Toast: The Restaurant Operating System

Sector

TechnologyConsumerVertical Software

Background

Will Schreiber is the co-founder and CEO of Bottle. We cover how Toast helps restaurants navigate the operational complexity of the industry, how their API ecosystem has helped them outcompete Square, and the growth prospects for deep vertical SaaS businesses more broadly.

Cover

Date

July 12, 2023

Episode Number

119

Background and Overview

History and Founding Context: Toast was founded by three MIT-educated engineers—Steve Fredette, Aman Narang, and Jonathan Grimm—who previously worked at Endeca, a database search engine sold to Oracle for over $1 billion. Inspired by Endeca’s deep vertical focus on Fortune 500 retail, the founders sought to address inefficiencies in the restaurant industry, a sector they identified as technologically underserved. Initially, they explored a mobile payment app but pivoted within six months to build a cloud-based POS system after recognizing the limitations of legacy on-premise systems like Aloha and NCR. This pivot was driven by the realization that restaurants struggled with outdated, crash-prone POS systems that hindered operations.

Business Category and Operations: Toast operates in the vertical market software (VMS) space, targeting independent restaurants and small chains (typically fewer than 15 locations). Unlike broad-based competitors like Square, Toast’s platform is tailored to the restaurant vertical, addressing specific pain points such as order management, kitchen coordination, and omnichannel sales (in-store, online, and delivery). The company employs a direct sales force, leveraging door-to-door outreach and strategic partnerships (e.g., with Gordon Food Service) to acquire customers. Toast’s employee base is not specified in the transcript, but its focus on customer success and onboarding suggests a significant investment in support staff.

Unique Dynamics: Toast’s business model is distinguished by its deep vertical focus, which allows it to address the complex, stakeholder-heavy nature of restaurant operations. Unlike general-purpose POS systems, Toast integrates with the restaurant’s entire workflow—managing orders, payments, inventory, payroll, and third-party services like DoorDash. Its cloud-based architecture and open API enable seamless integration with external partners, creating a robust ecosystem. This vertical specialization, combined with a strategic bet on Android-based custom hardware, sets Toast apart from competitors reliant on iOS or off-the-shelf devices.

Ownership and Valuation

Ownership and Fundraising: Toast’s early funding came from Steve Papa, a former Endeca executive, after multiple venture capitalists declined to invest, citing the challenges of selling to low-margin, tech-averse restaurants. The company raised several tranches of private capital before going public in 2021. Specific transaction details, enterprise values (EVs), or multiples are not provided in the transcript, and thus are omitted to avoid speculation.

Market Valuation: As a publicly traded company, Toast’s valuation is not explicitly stated in the transcript. However, its scale—processing over $100 billion in gross payment volume (GPV) annually and generating $3.7 billion in revenue—suggests a significant market cap. For context, vertical software companies with similar revenue profiles often trade at multiples of 5-10x revenue, depending on growth and profitability. Without specific valuation data, investors should refer to Toast’s latest earnings reports for current market cap and multiples.

Key Products and Services

Value Proposition: Toast’s platform serves as the “operating system” for restaurants, simplifying complex workflows and improving efficiency. Its core offerings include:

1. Point-of-Sale (POS) System: A cloud-based POS that manages in-store orders, payments, and kitchen coordination. It replaces legacy on-premise systems, offering a user-friendly interface and real-time data access.
2. Online Ordering: Enables restaurants to create branded online storefronts, integrating seamlessly with the POS for order fulfillment.
3. Payments Processing: Facilitates card-present (in-store) and card-not-present (online) transactions, capturing a percentage of each transaction.
4. Payroll and Inventory Management: Streamlines back-office tasks, charging $4 per employee per month for payroll services.
5. Financing: Offers revenue-based loans to fund restaurant expansion, leveraging transaction data to assess creditworthiness.
6. API Ecosystem: Allows third-party integrations (e.g., DoorDash, loyalty programs), enhancing functionality and stickiness.

Product Table

Unique Aspects

• Cloud-Based Architecture: By moving POS to the cloud, Toast enables real-time data access, API integrations, and omnichannel capabilities, a significant leap from legacy systems.
• Android-Based Hardware: Toast’s decision to build custom hardware on Android, rather than iOS, allows for cost-effective, tailored devices, reducing reliance on expensive third-party hardware like iPads.
• Ecosystem Stickiness: The API ecosystem fosters partnerships with third-party providers, increasing platform stickiness by making Toast the central hub for restaurant operations.

Segments and Revenue Model

Business Segments: Toast operates as a single-segment business focused on restaurant POS and related services. While it offers multiple products (SaaS, payments, hardware, payroll, financing), these are not reported as distinct segments in the transcript. All products target the same customer base: independent restaurants and small chains.

Revenue Mode: lToast generates revenue through three primary streams:

1. SaaS Subscriptions: Monthly fees ($0-$170 per location) for access to the POS software and omnichannel features. The free plan, offered with a two-year contract and higher transaction fees, targets smaller restaurants to reduce upfront costs.
2. Payments Processing: A 2.6-2.7% fee on each transaction, with Toast retaining ~50 basis points (0.5%) after interchange and bank fees. For a restaurant processing $100,000/month, Toast retains $500-$800 in payment fees.
3. Hardware Sales: One-time sales of terminals and handheld devices, priced from $100 to $1,000. Hardware is sold at a loss to lower barriers to adoption.

Revenue Mix

• SaaS: 13% of revenue (~$481 million annually), with 70% gross margins.
• Payments: 82% of revenue (~$3.03 billion), with 20-23% gross margins.
• Hardware and Services: 5% of revenue (~$185 million), with negative margins due to loss-leader strategy.

Revenue Drivers

• Volume: Driven by the number of restaurant locations (85,000 and growing) and their transaction volume (average $100,000/month per location). Growth comes from acquiring new restaurants and increasing same-store transaction volume.
• Pricing: SaaS fees are tiered based on features, while payment fees are influenced by transaction type (card-present vs. card-not-present) and competitive pricing (30 basis points lower than Square).
• Mix Shift: Higher-margin SaaS and add-on services (e.g., payroll, financing) increase revenue stickiness and profitability as restaurants adopt more features.

Headline Financials

Key Metrics

• Gross Payment Volume (GPV): $100 billion annually, projected to reach $110 billion.
• Revenue: $3.7 billion annually.
• Gross Margin: ~30% blended, with SaaS at 70% and payments at 20-23%.
• Locations: 85,000 restaurants.
• Revenue per Location: ~$43,500 annually ($3.7B ÷ 85,000), driven by ~$500-$800/month in payment fees and $0-$170/month in SaaS fees.

Financial Table

Revenue Trajectory: Toast’s revenue has grown rapidly due to its ability to capture market share in the SMB restaurant segment. The transcript notes “impressive growth quarters,” driven by:

• Location Growth: From 20 restaurants in 2012 to 85,000 today, reflecting strong product-market fit and effective go-to-market (GTM) strategy.
• Transaction Volume: Average restaurant processes $1.2 million annually, contributing to $100 billion in GPV.
• Add-On Services: Payroll, financing, and online ordering increase revenue per customer, with SaaS revenue growing as restaurants adopt more features.

Cost Structure and Operating Leverage

• Variable Costs: Primarily interchange and bank fees (~200-210 basis points of the 260-270 basis points withheld on payments), leaving Toast with a 50-basis-point spread. SaaS delivery costs are minimal, contributing to high SaaS margins (70%).
• Fixed Costs: Include R&D for software and hardware, sales and marketing (door-to-door sales, partnerships), and customer onboarding/support. The transcript notes rising customer acquisition costs, potentially due to international expansion or market saturation.
• Operating Leverage: As Toast scales, fixed costs (e.g., R&D, support infrastructure) become a smaller percentage of revenue, improving margins. However, hardware losses and high acquisition costs currently limit EBITDA margins.
• EBITDA Margin: Not specified, but likely low due to investment in growth and negative hardware margins. SaaS margins (70%) provide a path to higher profitability as the revenue mix shifts.

Capital Intensity and Free Cash Flow (FCF)

• Capex: Focused on hardware development and customer onboarding (e.g., Wi-Fi installation, migration from legacy systems). Hardware is a loss leader, increasing capital intensity.
• Net Working Capital (NWC): Likely minimal, as SaaS and payment revenues are collected upfront or in real-time. Inventory for hardware may create temporary NWC cycles.
• FCF: Not quantified, but likely constrained by capex and customer acquisition costs. Toast’s loss-leader hardware strategy and high sales investments suggest negative or low FCF in the near term.
• Capital Allocation: Primarily organic growth (new locations, international expansion) and product development (payroll, financing). No mention of M&A or buybacks.

Value Chain Position

Position in the Value Chain: Toast operates midstream in the restaurant technology value chain, acting as the central hub connecting upstream suppliers (e.g., payment processors, food distributors) and downstream customers (restaurants and their patrons). Its primary activities include:

• Software Development: Building and maintaining the cloud-based POS and add-on services.
• Hardware Production: Designing and distributing Android-based terminals.
• Customer Success: Onboarding, training, and support to ensure adoption and retention.
• Payment Processing: Facilitating transactions and retaining a spread.

Go-to-Market (GTM) StrategyToast employs a high-touch, direct sales model, leveraging:

• Door-to-Door Sales: Targeting restaurant managers with tailored pitches addressing POS pain points.
• Strategic Partnerships: E.g., with Gordon Food Service, to gain referrals and credibility.
• API Ecosystem: Encourages third-party integrations (e.g., loyalty apps) to drive adoption through partner networks.

Competitive Advantage: Toast’s value-add lies in its deep vertical focus, user-friendly interface, and ecosystem stickiness. By addressing the restaurant-specific complexities (e.g., kitchen coordination, omnichannel orders), it outperforms general-purpose competitors like Square in the restaurant vertical.

Customers and Suppliers

Customers

• Target: Independent restaurants and small chains (average $1.2 million in annual sales). Toast avoids large chains (>15 locations), which prefer enterprise solutions like Revel.
• Customer Mix: Primarily U.S.-based, with early international expansion into three new markets. No specific geographic or end-market breakdown provided.
• Retention: High stickiness due to integration with restaurant workflows and add-on services (e.g., payroll, financing), which reduce churn.

Suppliers

• Hardware: Likely sourced from contract manufacturers for Android-based terminals. Specific suppliers are not mentioned.
• Payment Processors: Banks and credit card companies (e.g., Visa, Mastercard) handle interchange fees, taking ~200-210 basis points of each transaction.
• Partners: Food distributors (e.g., Gordon Food Service) and third-party apps (e.g., DoorDash) enhance Toast’s ecosystem but are not traditional suppliers.

Pricing

Contract Structure

• SaaS: Monthly subscriptions ($0-$170/location), with the free plan requiring a two-year contract and higher payment fees.
• Payments: 2.6-2.7% per transaction (net 50 basis points to Toast). Card-not-present (online) transactions carry higher fees than card-present (in-store).
• Hardware: One-time purchases ($100-$1,000/unit), sold at a loss.
• Payroll: $4/employee/month, a predictable recurring fee.

Pricing Drivers

• Competitive Positioning: Toast offers a 30-basis-point discount on payment fees compared to Square, making it cost-competitive for restaurants with >$500,000 in annual sales.
• Value-Based Pricing: Higher SaaS tiers ($160-$170/month) include premium features like online ordering and delivery, justifying costs for larger restaurants.
• Mission-Criticality: The POS is the “heartbeat” of a restaurant, enabling Toast to charge for reliability and omnichannel capabilities.

Bottoms-Up Drivers

Revenue Drivers

• Volume: Driven by the number of locations (85,000) and transaction volume per location ($1.2 million/year). Growth comes from new customer acquisition and same-store sales growth.
• Pricing: SaaS fees are fixed, while payment fees scale with transaction volume. Toast’s ability to maintain or increase its 50-basis-point spread is critical.
• Mix: Shifting toward higher-margin SaaS and add-on services (13% of revenue) improves profitability. Payments (82%) dominate but have lower margins.
• Organic Growth: Driven by U.S. market penetration and early international expansion. No M&A activity is noted.

Cost Drivers

• Variable Costs: Interchange fees (~75-80% of payment revenue costs), software hosting, and customer support for SaaS. Hardware production costs exceed revenue.
• Fixed Costs: R&D, sales and marketing, and onboarding/support. Rising acquisition costs suggest increasing competition or market saturation.
• Contribution Margin: SaaS has a high contribution margin (70%), while payments have a lower margin (20-23%). Hardware has a negative contribution margin.
• Gross Margin: Blended at ~30%, reflecting the dominance of low-margin payments revenue.

FCF Drivers

• Net Income: Likely negative or low due to hardware losses and high acquisition costs.
• Capex: Hardware development and onboarding investments reduce FCF.
• NWC: Minimal, as revenues are collected in real-time. Hardware inventory may create temporary working capital needs.
• Cash Conversion Cycle: Short, given upfront SaaS and payment collections.

Market and Competitive Landscape

Market Overview

• Size: The U.S. restaurant industry includes 860,000 locations, but only 160,000 are true SMB single-location restaurants, Toast’s primary target. Chains (e.g., McDonald’s) dominate the remainder.
• Growth: Not quantified, but driven by population growth, dining trends, and technology adoption. The shift to omnichannel (online, delivery) accelerates demand for cloud-based POS.
• Market Structure: Fragmented in the SMB segment, with Toast holding ~50% share of the 160,000 SMB restaurants (85,000 locations). Chains use enterprise solutions like Revel.

Competitive Positioning

• Key Competitors: Square (broad-based, lower-cost), Revel (chain-focused), Clover, and custom solutions (e.g., Crumbl’s Stripe/Adyen stack).
• Toast’s Advantage: Deep vertical focus, user-friendly interface, and ecosystem stickiness. Toast outperforms Square in restaurants due to kitchen-specific features and lower payment fees.
• Market Share: ~50% of SMB restaurants, but only 10% of total U.S. restaurants, reflecting chain dominance.

Hamilton’s 7 Powers Analysis

1. Economies of Scale: Moderate. Toast benefits from fixed-cost leverage (R&D, support), but high acquisition costs and hardware losses limit scale advantages.
2. Network Effects: Weak. The API ecosystem creates indirect network effects by attracting partners, but restaurants do not directly benefit from other users on the platform.
3. Branding: Moderate. Toast is recognized as the leading restaurant POS, enhancing customer trust and willingness to pay.
4. Counter-Positioning: Strong. Toast’s restaurant-specific features and Android-based hardware make it difficult for broad-based competitors like Square to replicate its value proposition.
5. Cornered Resource: Weak. No proprietary technology or exclusive assets are noted.
6. Process Power: Strong. Toast’s streamlined onboarding, user-friendly interface, and integration with kitchen workflows create a superior operational process.
7. Switching Costs: High. Integration with restaurant workflows, add-on services, and employee training create significant barriers to switching.

Porter’s Five Forces

• New Entrants: Moderate. High barriers due to product complexity, customer acquisition costs, and switching costs, but low-cost competitors like Square pose a threat.
• Substitutes: Moderate. Custom solutions (e.g., Crumbl) and legacy systems are alternatives, but Toast’s omnichannel capabilities reduce substitution risk.
• Supplier Power: Low. Payment processors and hardware manufacturers are commoditized, with Toast retaining bargaining power.
• Buyer Power: Moderate. SMB restaurants are price-sensitive, but Toast’s lower fees and mission-critical role limit buyer leverage.
• Industry Rivalry: High. Intense competition from Square, Revel, and emerging custom solutions, with third-party providers (e.g., DoorDash) reducing POS stickiness.

Strategic Logic

Growth Strategy

• Land and Expand: Toast uses low-cost hardware and free SaaS plans to acquire customers, then upsells add-on services (payroll, financing) to increase revenue per location.
• International Expansion: Early efforts in three new markets, but challenges include lower processing rates (e.g., sub-1% in Europe) and cultural differences.
• Product Expansion: New features (e.g., pay-at-table) and add-ons (e.g., reservations) aim to capture more wallet share, though this risks alienating API partners.

Risks

• Market Saturation: With 85,000 of 160,000 SMB restaurants, Toast may exhaust U.S. growth opportunities, requiring international or upmarket expansion.
• Commoditization: As third-party providers (e.g., DoorDash) standardize integrations, Toast’s payment processing could become less sticky, reducing margins.
• Upmarket Challenges: Large chains demand lower fees (10 basis points vs. 50) and prefer custom solutions, limiting enterprise growth.

Minimum Efficient Scale (MES)Toast has achieved MES in the SMB restaurant segment, leveraging fixed-cost investments to dominate. However, international and upmarket expansion may require new investments, risking diseconomies of scale if growth falters.

Key Takeaways

1. Deep Vertical Focus: Toast’s restaurant-specific platform addresses complex workflows (e.g., kitchen coordination, omnichannel orders), creating a product moat that outperforms broad-based competitors like Square.
2. Revenue Model: Payments (82% of revenue) drive scale, but SaaS (13%) and add-ons offer higher margins and stickiness. Hardware is a loss leader to reduce adoption barriers.
3. Financial Dynamics: $3.7 billion in revenue with ~30% gross margins reflects a payments-heavy model. Rising acquisition costs and hardware losses constrain EBITDA and FCF, but SaaS growth could improve profitability.
4. Competitive Advantage: High switching costs, process power, and counter-positioning make Toast the preferred SMB restaurant POS, though commoditization risks loom as integrations standardize.
5. Growth Challenges: U.S. market saturation (50% SMB share) necessitates international expansion or new products, but cultural and pricing barriers abroad and upmarket competition pose risks.
6. Strategic Discipline: Toast’s focus on restaurants, scrappy distribution (e.g., Gordon Food Service partnership), and willingness to tackle hard problems (e.g., custom hardware) are key lessons for entrepreneurs.