for less; and perhaps most importantly, moving humanity through it’s next paradigm shift: giving us all more free time as data makes decisions for us.

But as much fun as it is to postulate when (not if) decision engines will give us more free time, we should examine the reality of data solutions for much of our business society.

The first evolution of data solutions was historical analysis. It was the capture, organization and presentation of, “the rear view mirror.” These reports would tell you what happened in the past, with little explanative power.  The user would need to interpret what might have caused the outcome. Firms would hire expensive data analysts to pore over data with tools like SAS. Forget about your average business owner having the time or money to analyze the data appropriately.

The next phase of evolution was predictive. This was discovering what happened in the past, finding trends, and stating, “if the conditions are like so, this is what will happen in the future.” During this phase the term Big Data crept into our vernacular; predictive data systems needed to pull in loads of information to improve the accuracy of its outputs - perhaps weather, GDP or other externalities that should be baked into the projections. This entailed taking lots of data from lots of different sources and letting machines help with the grunt work of prognostication.

Companies employing predictive analytics would still use data analysts to take a forecast and translate it into concrete action. It was only until recently that predictive solutions started to make their way into the middle market. The SMB (small, medium business) segment of the economy has yet to see much in the way of predictive solutions.

The most recent phase of data evolution is prescriptive analytics. Prescriptive analytics take the predictive output and recommends a decision. The decision itself is quantified and annotated so a human operator need not rummage through the data to determine what the decision is worth. In it’s most simple understanding, prescriptive analytics does all the heavy lifting of historical analysis and predictive analysis and then gives the user a digestible recommendation. “This is what you need to know from your data,” if you will.

We’ve seen firms move even one step further and let the machine make the decision for them. In other words, if the recommended action is A, and the confidence in the outcome is high enough, the machine will execute A automatically. You’re probably already using such technology but don’t even realize it! Ever booked a hotel or airline reservation? Through something called a Global Distribution System, sophisticated hotels and airlines are letting machines ingest price and booking data from around the world to determine what your booking should cost.

The majority of SMBs find themselves on the fence between nothing, and historical analytics. Depending on the vertical in question, even large enterprises find themselves with historical solutions but very weak predictive powers. Many of the legacy point of sale (POS) companies have developed fairly crude reporting to show the operator what happened last week, month and year. Cloud POS companies take the same crude reporting and make it prettier. A few Cloud companies have caught on that there is value in predictive solutions, but it ultimately gets to be a big distraction from their core business of sales, support and feature additions – despite what their investors think.

Since data science and machine learning prices are dropping, we’ve developed prescriptive solutions for the market. We see more and more SMBs using these tools every day, effectively leapfrogging the historical and predictive solution rungs of the evolutionary ladder, despite what antiquated systems their large, public competitors may use. In a way it’s not unlike the third world, who lacks basic infrastructure and are thus progressing straight to mobile for services like internet, communications, and payments.

Paradigm shifts are great for society: they advance our progress and give us more free time to discover new ways to improve our quality of life. We went from whaling for energy to drilling for it; manual farming to mechanized replacements; and from pen and paper to computers. Now we’ll go from data analysis to quantified decision making… or even automated decisions! How cool to see this next shift unfolding, and how humbling to be a part of it.

Does Cloud POS Crash This Year?

23 May

The technology sector is off to a rocky start for 2016. The NASDAQ has already fallen by 10%, large venture-backed startups are seeing downward corrections, and pundits everywhere are talking about a return of 2000. It’s not quite as bad as a Pets.com meltdown, but there are definitely a sizable number of highbrow startups with uneconomic business models.

Unlike 2000, many tech companies today have real revenues and scale. They’re earning tens of millions in revenue, or have tens of millions of eyeballs that they can monetize at some level. Will the scale of monetization be such that it produces positive unit economics for the startups? That’s what 2016 will lay bare.

A few of these later stage companies are already profitable. With the technology market trending down and a coming vacuum of private financing, it just means that their margins might be less than optimal. Instead of a company earning $100M in revenue it might only earn $50M because it has to cut its R&D on new product. Fundamentally it’s a small discrepancy because both outcomes produce relatively large companies, though it’s probably the difference between a founder having some ownership and looking for a new job if the company took “venture” capital.

But what about startups with inherently low profitability? How much wiggle room is there once venture funds pull back? Think about it this way: Google earns 60% gross margin. If that margin sinks to 20% it’s still above water. But what happens to a startup that’s expected to earn a low margin ( like 10%) at scale when venture capital stops subsidizing the business model?

This is the conundrum I expect cloud POS companies will face in the very near future. POS is a very low margin business. Cloud POS has made margins fall even lower. The name of the game in cloud POS is to decrease the upfront cost of ownership and make money as a platform. It’s the right idea, but without the financing to see it through to scale it’s an utter disaster. And by scale, I mean 20+ years since it will take any POS company several decades to reach enough customers for a platform play.

A big problem is that there are just too many cloud POS systems out there. I blame software. Developing software has never been easier. Don’t believe me? Give me $5,000 and an Elance account and I’ll come back with a working POS in 3 weeks. The product might be complete crap once you get under the hood, but I’ll have one to sell.

Cloud POS is also having a difficult time with its distribution model. First it spent a lot of money on SEO and handled all the sales directly. Investors realized this was the definition of linear – not exponential – growth, and told the POS companies to build a channel. Well, cloud discovered what legacy POS companies have been frustrated with for decades: very few resellers can actually sell product at a repeatable rate. With no ability to control the channel, cloud POS companies turned to a referral model, whereby payment processors would send POS companies merchant referrals. This last effort is still being sussed out, but the data I have shows that the rate of growth remains linear with a pretty low constant.

Ultimately product is not the hard part about brick and mortar: distribution is. It’s at least 80% of your cost structure. Few people really seem to understand why it took Micros 35 years to scale to only 60K restaurants. It’s a very competitive world with low margins, high churn, and customers who look at you as a cost center.

I expect cloud POS consolidation soon. I think payment processors will continue acquiring cloud POS so they have something sticky to offer merchants, preventing churn in their core processing business. This will fit well with many cloud POS companies who are struggling to support themselves. However, most processors don’t know the value of POS, nor how to sell product on value, and that shall be a fun dance to observe.

The irony in all of this is that cloud POS will need to rely on the POS models of old. Since cloud POS is so cheap it is betting on selling additional products to merchants who use its POS. Who ultimately builds, sells and supports these additional products is moot: can the merchant afford them? Cloud POS’s current customers are very small merchants (sub $500K/year revenues). They aren’t going to pay for analytics or marketing. For cloud POS to be successful, it will need to convert chains and large independent merchants.

The makeup of the decision makers at chains and larger merchants are not young, 20-something Stanford grads. They don’t really understand technology, but they get relationships. They know that it took their current POS rep three years to prove his worth before they even entertained the notion of switching systems.

These kinds of sales take time. It takes feet on the street and solid rapports. It takes a business model that incentivizes the sales person to make the sale… which is hard to do with cloud pricing today. Ultimately, it takes ingredients that the cloud POS were created to eliminate. Yes, in a generation merchants will do self-discovery and buy their POS online, just like they do most everything else these days. But then is not now. And I don’t know if current cloud investors will wait a generation to see it through.

All You Need to Know About “Venture” Capital for 2016

23 May

Very few investors are honest about the transition taking place in startup financial markets. I saw the first real candor in Joe Dwyer’s blog post in 2014. It’s long, but if you really want to understand what’s happening you cannot spend a better 15 minutes of your day. The most recent piece, by Rob Go at NextView Ventures, is also visually insightful, though less analytical.

Here’s how we got here.

When the financial markets crashed in 2008, some people thought printing a lot of money would be a great idea. The allure of loaning money via credit instruments faded as governments around the world dropped interest rates. So if you wanted to earn a return, you sought the equity markets.

Large limited partners (institutionals that provide investor groups their funds) realized that credit instruments were no longer useful for their portfolio. Seeking returns, they needed to focus on higher risk investment strategies like private equity.

Private equity is a catch-all term for investing private money in return for equity ownership. Upstream is venture capital, who seeds money into crazy ideas that offer chances at big returns. Midstream are conventional growth funds who might take a company earning $20M in revenue and find a way to leverage debt to earn a 2-3x return over a relatively short period of time. On the far end of downstream are buyout funds, whose job is to spend a lot of money buying companies and earn a 50% return over their time horizon. Because the capital invested is so large, returns are measured on a cash-on-cash basis. I’ve generated a pitiful graphic to show you how this looks.


With a glut of limited partner investor dollars flooding the private equity markets, many venture capital firms increased their fund sizes remarkably. I’m pretty lazy (if you couldn’t tell from the umbrella graphic) so I grabbed a chart from GSV Capital. The underlying data comes from the National Venture Capital Association. What should be immediately evident – though a few years stale – is that the size of the average venture fund has ballooned beyond 1990′s levels.

Now let’s discuss how venture capital funds work. When a venture firm raises a fund they earn a flat management fee on the amounts raised and carried interest on the profits.  So if a fund is $100M, let’s say, the venture firm might earn $2M no matter what happens. If a deal makes money, the venture firm might earn 20% of the profits. If it loses money, that’s someone else’s problem.

A venture fund is around for 10 years; the limited partner investors in venture funds cannot pull their money out until the fund sunsets. So regardless of fund performance, venture capital partners can still play unlimited rounds of golf late into year nine. Not too shabby, eh?

A venture firm will deploy a percentage of its fund in new deals the first few years. The remaining money is retained to make follow-on investments in existing investments, letting an investor double down on the good ones. Partners at the venture fund sponsor each investment. In essence you have a small number of people debating where the limited dollars get placed.

When venture firms raised large funds they didn’t take on a proportionate number of new partners. The net result is that the number of investments stays the same. Well if you need to deploy 10x the amount of capital over the same period of time without increasing the number of deals, what do you do? You increase the average investment by 10x.

This has left us with private equity creep: venture capital, by the nature of their check size, is getting into traditional growth equity. And it’s not as if growth equity isn’t already a competitive asset class. Thus in order for the venture firms to win deals over conventional growth equity, they have to go above and beyond competing funds. Easiest option? Increase the valuation on the investment round to impress the founders.

In this way venture capital is putting their larger funds to work. Check size is increasing, and “venture” risk is nowhere to be found. In most cases by the time a founder can raise money, there’s no reason to! You’ve had to bootstrap your startup to profitability and millions in revenue to get anyone’s attention. As Jason Lemkin pointed out, today’s “venture” investors think you should be going from $1M to $10M in annual revenue in fewer than five quarters. Organically.

What’s not discussed are the terms of these high-flying venture rounds. We see large numbers floating around and the market gets frenzied. But there’s a reason founders have been pretty quiet on terms. I’m willing to bet that there are aggressive ratchets and liquidation preferences in place should the startup miss a certain milestone within a short period of time. This is what happened to Square’s IPO. A similar arrangement bumped Zenefits’ founder out the door as well. Fenwick and West published a very recent survey with some specifics.

The only people raising true venture money are celebrity founders. Everyone else is required to build a profitable business churning out millions in revenue, or scaling millions of users a month. I’ve made a flow chart to help you understand raising money as a startup.

If this is feeling a lot like the Little Red Hen, you’d be right. Why don’t venture capitalists admit this? Because they want to see every possible deal. This helps investors hone future investment theses and perform cheap competitive diligence on existing investments. One could argue the startup gets valuable feedback, but venture firms rarely tell a startup the truth so they can preserve optionality down the road. This isn’t meant to be so much of a critique as it is a reality check, and founders should be aware going in.

If you’re thinking about changing the world with a really big idea, you might want to consider notching a few billion-dollar wins first. Focus on building a sustainable business without venture money. Yes, this means the really big, transformational ideas will only be started by celebrity founders who can raise money to build prototypes. But unless you’re able to convince 50 people to work free of charge for years on a transformational startup, you had better focus on a smaller endeavor.

Why Large Companies Suck at Innovation

23 May

People frequently wonder how it is that massive companies, like Blockbuster and Kodak, couldn’t keep up with innovation. It’s even more intriguing when young startups plead industry incumbents to partner or buy them years before they ultimately kill the incumbent. “But the incumbent had all the resources in the world,” outsiders say.

That’s true: incumbents are rich. They’re rich in revenue, profits and other assets. They’re rich in the amount of human capital at their disposal, their brand equity, and their networks. But they’re also poor in non-obvious ways. This is how even the Goliaths can tumble to the Davids in time.

The culture at large companies does not reward failure and risk taking. Rarely are the founders still around by the time a business IPOs – investors have booted them out or hired professional management. Sometimes this has merit, other times it’s detrimental.

The hired-CEO is there to keep their job. Keeping their job means appeasing the board. Appeasing the board means delighting shareholders… who just want quarterly returns. Rarely are CEOs given the leeway of Jeff Bezos at Amazon, who can reinvest earnings into crazy (and awesomely innovate) ideas; hello AWS!

So the culture, from the CEO down, is to keep meeting quarterly goals. And meeting quarterly goals can be stupid if your entire industry is changing. Look, just because someone carries a title like CEO and earns millions a year does not mean they’re competent: peek no further than Managing Directors at investment banks who earned tens of millions and pushed financial instruments they didn’t understand (CDOs) until the housing markets collapsed on them. I likewise have stories from the restaurant industry that would absolutely blow your mind. Salary does not equal savvy!

Employees at large companies are also not appropriately incentivized to create new value. Getting something right the first time is a total fluke; success comes with scars. Allowing employees to fail without repercussion would drive a hired-CEO insane –  that’s not closer to the quarterly goal, which means the CEO’s job is needlessly at-risk.

Thus there is no compensation program in place to support risk-taking and ensure a large outcome earns employees a large payday. In fact it’s most certainly the opposite: politics – not meritocracy – determine promotions at large companies. People are impressed with useless measures like age and “the number of people you’ve managed.” Just a thought, but that guy that’s been stuck in Kindergarten the past 10 years might not be the guy you want serving as Kindergarten class president. I don’t care how old they are – if they weren’t paying attention the first 10 times why are you spotting them on the 11th?

People at large companies are trained to execute, not invent. They’re trained to meet those quarterly goals and operate within a system that places emphasis on execution against a known quantity. Here’s the product, here’s the channel, here’s the price – don’t f*ck it up.

Successful invention requires hiring entirely new people, who frankly don’t want to work at your large company. They don’t want to deal with the politics and time sucks of useless meetings to stroke some middle manager’s ego. Neither do they limit work hours to 9-5 and turn down opportunities to learn and improve themselves. I find it massively amusing how the overwhelming majority – call it 97% – of people at large companies ignore outside emails because they’re “busy”… though they somehow find time to post pictures on facebook and make self-proclaimed quips on twitter. Funny how that works.

Invention require inventors. Inventors question. They listen for feedback. They make a hypothesis, test, and repeat until they get something useful. That is an entirely different skill set than one possessed by someone who doesn’t need to learn anything new because, “it’s always been done like this.” If only they’d bothered to read those emails they ignored, they might have learned why their company will be put out of business in three years.

To find success with innovation, you need to remove the innovators from those interested in self-preservation; create a separate and distinct division of the company. Make sure everyone knows that group is going to fail. And support it.

Hire entrepreneurs to work in your new division. Call them EIRs (entrepreneurs in residence). Give them a salary but let them know anything they take in compensation is subtracted from the equity they’d get if their idea is spun out. Here you’ll find people who are entrepreneurial enough to bake new ideas, but not so untethered that they don’t need a salary.

Grant the innovators access to your customers and product managers. Your advantage is that you can sidestep the miserable, early work of talking with prospective customers and understanding the status quo solutions in the market. This drastically speeds up the time it takes to find something that works.

If an idea is working – meaning customers have signed on and you’re producing a new stream of revenue – formalize the efforts by creating a new company. Seed the company with corporate venture dollars and spin them out so management is appropriately incentivized to make it successful. You have equity ownership in the company, and you can always buy it back if needed.

Obviously this requires a CEO who has the cerebral fortitude to create such a division. And not all CEOs can think this far ahead… regardless of their paycheck.

Retailers are Abusive

23 May

In the world of software as a service (SaaS), there are some common rules of thumb. How much you should spend acquiring customers, how much each customer should be worth, etc.. David Skok, widely seen as the Godfather of SaaS, has an excellent blog describing metrics for growth, profitability and product development. A great read if you want to understand how businesses are objectively measured for high growth potential by investors.

One of the well-known truisms for SaaS is the 3:1 value principle: whatever you charge the customer, you should be able to quantify three times the ROI. The metrics could be savings, revenue generation, or something else. Occasionally you’ll find more nuanced value propositions, where a SaaS tool might save you time or help you hire people faster. These activities are harder to objectively measure, and it’s up to the salesperson to derive the value for the customer.

As markets get more and more competitive, companies have started settling for lower ROI. If we look at a large enterprise resource planning (ERP) system in healthcare, it’s not uncommon to find ROI metrics that are less than 100%. You could look at the math this way: instead of building and maintaining a system in-house for $1M a year, the hospital might opt to pay a SaaS provider $750K a year for the same product. If we followed the 3:1 value principle, the SaaS provider should demonstrate value of $2.25M. In this example the SaaS solution is only showing a ROI of 25%; but that beats zero ROI.

In brick and mortar retail, the trend is often the other way. The status quo is partly responsible for these large ROI outcomes: most brick and mortar operators are missing very basic technology improvements that other industries have had for literal decades. What would normally constitute trivial improvements can have a big impact in retail.

Many of the startups I see chasing brick and mortar constantly deliver 1,000% ROI. That’s more than THREE times the SaaS rule of thumb, and exponentially larger than the ROI of ERP SaaS. Unfortunately, retail SaaS providers must generate these levels of ROI in order to get the retailer’s attention. Why?

In many cases the retailers believe they can either build the products themselves (though for some strange reason they haven’t) or the value isn’t enough to get excited. A billionaire hedge fund manager has been underperforming the market, wrote an op-ed, and is being slammed for not spending time on his business. Retailers keeps getting their asses handed to them by digital evolution but management is passing on solid ROI products. Where are the activist investors when you need ‘em?

In a classic Catch 22, retail’s modus operandi has put them in a very quantifiable – and precarious - position. It’s clear from any rational outsider that management in brick and mortar enterprise suffers under the Emperor’s New Clothes delusion, and exceptionally few have taken them to task. I’ll soon share how this way of thinking has, and continues, to perpetuate the stagnating feudalism that retail has grown into.

(Lack of) Capital Efficiency in Brick and Mortar

23 May

Life is a game of tradeoffs. You want to get shredded? Hit the gym like a fiend and don’t ingest candy again. Be a great guitarist? Rock the strings for hours a day, even when your scabs rip off. Die rich? Win the lottery. Or work hard. Something like that.

Investors must also dive into mental calculus when deploying their limited funds. It’s not unlike the rigors we plebeians face when choosing what to order off the dollar menu: which of these items is going to give me the greatest satisfaction for the least amount of coin? Obviously our choices are harder, but the concept is the same.

Achieving rapid growth in brick and mortar is a very tricky proposition. In fact, as you muse your way through this drivel, you’ll see how it might be one of the least capital efficient investments you can make. That’s not to say there can’t be relative breakouts. But there are so few, I wonder why investors put money into the space at all. Why blow a crisp, $1 bill on a single french fry when you might get a whole burger down the street?

First things first: brick and mortar requires real work. There is no “build it and they will come” phenomenon like there is in social media (at least the right product hasn’t shown it yet). Mark Zuckerberg would have crapped the bed if he had to leave his dorm room and talk with prospective customers.

Brick and mortar requires sales. Sales to people whose email you can’t just find online. Sales to businesses who use so many different systems there’s nothing close to 80/20. Literally millions of sales to proprietors who do not care to understand your product but are worried about making next week’s payroll. Your product might solve the payroll problem, but it’s hard to get their attention.

Distribution in brick and mortar is 80% of the cost structure. At least. Building software is easy. That’s why you can routinely find thousands of merchants using products that look like a kindergartener high on rubber cement fumes patched it together between a macaroni necklace tutorial and finger painting. There are way better products out there but without someone picking up the phone the merchant will never know about them. As cloud POS app stores have unequivocally shown: merchants do NOT do any self-discovery. Yet.

Because it’s so hard, investor dollars have an easier time finding a return elsewhere. For instance, ecommerce and B2C companies can produce greater returns in far shorter times because there’s no sales cycle; virality in non brick and mortar companies is exponentially more common. Looking at Fortune’s list of Unicorns, there are questionably 6 out of 174 entrants that serve SMB brick and mortar: Zenefits (which is imploding), Delivery Hero (which has raised $1.39B at a market cap of ~$3B), Powa (just declared bankruptcy), Zocdoc (sells to well-educated doctors), Gusto (no idea if market cap is justified), and Zomato (uses third world labor in India to scale).

If we go about it the other way, we can see that none of the most valuable technology companies in the last two decades got there by serving brick and mortar. What are the “wins” in brick in mortar, then?

Intuit is the most successful SMB (small/medium business) product that I can think of. They’re in over 5M merchants across the globe with a market cap of $25B. They were started in 1983, which means they accomplished this over a 33 year history. Their success starts before the internet, and this may have been a crucial ingredient: small businesses had to go to the bank a lot more frequently than today. Intuit partnered with banks to help sell their software to SMBs. With some initial successes, Intuit started partnering with accountants to further move the needle. Intuit is a real outlier in this regard.

Constant Contact is another win, though remarkably smaller. They took early venture money and struggled to find a scalable distribution model for years. Gail Goodman, their CEO and founder, shares a wonderful talk about how they crossed that chasm. Because Constant Contact contact took so long (10 years) to reach 9 figure annual revenues, they went through a demoralizing down round. Beware VC money!

ZipRecruiter is a new entrant that has ballooned to $50M in annual revenue in under 4 years with zero external financing. My understanding is that ZipRecruiter primarily sells their job posting/management platform to SMBs. I’m not as educated on this company, but it seems they scraped data across job posting platforms. They then took a hack from Airbnb and posted their own services on places like Craigslist, getting SMBs to sign up. After initial bills are paid, hit the marketing budget for rinse and repeat.

Two other wins are Opentable and Groupon. OpenTable effectively held restaurants captive: they raised a lot of money (because it was the 90′s) and built a marketplace. Restaurants, convinced OpenTable drives most of their traffic, fork over > $600/mo for the product – an amount unheard of by brick and mortar standards. Groupon capitalized on merchants’ desires for “butts in seats” at any cost. After 5 years the merchants that were still alive realized Groupon’s model was a sham and Groupon has had to make several pivots since.

There are a bevy of other brick and mortar service/product companies that are awesome in their own right, but not quite the $B company: Belly, LevelUp, FiveStars, Womply, Swipely etc. Of course, don’t forget the cloud POS companies making a run: ShopKeep, Revel, Toast and Lightspeed. Again, the sales cycles and contract value for a brick and mortar merchant is so low that it’s ridiculously hard to become a $B company on true financials.

Brick and mortar takes work. Work takes time. Time kills ROI. Some investors will still put money into brick and mortar for either lack of market understanding, or financial engineering at the expense of the founders. Many, however, rightly avoid the space altogether. If commerce continues its shift from offline to online, that may be a prescient move.

How Low Will POS Prices Fall?

23 May

I’ve made it clear in earlier publications that the POS industry is going through a major overhaul. Costs have dropped by 75% and ongoing services are also substantially cheaper. All in all this is great news for merchants.

The question now becomes: how low will POS prices fall? There are two areas that should be examined to arrive at a reasonable conclusion. First, we should look at hardware and software costs. Second, and perhaps more importantly, we should examine business models. The latter, I’ll contend, will have profound implications that will ripple throughout the industry. If you thought the introduction of cloud changed things, just wait three years.

POS hardware prices have fallen steeply over the past five years. If we look at an analogue, LCD prices dropped 80% between 2004 and 2008 while production costs dropped 50%. LCD manufacturers experienced a $13B loss in 2012, even as volume was up. Why? In a single word: commoditization. The same can be said for POS hardware.

Software prices are also falling. The costs to develop code shrink as open-source libraries grow and rapid deployment frameworks catch on. Data processing and storage costs have also collapsed with the expansion of cheaper servers and faster connectivity. Cloud POS offers mobile reporting, data backups and a software licensing model far, far below legacy software POS costs. Below is a graphic showing Amazon’s storage prices over time.

I’ve gone ahead and combined the hardware, software and ancillary costs of POS to produce a graph that shows lifetime costs in an apples-to-apples fashion. This means including expensive legacy cloud access tools like MyMicros (at a totally reasonable $1,500/year). I also want to note that legacy payment processing is factored into these historical prices. Payment prices have come down, and legacy POS companies (like Micros) are no longer getting away with their MerchantLink processing scam. All costs are summed for the lifetime of a small merchant, which I assume is 30 months.

I think hardware prices are close to the bottom. Hardware manufacturers are either losing money or breaking even: that’s a pretty good indication that we won’t fall too much farther. There will still be improvements made to production processes and distribution, but I don’t expect anything like the rapid descent we’ve seen the previous five years. Software prices will also continue their gradual decline.

As low as hardware and software costs are, they might evaporate entirely. Software and hardware costs might be entirely underwritten by the provider in a not-too-distant future. A new type of business model is gaining steam, and sophisticated parties are taking a hard look at how to make it work.

Merchants generate data. Lots of it. Data that tells a clever observer who’s making purchases, what they’re buying, and the prices they’re paying. This data has been sufficiently mined in the grocery industry for decades: between Nielsen and IRI, $6B in annual revenue is generated helping manufacturers make heads from tails in grocery purchases.

A lot of commerce happens outside the grocery vertical. Doesn’t it follow that the same kind of data could also generate billions in revenue? Sophisticated parties are seeing how much each merchant’s data might be worth. And if the numbers jive at scale, it’s not impossible to imagine free POS systems in exchange for the data. Nielsen provides consumers free scanners and pays them to generate panel data, and companies like Zenefits are giving away free SaaS product to earn revenue from something other than the freebies.

Don’t think that merchants are being shortchanged. In addition to having a free POS, merchants will start benefiting in ways grocers have for decades. Merchants will start seeing amazing 3rd party solutions built on top of the data, more help from their suppliers and distributors – including more promotional dollars, and increased revenues with online commerce opportunities.

Merchants should celebrate private market innovation. While POS, payments and their respective channels battle over their future business models, merchants continue to win.