Why POS and Payment companies should be upselling more

29 Aug

It’s no secret that churn is a huge problem in brick and mortar. Depending how you splice the numbers, it’s between 25% and 35% annually. Some of that is avoidable but a large portion is not.

I’ve always held a hypothesis that there exists a way to substantially reduce churn. Unfortunately, I could never find numbers to test my hypothesis. Until recently.

Sammy Abdullah of the DAN Fund has published numbers for public companies. In his analysis he takes a position that successful companies do a lot of upselling to existing accounts, and those efforts are rewarded handsomely.

He breaks out the three benefits of upselling as follows:

  1. Shorter sales cycles! You already have a relationship with the account and know the pertinent contact information. Selling something new to an existing account is mucheasier than finding a new one.
  2.  Churn reduction! By proactively having conversations you’ll learn more about how existing accounts are performing, and possibly find a way to keep accounts from churning.
  3. If you successfully upsell, you are now stickier and could prevent an account from churning. You’ve become a single source for multiple points of value.

Before I dig into Sammy’s data, his rationale should sound familiar if you’ve at all followed POS and payments over the past two years: payments companies are purchasing or reselling POS solutions to their merchants. Why?

It’s much harder to yank out a POS – with all your business data and business processes – than it is to switch payment processors. While POS might have some accretive revenue impact for the processors, it’s mostly about reducing churn and ensuring the processing revenues (where processors make their money) stay where they are. Yes, in theory the payments channel will start to become better educated and offer more value around the POS, but that’s not reality today.

Net retention is defined as revenue at the beginning of a period + new revenue from existing customers – revenue loss. If this is greater than 100%, it means you’re selling more to your existing account than you’re losing in churn. If you look at the companies that are disclosing numbers, you’ll observe that net retention is improving – meaning all these companies are focused on increasing sales per customer.

If we go to the right side of the table we see that a number of these companies are generating significant growth from upselling. Interestingly, those companies that derive a large portion of their growth from upselling have net retention rates > 100%.

In other words, upselling means they’re losing fewer accounts!

There is something to be learned by a growing trend of public software companies: upselling works. Since POS and Payments companies have dangerously high levels of churn, they should be paying attention. But it’s not exactly easy for most of them to fix the problem.

First, as I’ve argued ad nauseum, POS and Payments industries are not high margin businesses. Compare Visa to First Data, or OpenTable to NCR. Whenever you’re in the business of acquiring merchants, margins go to shit. OpenTable does some merchant acquisition, but it’s a differentiated service and the only large reservation platform on the market. So while their profit margins were low in the early years, they now benefit from the margins a software business brings.

There are also plaguing cultural issues. Being good at payments or POS does not a product business make. You need engineers, product managers and people who understand the myriad moving pieces of the technology landscape. It’s really hard to find people of this caliber that want to work at a legacy payment/POS company. Yes, you might entice them with a high salary and the promise of a changing landscape (the latter is more true than it’s ever been), but one week in and they’ll realize the organization is culturally-backwards and quit.

Still don’t believe that POS and payments companies have a hard time with non-core efforts? Here’s a list of failed products these industries would soon forget.

  • Heartland built Prosper POS, a homegrown effort that took 3 years and $7M but ultimately failed.
  • Heartland, making a strategic play in a POS world it didn’t quite grasp, acquired Leaf POS for $20M. The investment was written off within a year.
  • First Data built Offerwise, a card linked offering platform. It flopped for a number of reasons, including lack of POS integrations and proper merchant onboarding for the rebates.
  • First Data launched eGift social to move gift cards over Facebook. Facebook was not involved, integration was never complete and the customer journey a nightmare.
  • Perka, a loyalty app acquired by First Data, was never able to make meaningful penetration as the payment behemoth couldn’t convince merchants it knew much outside of payments.
  • In the same vein as Heartland, First Data private labeled Microsoft Dynamics POSin 2007 and sold it downmarket. They had a 100,000 unit sales projection but purchased it all back, killing the POS effort in 2009.
  • NCR built Guest Manager, a reservation system, that has largely failed with paltry penetration numbers and no consumer platform.
  • NCR’s Radiant bought CIM, an accounting tool for college seating. The product was a loss leader for market penetration but NCR stopped product development and the product fell too far behind to be relevant.

That doesn’t mean that the payments world always looks likes this. We believe POS companies achieve higher levels of profitability in time with data availability, and based on the nature of the data business POS and payments companies will see a natural merging (more rationale on a coming post). These two charts help provide a visual for how POS companies spend their money now.

Margin: <10%

As POS matures, it will create more free cash flow for itself. How it invests this money remains to be seen. It could start developing the very products it needs to upsell, but there’s always a risk of “not invented here” that limits the business to subpar, non-core products. If POS companies go the way that young technology companies go, you’d expect an expense chart like the following.

Margin 35%

How does this happen? Let’s walk through it:

  1. Compliance costs increase as a percentage of overall expenses but the net dollar amount stays the same. ISVs are not spending more on compliance than they are today
  2. POS becomes commoditized so there are fewer people needed to hammer on features. Since third parties will be making many of the useful features, development shrinks
  3. As you let people go, operations and overhead shrink as well
  4. Most of the expense growth comes from sales. The dealer channels dry up as merchants start buying commoditized POS products directly on the internet or from payment referrals. This line item expense now assumes significant spend on search engine optimization, email marketing and possible referral fees
  5. Services expenses fall since the POS gets easier to support remotely. Internet-enabled systems allow for remote diagnosis and repairs

And the margin grows more than three times as the ISV starts earning significant revenue from the third parties that they’re relying on for feature enhancements.

Today though, no POS company is truly operating as a data company. That’s because we’re still in this transitory period. If POS and payments companies want to reduce churn and create significant revenues on additional, non-core products, they should source those products from a best-of-breed provider. I’ll leave it to them to figure out where to turn, but the reason for doing looks more compelling than ever thanks to Sammy’s work.