• jking815

Payments Companies Will Never Be Software Companies Absent Cultural Overhauls

Software moves at an amazingly competitive pace. This is primarily attributed to three realities:

Software is becoming faster and cheaper to build. Infrastructure (think AWS, which has democratized launching applications) and open source tools mean competitors can pop up overnightCustomers see how much better software is making their lives and therefore the demand for software is the highest it’s ever beenSoftware is massively scalable and lucrative. You can build a billion-dollar business with fewer people than ever before and achieve astronomical valuation multiples along the way

Companies – technology or otherwise – cannot rest on their laurels and expect to survive more than a few years in the face of this level of innovation. The below graphic should make this apparent.

This is precisely why technology leaders invest so much in research and development (R&D). According to Kleiner Perkins, a widely respected venture capital group, technology companies are some of the leading spenders on R&D by absolute value as well as percentages of revenue.

And it’s rising.

Google even has a famous resource allocation model called 70/20/10 – 70% of their time is spent on day-to-day business, 20% is spent on innovation, and 10% spent on crazy moonshots.

Given that software companies are pouring so much of their time and money into R&D to stay competitive, how do payments companies fare? Remember, these are the entities consuming software businesses in POS assets so they’ve entered into the software arena whether they care to acknowledge the truth.

EVO Payments: spent $44.3M on “computer software” relative to 2018 revenues of $565M, or 7.8% of revenue was spent on R&D.Fiserv: spent $496M on R&D relative to 2018 revenues of $5.82B, or 8.5% of revenue was spent on R&D.Global Payments: spent $213M on R&D relative to 2018 revenues of $3.366B, or 6.3% of revenue was spent on R&D.First Data: spent $143M on R&D relative to 2018 revenues of $9.498B, or 1.5% of revenue was spent on R&D.NCR: spent $252M on R&D relative to 2018 revenues of $6.41B, or 3.9% of revenue spent was on R&D.Square: spent $497M on R&D relative to 2018 revenues of $3.3B, or 15% of revenue was spent on R&D.TSYS – spent $39M on “Additions to internally developed computer software” relative to 2018 revenues of $3.816B, or 1% of revenue was spent on R&D.Worldpay: nominally spent $1.07B on R&D (it includes plant, property, and other capitalized items so we expect this number is grossly inflated) relative to 2018 revenues $3.925B, or $27% of revenue was spent on R&D.

By contrast Toast wants to spend $1B on R&D over the next 5 years, or $200M a year on average. Toast will end 2019 with close to $225M in revenues, so Toast is aggressively reinvesting in R&D. At this rate of innovation they will eat material market share away from payments and POS incumbents. (Note: Toast would need to continue a torrential growth rate in the triple digits to justify this level of continual R&D spend.)

This quick analysis should make it abundantly clear that payments companies are not investing sufficient levels of capital into R&D if they want to maintain relevant software assets (i.e. POS). Without material cultural changes and more sophisticated capital allocation, payments companies will erode market share at the hands of true software companies like Square, Stripe, and Toast, regardless of how many “software assets” they acquire.

Payments industries have always benefitted from a heat shield that protects them from their own incompetence. By that we mean that payments products are not only legislated monopolies with guaranteed demand (which begs the question how anyone could ever really be a payments processing “entrepreneur” since they would have never created anything novel or of true economic value in the sense that it moves society forward) but come with such high margins that payments businesses can be managed like dog shit and thrive; seriously, we’ve met many ISOs whose founders are worth $30M, $40M, or more and they would fail if they actually had to innovate.

Life is short so it’s probably better to be lucky than good. But by getting into POS and software generally, payments companies might just discover that they actually need to be good: viewing the POS as a mechanism to reduce payments churn is a loser strategy of epic proportions.

You can only be lucky for so long.

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