Will Heartland’s Upcoming Cloud POS Flop?

15 Nov

Before being scooped up by Global Payments earlier this year, Heartland operated along an aggressive strategy to roll up a number of legacy point of sale (POS) systems. The maneuver was mostly focused on the hospitality vertical – where Heartland has a large presence.

And it was smart. Bob Carr, Heartland’s founder and then-CEO, knew that payments was a high churn business. If the processor could own the POS asset, it would be much harder for the merchant to leave… something pioneered by Harbortouch, even though they catch flack for it to this day.

Further, Bob Carr saw what many in the field did not: that new, cloud POS entrants were raising tens of millions of dollars on the promise of democratizing data and building platforms that would forever change the local merchant. What these Silicon Valley folk did not understand was the cost of distribution. If a cloud POS was raising so much money on top of a few hundred installs, there was surely an arbitrage in taking a POS system with a larger footprint and converting it to cloud.

This became Heartland Commerce: a consolidated play where payments, POS and merchant add-ons could be offered from one portal. The rub, of course, was truly bringing those legacy POS systems into the cloud and making the data available.

What started out as a sure-thing quickly fizzled as the Global Payments acquisition leaned on the organization. Diligence into the poor database design and extraction schemas looked more daunting. It was then decided that a fresh $25MM should be appropriated to build a new, cloud POS.

And from the ashes shall rise a phoenix

The strategy behind Heartland’s new cloud POS – Zingo – was threefold.

1) In absorbing several disparate legacy POS systems, the new cloud system could pick and choose from a repository of robust, market-hardened features that most cloud POS systems would lack

2) Because the foundation of the new cloud POS would be from legacy POS systems across multiple verticals, the new cloud POS would serve many markets

3) Having a massive direct sales force of payments professionals, in addition to dealer channels from the acquired POS companies, could combine for an enviable distribution network

On paper it looks great. But it’s also uncharted territory.

There are solid POS systems that have been built for two or three million dollars – isn’t $25MM overkill? Most successful POS systems serve one – and only one – vertical because building relevant features for multiple segments even within a vertical can be daunting. I can’t imagine the complexity in building a POS for all segments across multiple verticals. In fact it’s why Micros has abandoned parts of the market after its Oracle acquisition: there was not enough potential growth in certain segments.

And what is this about leveraging the Heartland channel? When Heartland purchased its legacy POS systems the dealers for those systems became property of Heartland. Heartland put some pretty aggressive agreements in front of the dealers, and the provisions are not the most dealer-friendly.

First, dealers have a quota. To maintain dealer status, a dealer must maintain $48,000 in annual sales. That’s high relative to other POS companies we know.

Second, Heartland has the right to purchase a dealer without the dealer being able to refuse the acquisition.

Third, Heartland will directly sell POS any merchant account with more than 100 locations.

Fourth, Heartland can sell products to merchants around the dealer so long as that merchant contacts Heartland directly. This is a huge deal, especially since we must acknowledge that merchants are increasingly either finding solutions via SEO or from payment provider referrals.

In effect, Heartland has engineered its dealer agreements with a realistic look towards the future

But none of this may be as critical as the financial realities in being a dealer under the new Heartland banner, and that’s encapsulated with this statement:

Dealers cannot refuse Heartland payment reps access to their merchants.

Basically, Heartland has the right to jettison existing dealer payment agreements and replace them with their own, even if that earns the dealer substantially less money.

I worked with several dealers to juxtapose old business models to new business models under Heartland rule. The results are surprising.

It’s quickly evident that software margins are far less under the Heartland (HPY) system than independent POS dealers had previously. Credit card processing residuals – where most dealers make a large portion of their income – is also down. I need to add some text formatting here because this is a huge deal!

As a dealer, you can only refer credit card business to Heartland. If Heartland successfully enrolls the merchant in their processing then the dealer earns $20 per month and $0.02 per transaction. If the dealer chooses NOT to refer payments to Heartland – in other words, because the dealer makes way more money under its existing processor arrangement – Heartland can approach the merchant and sell its processing directly, which means the dealer will see nothing (technically it’s $20/mo, but that’s trivial in comparison).

To put that into tangible numbers, for a merchant processing $1MM annually, that processing contract is the difference between annually earning $2,760 (non-Heartland processing) and $789 (Heartland processing).

Unfortunately, the end merchant is also paying more for POS products under the Heartland umbrella. Here’s a chart of the same services before and after Heartland involvement. As can be seen, software is now more expensive (because Heartland charges a perpetual 10% annual fee for software updates and bug reporting) and credit card processing could be made twice as expensive if it’s NOT Heartland processing.

The same costs are reflected on the dealer’s balance sheet as well. Dealers under Heartland are now paying more for their POS software and could be paying twice as much if they choose not to refer Heartland’s payments processing.

Heartland believes its dealers can make up lost revenue selling add-ons: additional products in Heartland Commerce. Heartland visualizes this as a flower and petals analogy.

It’s not a bad strategy assuming each of the add-ons could stand as a solution on its own. Unfortunately, I’ve seen far too many POS companies – which are much closer to product companies than Heartland, a payments company – consistently screw up any product that wasn’t POS.

An expensive price tag, broad ambitions, and upside-down channel economics make Heartland’s new POS tough to assess. Add to that the historical difficulty with integrating to Heartland’s flagship POS product – XPient – and it could spell trouble.

As much as Bob Carr was a visionary and guiding force for the payments industry, his departure might signal a cultural change that only works in one party’s favor. Without an ecosystem that wins – including the customer and the channel – this could be more than Heartland – err, Global – can stomach.