The shift from perpetual license-based business models to solely focusing as software as a service (SaaS) has been a defining trend over the past 20 years. Led by Salesforce as the first pure-play SaaS superstar, companies of all types have shifted including Adobe and Autodesk, and also others were born into the business model, such as Dropbox, Netflix, and Wix. Over time, this has led to us accepting this recurring payment model, being integrated as a normal way of purchasing solutions. However, as innovations occur - one that has become an unbundling of sorts, focusing on vertical SaaS.
What is vertical SaaS? Let's dig in!
In the wave of early SaaS companies coming to the market as the internet grew in popularity, they often sought to solve broad problems that were across multiple industries, thus meaning they operated horizontally. This means they have large total addressable markets and can tailor their marketing messages into numerous industries and company sizes. Vertical SaaS is an offshoot of this as it is when a company focuses on one industry as a strategy. A couple of good examples of this include Veeva as a CRM for the life sciences industry, Plangrid as productivity software for the construction industry, and Gorgias as the Help Desk solution for e-commerce companies powered by Shopify.
So, why would a company do this?
At first thought, it seems a bit weird as to why a company would limit itself from an addressable market perspective. However, when you unpack the wrapper, many benefits can be found. Let me break them down.
Better targeted advertising = lower acquisition costs
As horizontal companies have to tailor their product and messaging to multiple industries, they spread themselves thin on their marketing efforts. Comparatively, focusing only on one vertical means that marketing teams can be much more tailored in their messaging, positioning, and ultimately brand perception. This can lead to significantly lower customer acquisition costs compared to horizontal companies that cast a wide net.
Finite industry focus = Specific industry-based hiring
By only focusing a few industries, vertical companies can focus on hiring not just people with a tech background, but rather industry-specific experts. By hiring both of these, they can pair them together, leading to efficiencies in being able to close deals, especially when it comes to speaking industry lingo. At Coohom, I focused on the home furnishings industry and our team had hired an industry consultant to help us with this specifically.
More concentrated development efforts = deeper product value
As horizontal firms focus on multiple industries, their product becomes pretty broad in the offering. When sold, it is likely that it is the best solution in the market today and not the one that perfectly fits the needs of their business requirements. By focusing on a few industries, vertical firms can develop deeper for their customer requirements, building out functionality that truly proves valuable. This can speed up decision making on product development and make the company more efficient with capital. It also opens up for a company to develop integrations that are specific to the platforms and tools with the workflows that its customers use today.
Deep functionality = easier sales process
Selling any product is a difficult task. Companies that have a product that goes deep in solving particular problems better than competitors that are broad in their solution make it easier for a sales team to close deals. That, coupled with the fact that the product marketing team will be aiming them with more direct content that talks to their buyer, it becomes easier for a sales team to explain why its solution is the best one in the market for their direct need.
Extra-relevant product = higher lifetime values & greater upsell opportunities
As a result of having a more deeply integrated product that meets their needs, customers are less likely to switch vendors, which in turn leads to higher lifetime values. Lifetime value is the measure of how long a customer will continue paying for the services. This is one of the key metrics for measuring the longevity of any SaaS company. On top of this, with deeper functionality being built, there are more opportunities for upsell and expansion of accounts.
Low CAC and high LTV = Higher valuation multiples
As SaaS companies are built around measuring the efficiency of capital - largely driven by the ratio of customer acquisition costs to lifetime value - these efficiencies can lead to higher valuation multiples. While they seem to have smaller addressable markets, they make up for it by focusing on going deep on providing value to companies within one domain.
As more companies rely on SaaS, going deep and focusing on a few key industries seems to provide great value in the long-term. Being more capital efficient, knowing their customer better, and also developing deeper product innovation are some of the key advantages that come out of this. As SaaS becomes a mature business model, I predict that more companies will start to pick apart horizontal companies with large addressable markets and build industry-specific offerings.
But, with everything, risks also need to be looked at. For example, companies that focus on one industry may face issues when that vertical is hit with regulatory issues, declining growth, and other turbulence, such as the current state with the pandemic situation. Toast, a point of sale software provider that focuses on the restaurant industry and boasted a valuation of ~$5B, just cut nearly half of its workforce due to the current state of the world as an example.