Restaurant Research – Concerns for Toast’s TAM

We don’t have it out for Toast.

Toast is perhaps one of the greatest execution stories in the history of retail. Lots of helpful tailwinds, sure, but still some amazing execution.

And you have founders who are MIT-level smart that debase themselves on a daily basis to sell to people that don’t even care about anything.

Talk about charity work.

Our beef with Toast is that they’re not transparent, and their culture is a product of greed. Former sales people we’ve talked with are so aggressive it’s no wonder they haven’t penetrated enterprise.

But then again you have to be that tenacious to find any growth in an industry with miserably high churn and an even more miserably high number of morons as customers.

Because despite Toast’s execution, they’re still selling to “the worst set of clients in the world” according to Jim Cramer.

And we agree.

The following will make clear exactly what these challenges pose for Toast’s real TAM.

Upmarket

This is the most obvious black eye for Toast, having hired an absolute legend to run the enterprise division only to cut the entirety of their division during COVID.

Toast’s enterprise efforts were further foiled as they lost Jamba Juice at the end of 2022.

That said, we know several 100-unit chains that use Toast, and a few more of that magnitude that are testing Toast in labs.

Toast lacks some features that larger customers need, but their biggest challenge is their reputation as the payment bros of POS. Toast hoisted the white flag with their Freedom Pay partnership, giving larger customers payments flexibility, but (nearly) every CIO we’ve talked with is still skeptical that the company won’t screw them, or screw their customers (hello $1 ordering fee), which in turn sours the restaurant’s reputation.

It’s just too big of a risk, especially as Toast bleeds $400M in annual losses.

There are two legitimate, relatively large POS players upmarket today – PAR and Oracle. (Revel is discounted nearly immediately because nobody in enterprise wants to use expensive iOS devices).

Toast would need to out-execute these companies to win the market.

Oracle has an insane feature moat, and it’s Oracle: a brand that larger merchants (think Starbucks, McDonald’s, et al.) feel comfortable selecting to support their efforts. This is a long battle for Toast.

A little more downstream is PAR, although they just won Burger King’s US business and could take the entire RBI portfolio on POS, ordering, and loyalty. That said, PAR is more imminently surpassable by Toast, as PAR lacks the scale (only a $1.1B company) and feature maturity of Oracle. PAR is also thin when it comes to a true table service feature set, meaning it’s a bit of a lopsided competitor to Toast.

There are ~300K US enterprise restaurant locations according to NPD Research, so not exactly a small market, but small by profit: PAR is making $3K per store annually for POS and order routing on Burger King, and only $500 per store annually for POS at Arby’s.

Toast is currently netting $12,000 per store, still not profitable, and will need to ratchet that to $19,000 annually pretty shortly to be a rule of 40 company.

Even taking the mean of PAR’s ACV above, that’s $1,750 per year per store in enterprise for POS+.

That’s roughly 15% of what Toast makes today, and will be 9% of what Toast will be making on an SMB once they reach profitability.

Does Toast really want to move upmarket given this math?

The dirty secret with enterprise merchants is that it’s a forever slog of customizations, and gross margins are fucking horrendous. No payments to save Toast here. At least not above the table.

If Toast truly believes in their brand and inbound funnel, Toast could likely churn through 2-20 SMB customers (depends how Toast would calculate CAC for inbound and how Toast rationalizes the absurd length of restaurant enterprise sales) before it would even make sense to support an enterprise merchant.

While upmarket seems near-term untenable, we’re not sure it’s a market Toast really wants to be in, despite the nominal TAM expansion.

ARPU Expansion

We’re going to yell this until we’re blue in the face, but there’s no such thing as material ARPU expansion in restaurants, and retail more broadly.

These people just do NOT pay for value.

As someone once said, you can’t sell value to people if they’re too dumb to understand it. In those instance you will only make money if you steal from them.

It ain’t wrong.

If you comb through Ks and Qs of public retailers you’ll see that they spend pittance on technology.

Bottoms-up and top-down math continues to demonstrate that it’s 10-20 bps of their gross revenues. This is clearly excluding payments fees, which are NOT technology spend, and the percentages of spend are a bit higher in SMB segments simply because revenues are lower per store (e.g. a store doing $1M in annual revenues is going to pay $5K annually for a POS, which is already 50 bps).

It’s not that technology doesn’t create value – far from it.

It’s that the retailers aren’t smart enough to put together a business case to understand the ROI.

We suspect this is what Toast is finally realizing.

Shit, these restaurants won’t pay any more for bolt-ons no matter how valuable they are.

Here’s a way to prove our point.

Go find a restaurant solutions company that achieved a meaningful revenue milestone ($100M ARR) in an investible period (< 5 years) of time.

Bet you can’t find one that didn’t steal from the restaurant.

Shut up and repeat: restaurants won’t pay for value.

Anecdotally we believe the ARPU expansion Toast sees today is because they’re automatically charging more for software that was made free in an introductory offering and the restaurants just don’t have the time/IQ to catch it.

Toast account rep: Hey it looks like you’re having a problem with your labor: it’s too high.

Restaurant: Muh butthole iz a-itchin

Toast account rep: Uhhh, okay, well look we have this-

Restaurant: not now I’m gunna itch my butthole reallllll guud

Toast account rep: … I think you mean scratch but leave me out of it-

Restaurant: Oh dang, I dun havt the poop on muh nails again. Gotta lick em off ‘for I make this fuud

Toast account rep: I hate my life

Restaurant: Nom, nom, nom

Toast account rep: Okay well great, we’ll set you up with our labor management software. It’s free for 90 days then we’ll start billing-

Restaurant: MMMM this be guuuuuuu-

Toast account rep: hangs up receiver so fast there’s a thunderclap

Toast can only increase ARPU if they find things restaurants are already spending money on, build a replacement, and then charge substantially more in the payment stream, which merchants don’t know how to audit.

Geography

As Toast moves East into Europe – or really any OECD country not named USA – we question their revenue potential.

In the US, which has the most expensive cost of payments globally due to our fake capitalism (ie we want capitalism but actually behave statist – see how long it took Square to get a bank license, for instance), Toast can rip high margins on merchants doing $1M in GPV.

Use this table as the standard: Toast is ripping 2-3x expected margins.

In Europe, interchange is capped at 0.3%. Acquirers still add margins, but acquirers we know in Europe tell us that the margins aren’t nearly as thick once accounting for international card mix (very expensive cost of acceptance) and chargebacks.

This graphic from Sapphire Ventures lays out the EU payments margins pretty well:

Note that the acquirers here are making a fair 10bps.

Now, this is likely a diagram for larger merchants, but it’s reasonable to expect that Toast will find itself only staring downward from 30 bps of margin on their target customer.

And unlike in the US, where Toast’s average merchant does $1M of GPV, making CAC:LTV a little more tenable, in the EU the average SMB does far less volume.

For example, look at this graphic of average monthly revenue of food establishments in France.

Or if you go the other way, European food sales are projected to be about $700B annually on a base of 890,00 restaurant locations.

That’s $100K-$200K euros per rooftop.

These merchants won’t accept Toast’s rack rate on software pricing, which is nearly $6,000 per year in the US ($587M ARR / 99,000 locations).

And even if Toast rips 100 bps on $200K in turnover, that’s only $2,000 annually.

Because look at the competition: the gold standard we’ve seen in POS with any sort of outbound sales motion is eposnow, who boostrapped itself to meaningful revenue with inside sales and marketing. Honestly, what they’ve done is worth a case study in its own right.

Eposnow is charging < $1,500 annually for software, and maybe making 40bps on payments for a merchant doing $200K in turnover (another $1,000 generously).

At these numbers Toast cannot rely on their current distribution models where CAC is $10,000, because they’ll burn too much money to make it work.

Instead, Toast will either need to go after a very, very small segment of the market that does higher turnover, or fight amongst everyone else for inbound leads.

Toast is a great business – or at least can be when they streamline US operations to cut out costs.

But we aren’t betting on them to be the POS for everyone who serves food globally.