This is the Ford Mustang. Have you ever stopped to wonder what parts of the Mustang are made by Ford and what parts are made by someone else?
So did we.
Hence we found a graphic of Ford Mustang suppliers to help us prove a point.
It may surprise you to learn that even the world’s largest companies cannot do everything. Or more precisely, at least well enough to be economical. That’s why we are quick to highlight the recognized limitations of companies like Apple, who has $250B in cash, and Google, who despite being a leading software innovator with great gross margins failed at Google+, their Facebook analogue. (Update 10/8: Google is shutting down Google+)
Fortunately none of these companies are bigger, have more resources, or are more efficient than a POS company though, right?
That’s what many POS companies are implicitly telling the market when they try to build everything. Which brings us to the next POS company embarking on the painful path to learn this very expensive lesson, Lavu POS.
Lavu took $15M in private equity (PE) money from Aldrich Capital in the summer of 2015. PE funds generally hold an asset for no more than five years which means Aldrich will likely divest of Lavu in the summer of 2020. Yet we imagine that Lavu’s organic sales growth is not going terribly well since they’re now aggressively expanding beyond the core POS product. According to the press release,
The company [Aldrich Capital] plans to evolve Lavu from its traditional focus on point-of-sale tools for restaurants to conduct daily service operations on mobile devices to a comprehensive business-management option for restaurants with data analytics, workforce oversight and inventory control.
We have a number of observations here.
First, which we’ve been discussing for over two years now, is that POS and payments companies cannot do everything themselves. Payments companies lack software DNA and POS companies, until the recent cloud entrants, faced the same cultural challenges. That said, POS is a real pain in the ass. Ask any of the cloud POS companies how much money they’re making and the candid answer would be “not much”. That’s not a ding against them so much as it is the industry: merchants make for very difficult customers. Relatively long sales cycles, cheap, unsophisticated buyers, and demanding support requirements leave little bread to go around the table.
Second, even if Lavu could produce best-of-breed solutions on top of their POS (which they will find they cannot), their customers are not going to take them in any meaningful number. Lavu’s average customer skews small to the tune of $500K in annual revenues. These merchants don’t have discretionary budgets for solutions, no matter how good they might be. Let us share what we’re hearing in Lavu’s press release:
“…a comprehensive business-management option for restaurants with data analytics…” Lavu’s smaller merchants don’t know what data analytics are and they’re not going to sit down to find out. An additional worry is that Lavu is building nothing but a bunch of pretty reports. If you cannot get prescriptive, don’t expect anyone to use your tools. The scale at small merchants isn’t there for someone to sit around and play with reports all afternoon.
“…a comprehensive business-management option for restaurants with… workforce oversight…” Smaller merchants have little to optimize. A business that does $500K a year is just as likely to be a family business with relatives working every position. You think the owner wants to know that uncle Joey is stealing from him? That he’ll risk ruining his family relationships over $500 in monies pocketed monthly? Have you never watched an episode of Bar Rescue?
“…a comprehensive business-management option for restaurants with… inventory control.” Small merchants don’t do inventory. Go ask Sysco and US Foods and they’ll tell you 85% of their customers don’t even know their COGS. You know why? Because building recipes, doing par counts, and tracking shrinkage is a lot of work. Most restaurants don’t have the economies of scale to do this. Is it critical to a merchant’s survival? Absolutely. But why do you think so many restaurants go belly up annually? From the same article, “Restaurants with 20 or fewer employees fail more often than other service business, but those with 21 or more employees have a median lifespan that is 9 months longer than other businesses of the same size.”
Guess how many employees the average Lavu restaurant has?
Lavu likely arrived here because their PE owners don’t really understand the space. We see this all the time: investors infrequently have a vertical focus because it limits their “scope” for capital deployment. And since there’s so much money sloshing around the private markets there are funds that have more money than they probably should. We’ll now share the model a PE firm is likely employing to arrive at the decision to build all these bolt-ons on top of POS systems.
There are some major errors in these assumptions, however.
First is the attach rate. The attach rate for a partner’s bolt-on is significantly higher because the product is better. We would lower the attach rate for the in-house bolt-on substantially.
Second is the operating profit. Operating profit takes out things like engineering costs (R&D), sales, marketing, support, and associated back office work. A 50% operating profit is way too high if you honestly believe your bolt-os are going to be relevant: it’s not as if bolt-on competitors are abandoning innovation. The POS company likely sees an operating profit of 25% for their core business, so why are these bolt-ons suddenly going to have a 2x operating profit increase?
At least, not if the POS company wants their bolt-ons to be competitive. To think otherwise is to live in a fantasy. Why?
Because sales now has to be fluent enough to sell all your bolt-ons. Support now has to know how to support all your bolt-ons. Engineering now has to be fluent enough to build all your bolt-on so they’re market-relevant and competitive. Oh, and you have to be convinced that any attention paid to bolt-ons is not detracting from your core POS business and all the work that product line takes (features, bugs, sales, support, etc.).
So in reality, the numbers will look more like these.
And that’s assuming a Lavu merchant pays $100/mo for something, which they won’t.
When we ran a survey a few weeks ago we received this response in an open comment box:
“I’d like to see Lavu included in the analysis. It has been rarely mentioned and is a good, lower-end option for restaurants.”
You know what – we’d like to include better analysis of Lavu in our articles too. But they never respond to any of our inquiries, including the outreach we made for feedback on this article. This is a common theme with POS companies that believe they’ll build everything, see themselves as innovation savants, and are suspicious of anyone from the outside “stealing” something from them.
It seems the writing was on the wall all along.