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The Frontier: Extend Through the Value Chain

AUTHORS:

Dave Yuan

Founder and Partner, Tidemark

Extending into the (Vertical SaaS) frontier

Now we approach the frontier—after a Vertical SaaS Vendor (VSV) has won its category, it has the opportunity to extend through the value chain. In addition to the merchant, the VSV can sell to the merchant’s suppliers, employees, and consumers. If it is successful, it can start the cycle over again: Win, Expand, and Extend. 

The businesses who succeed on this path are superlative, with control points across multiple constituents and interlocking workflows. At its highest form, a VSV transforms from a simple tool into a multi-stakeholder platform, setting the direction for an entire industry.    

The question is how?

I have observed the following pattern: 

  1. Help your merchant customer with the key job to be done with the target stakeholder (a merchant’s customer, employee, or supplier).  
  1. Look for merchant-side network effects which are often to be found with aggregating scale or data sharing.
  1. Land a wedge offering with the target stakeholder at the end of the merchant workflow.
  1. Build a two-sided network if the market structure is favorable.

Put on your goggles, because today we are swimming in the deep end of the pool. As I philosophize on how to build the holy grail of a network, I recognize the data points are sparse and successful VSVs are few.  But I believe that this opportunity is real and that the next generation of VSVs leaders will be platforms and networks.  This article is me putting my stake in the ground—extension strategy is the future of SaaS. 

Step 1: Help the Merchant with the Key Job to be Done 

You start the process by providing your core merchant customer an application that automates the key job to be done with your new, target stakeholder. I know, I know, that’s a sentence full of jargon. Put simply, you’re optimizing towards two things:

  1. Solving the key job to be done ensures initial demand from, and adds to your account control with your merchant customer
  2. Working with the target stakeholder gives you a trusted connection 

The closer your product gets to the target stakeholder, the more opportunity you have to create a control point with them. Ideally your merchant-facing app can create data and/or workflow gravity, bring in demand or funds, or change the consumer experience for the target stakeholder. 

For example, if your merchant’s employees were the target stakeholder, ideally the application you sell to the merchant would have any of the following attributes: 

  • Access to key employee data such as tax, or contact information (data gravity)
  • Automation of tedious tasks such as shift scheduling (workflow gravity)
  • Acceleration of wages (bring in funds)
  • Increased tips and earnings (incremental demand)
  • Facilitate communication with the employer, or with coworkers (multi-party communication).  

If you pick the right merchant application, it naturally sets you up with attributes to establish a control point with your target stakeholder.


Step 2: Merchant Side Network Effects 

As you scale, you may find “same-side network effects,” where the value proposition benefits from collective scale. Group purchasing organizations (GPOs) are a great example of where a VSV can aggregate a merchant's collective buying scale to negotiate preferential pricing or terms. GPOs work best when the supplier market is fragmented and your merchant’s collective scale can exert meaningful buyer power. 

When a GPO hits its stride, it can have net revenues of 1-2% of GMV with some providers hitting 50% EBITDA margins. The successful companies who have deployed this strategy range from the healthcare industry to the public sector to hospitality. I’ll have more on these organizations in an upcoming essay, but it is an opportunity that is available to the VSV that dreams big enough.

You should also look for data sharing opportunities across merchants. There can be concerns with data sharing, but local merchants tend to be pragmatic and open to methods that avoid competition and privacy risk. Co-operative analytics, benchmarking, retargeting, bundling, and affiliate networks can be powerful multiplayer merchant offerings, particularly in verticals that are highly fragmented.

Step 3: Land a Wedge Offering with the Target Stakeholder 

Your merchant application offers engagement with the target stakeholder. Take that opportunity to provide the target stakeholder a wedge offering that creates a landing point to make them your customer. Ultimately, you’re looking to establish a control point with the target stakeholder, so think through the concepts from our control points essay.

Your merchant side application is typically a workflow, so your target stakeholder wedge is often an extension of this workflow to allow a fully digital experience or “straight through processing.” As in all great products, the more friction you can remove from a workflow, the happier everybody will be.

The wedge may need to integrate into the target stakeholders’ incumbent software provider. In that case, it is important to complement rather than try to rip and replace that other system. Go light on the monetization (freemium, indirect, take rate, tiered), and have your wedge improve the value of the incumbent system. Extending through the value chain can be a 10 year affair, so play the long game.

You are now selling to two stakeholders on two sides of the same transaction.  In order to be effective, you need to make sure that both stakeholders trust that you are aligned to their success. Rather than focus on monetization that is licensed or seat-based, it may be worth implementing a usage-based pricing model for this product. The more closely you can align both sides of success to your revenue, the more trusted a partner you will be to both parties.To minimize conflict, respect incumbent behavior or industry precedents. Use your engagement with both stakeholders to add value to the transaction itself. Over time, you may need to consider separate business units, compensation schemes, and broader organizational change as you scale. 

Adding Value

To show you are benefiting all stakeholders—merchant, target stakeholder, and end consumer—you need to demonstrate you are adding value to the transaction rather than just exerting power from merchant density. 

Some examples of adding value to the target stakeholders include:

  • Reduced cost and increased transactional speed: Everybody likes being paid quicker or electronically. By making it easy, a VSV can make everybody happy. Bill.com is the canonical example. They help small business merchants automate the monthly task of paying bills, but also help suppliers to get paid more quickly. And both sides avoid data entry and reconciliation because it’s all done within the same software. 
  • Multi-party digital communications or contracting: Procore is a great example of this capability; they help owners (consumer), general contractors (core merchant customer), and specialist general contractors (suppliers) communicate and contract all on the same software platform. 
    Xometry allows industrial designers to upload their CAD designs and receive instant quotes or estimates via messaging from various sub manufacturers required to build the end product.  For this service and the aggregation of suppliers, Xometry receives a 25-30% take rate.  

  • Multi-party product or service information and education. Some examples: Salon SaaS vendors are working on communication channels that help beauty product companies communicate product information across salon, stylist, and consumer.  Product information management company Salsify unifies product catalogs across suppliers and retailers. Order and pay at table providers are building capabilities to allow consumers to engage with restaurant menus, and share preferences and reviews across friend groups. 

  • Reduced risk of transactions and improving payment flows: Amazon, while not a pure play VSV, takes elements of this strategy by reducing consumer risk from merchants. For payment flows, look no further than one of our favorite VSVs, Toast. They offer “earned wage access” products that allow restaurant employees early wage access, on-demand pay, and instant pay, all of which help employees get access to their money before their scheduled payday.
  • Access to funds or credit: ServiceTitan offers consumer financing so a merchant’s end customers can easily finance capital expenditures like HVAC equipment. 

What Happens if the Target Stakeholder is an Individual?

When the target stakeholder is an individual—a consumer or an employee—the concept of a wedge and a control point can become quite different. Individuals are more idiosyncratic. What you’re looking for is ongoing engagement that can come from familiarity from repeat usage, engagement being  mandated by the merchant, high utility, or a magical consumer experience.

A magical consumer experience is generally a function of incredible design which delights via aesthetic and logical flow. It can also be enriched by data that reduces friction to an absolute minimum, or content that improves the value of the good or service or the consideration process.  Shopify, for example, has created a verified identity network Shop Pay that allows a consumer to speed through the checkout process via their Shop app which facilitates the post purchase experience, brings back consumers for repeat purchases, and helps establish consumer trust. 

Step 4: The Big Leap to a Two-Sided Marketplace

Whether you are targeting individual consumers or enterprises, getting to sufficient regional and value density allows you to go after one of the biggest opportunities of all—a marketplace.

This is the holy grail of a VSV—using the strength of its merchant offering to launch a two-sided marketplace with a target stakeholder. In my experience, these marketplaces typically enjoy 15-30% take rates (and sometimes up to 75%), so the economics can be enormous. 

Marketplaces are notoriously difficult to launch as they require scale on both sides (i.e., the  chicken or egg problem) to be effective. A VSV benefits from a head start on the merchant side, but that doesn’t mean the path is easy. Marketplaces typically require a very high level of local market density to provide effective selection and scope. The VSV also needs significant local density of the target stakeholders. If those stakeholders are individuals (employee or consumer), generating that density may require entirely new competencies from the VSV and significant capital investment.  

The final question for VSVs to consider is how to maximize their chances for success. The companies that have done this successfully are few, but we can theorize the following four conditions must exist: 

  1. Opportunity to start locally where a VSV can scale density: It is hard to overstate the importance of density to a marketplace. Start a narrow marketplace where you can achieve strong density quickly. Often that means at the city or even at the neighborhood level. The good news is that most Vertical SaaS markets tend to be local, not national. 

  1. Cross-side network effects exist: These dynamics are where density on one side of the marketplace improves the value proposition to the other side. Look for situations where the VSV’s strength on the merchant side makes the marketplace attractive to the target stakeholder. For example, CCC’s leadership in auto body repair shops (the buy side) makes a CCC parts marketplace highly attractive to parts vendors (the supply side). This is particularly true where merchants tend not to list in multiple apps or offer non-commodity supply. 

  1. The target stakeholders tend to exhibit high repeat rates and virality: Aggregating density of target stakeholders can be incredibly expensive if they are individuals, so ideally you want them to engage frequently and tell others. 
    Virality compounds, so small changes in virality can have outsized impact on customer acquisition and local market density over time.
    High frequency not only improves the payback of customer acquisition economics, but also creates brand loyalty and high engagement to cross-sell other products in the future. And intuitively it just makes sense—the company whose product is used everyday is going to have an easier time.

  1. Ability to change the experience: A VSV is often challenged by pre-existing marketplace competitors and high acquisition costs for target stakeholders.  A VSV should have strong conviction that it can change the experience for the target stakeholder. 
    It is particularly important for the consumer category, where a magical experience is key to future consideration and repeat purchase. My belief is that a VSV is unfairly positioned to change the experience as it has multiple stakeholders on a common software platform, something other competitors will struggle to replicate.

Share your thoughts

Few companies have successfully extended through the value chain, but those that have are superlative. They enjoy new markets that may be greater than that of the original business, have  control points with multi-constituents that create incredible moats, and the creation of a two-sided marketplace achieves a step function increase in monetization. Having multiple stakeholders on a common software platform can also transform the consumer experience, industry efficiency, and industry economics! Our belief is that when a VSV extends, it is the rare case where everybody wins. An extension strategy results in a better business and more functional market. 

In the upcoming weeks we’ll be doing private releases of specific essays on how to extend to the supplier, the consumer, and the employee.  Please sign up here if you’d like to be added to the list. 

If you have thoughts or comments or want to get involved, reach out to us at knowledge@tidemarkcap.com.

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The information presented in this post is for illustrative purposes only and is not an offer to sell or the solicitation of an offer to purchase an interest in any private fund managed or sponsored by Tidemark or any of the securities of any company discussed. Companies discussed in these posts may include current Tidemark portfolio companies and/or prior investments made by Tidemark employees while at other investment firms. These companies identified above are not necessarily representative of all Tidemark investments, and no assumption should be made that the investments identified were or will be profitable. The information in this post is not presented with a view to providing investment advice with respect to any security, or making any claim as to the past, current or future performance thereof.

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