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22 (And Counting) Truths About Vertical SaaS
Founder and General Partner, Tidemark
We’re moving through concepts quickly in the Vertical SaaS Knowledge Project, so we wanted to create a common language and establish key concepts as a foundation for our discussion. Our goal was to help you move past jargon and get straight to the stuff that matters. With that, we give you our truths:
#1-6: The Players
Because we are going to use these terms a lot as we talk through various slices of the value chain, we’ve standardized and abbreviated the different players.
- #1 Vertical SaaS Vendor (VSV): In the diagram above, it's the vendor (e.g,. Toast) that sells point-of-sale software to the merchant.
- #2 Merchant: The merchant is the initial direct customer of the VSV. Typically it’s a small customer or SMB. In the diagram above, the merchant is a restaurant. The restaurant hires employees, buys goods and services from suppliers, and sells goods to consumers.
- #3 Consumer: The merchant’s end customer. In the example above, it’s the person dining at the restaurant.
- #4 Supplier: The provider of goods and services to the merchant. Sometimes these goods and services are described as Spend. Spend is the raw materials, services, and other items a merchant needs to deliver its services or products.
- #5 Employees: A special type of supplier because of their role in the end consumer experience and the bespoke regulation relating to labor employment.
- #6 Stakeholders: Refers to all players in the value chain: the merchant, the consumer, the supplier, and the employee. In the Extend section, we will use the term Targeted Stakeholder to refer to a stakeholder that isn’t the merchant.
#7 Control Points
A Control Point is the most important application in your software suite. It is the last software package a customer turns off before shutting down for the day. Control points are not unique to Vertical SaaS, but because of the Single Point of Accountability (see below), they are even more strategic than in other markets. There are typically only one or two control points: one in the front office that touches the customer and drives sales, and one in the back office. Getting the control point right is so important that we dedicate a piece specifically to ways to think about control points.
#8 Owner as Customer
The end customer defines many of the challenges and opportunities of Vertical SaaS. Most verticals are highly fragmented and the end customers are typically small business merchants. The software buyer for these merchants is often the owner, or sits next to the owner, and is commonly a significant user of the software. This is an important and positive dynamic in Vertical SaaS because the software buyer is also the user, so they are familiar with the products and value proposition, and have singular decision authority. There is no better customer to have than the one who writes the checks for the organization.
#9 Single Point of Accountability
Small business owners are busy people who run complex businesses and live complex lives. For example, the typical restaurant owner is also the operator, the cook, and the accountant. For these reasons, purchasing goods and services from a single vendor is preferable. If anything goes wrong, there’s a single point of contact.
#10 Time to Value
Busy owners on a tight budget have little patience for seeing a return on investment. These customers require super easy-to-use, easy-to-onboard products. They are more likely to use a product that is built for their industry and problem set. Functions that touch the customer or the product tend to be more “verticalized” than others. Complexity, regulation, and specialization tend to require too much customization to work with a horizontal product.
If a VSV occupies a control point, it has an unfair opportunity to sell multiple products to the same customer. Multi-Product companies enjoy higher ARPU, LTV, and net revenue retention rates (“NRR”). As a result, they have a larger TAM, grow faster, and are more profitable for a given rate of growth. This is one of the main reasons why Vertical SaaS companies can be superlative software models.
#12 Deskless Worker
Because of the Single Throat to Choke, an initial offering might need to be broad and replace, work with, or substitute for multiple offerings. Vertical SaaS vendors may need to become hardware, network, or business advisors. With most customers working in a non-office/deskless environment, software can’t deliver value if the WiFi isn’t working or if there is an issue with the phone or tablet operating system. Many VSV support calls are about basic IT things such as getting the WiFi back up. Hardware is its own thicket requiring manufacturing, inventory management, in-person installation, and, most of the time, negative gross margins.
#13 Growth Equation
The typical Growth Equation of a Vertical SaaS company is Locations x ARPU. Locations is a more atomic metric than customers because it takes into account how many actual retail storefronts (hotels, restaurants, etc.) exist. Scaling locations can be challenging because small businesses have fewer resources and tend to be local. Having strong product-led growth, performance marketing, or an efficient salesforce (inside and local) is critical. ARPU (Average Revenue Per User) is the dollar value that the VSV can charge its merchant customer. It is one of the most exciting opportunities in Vertical SaaS, as a VSV is often well positioned to cross-sell multiple products and financial services to the same merchant customer. A great VSV has multiple products being utilized at multiple locations, all by the same SMB customer.
#14 High Market Share
Leaders in horizontal software markets struggle to get to 20% market share, whereas leaders in many vertical & SMB markets can exceed 40%+ market share. Why?
- #15 Smaller market: This is a bug, but also a feature. Fewer competitors are being funded to compete. See our essay on Vertical TAM and Concentration.
- #16 Vertical focus/awareness and affiliation: Vendors become known for an end market. (e.g., “If you’re a restaurant, you should really pick Toast. They’ve been built for restaurants.”) This focus also extends to the workforce—by staffing the entire org with employees who truly get the vertical you are serving (typically by hiring from within the industry) everyone from product to sales speaks your customer’s language.
- #17 Local brand awareness: Many vertical markets are local and local merchants talk. When a vendor reaches a certain threshold in local market share—we’ve found it to be roughly 10%—it becomes easier to grow. Top-of-funnel leads and conversion rates increase, customer acquisition cost (CAC) decreases, and local markets get “deeper.” With local brand awareness you can capture a higher market share but the market also gets bigger as a result. Pragmatically, TAM is determined by sales territories. If you shrink territories at the same productivity, the number of territories increases and therefore TAM increases.
- #18 Light network effect: Owners and employees become familiar with your system. When they switch jobs or start a new business (there can be high endemic turnover at both the company and employee level) they will bring along the tools that are familiar.
- #19 Strong network effect: Similar to the above, when suppliers and customers get used to the market leading system, it adds to market acceptance. We’ve seen some extreme forms where customers or suppliers mandate systems, which can really amplify the network effect.
#20 Limited Lead Pool
An important concept in Vertical SaaS is the Limited Lead Pool. Because of the finite end market, you should not build a sales culture that just burns leads. In addition, local market brand awareness and light network effects warrant investing in relationships. That doesn't work if every merchant gets a call every day. You must build rapport.
#21 Value Chain Extension Opportunity
As Vertical SaaS companies reach high market share, they have a unique opportunity to extend beyond their end customer, up and down the value chain (see our essay on Patterns of Extension). Extending forward refers to expanding closer to the customer (e.g. ZipRecruiter extending from recruiting software to a branded consumer job board). Extending backward refers to following the money and moving towards your customer’s supplier (e.g. CCC extending from auto insurance customers to auto body repair shops to parts marketplaces).
#22 Industry Control Points
An Industry Control Point spans multiple parties or industry actors. It is a concept that brings together network effects, industry work, data, and payment flows in an extremely powerful way. Some we have seen include:
- Multi-party payments escrow and reconciliation
- Multi-party communications and collaboration
- Multi-party purchasing
- Multi-party reporting
That’s all the truths we can handle for now… let us know if there are any we missed!
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We love the idea of bringing together a community to explore the boundaries of Vertical SaaS and are excited by what we can learn from each other. If you have thoughts or comments or want to get involved, reach out to us at email@example.com. If you would like to keep updated as we publish these essays, sign up below.
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.