Verticalization of Software is Eating the World
Efficient CAC is a helluva drug :)
One of the most fascinating trends I’ve been observing in the public enterprise software landscape has been the increasing movement of various companies to selling more verticalized solutions.
I’ll talk though some specific examples in more detail below but first let’s talk through why this is happening.
The biggest challenge that vertical market software (VMS) companies typically face is the question of Total Addressable Market size. Is the market big enough to support a massive software company. This is why for the longest time, investors and founders would shy away from starting VMS businesses. In fact, Constellation Software is now a $37B business that acquires various VMS companies. For example, I’m not sure how big of a market boating software or tennis court booking software is but Constellation has bought them and combined with others, created a large public company.
However, this has changed in recent times as we’ve seen Veeva (life sciences CRM) valued at $25B, Guidewire (property & casualty insurance software) valued at $7B, and ServiceTitan (home service software) valued in private markets at $9.5B. No longer is there a question if a VMS company can be big enough.
We’ve talked about the challenges VMS businesses face but what are the benefits?
The amazing thing about building a VMS business is your user pain point is fairly well defined and consistent, your customers mainly exist within the same communities making them easier to reach, and knocking down a few key beachhead customers goes a long way in convincing other customers in the category to adopt your solution as well so as not to get left behind. Plus, since not many people have domain expertise of the pain points your users experience, VMS businesses typically has less competition as well.
All of this leads to decreased CAC. Just like product led growth businesses are flipping traditional enterprise software go-to-market motions on their heads. So are VMS businesses doing that with even more cash flow generation earlier in the company lifecycle.
Large Enterprise Software Companies Focusing More on Vertical Solution Selling
So with that background why are we seeing more horizontal massive scale enterprise software companies moving into vertical solutions?
There’s plenty more examples from public enterprise software companies valued $10B+. At a certain revenue scale and maturity of the market, vertical solutions actually are a better gtm than going wide across all industries. Both these factors need to be at play though for a horizontal company to make this shift.
Why “certain revenue scale”? Because the horizontal company needs to be making enough cash flow and have a large enough stable customer base to warrant and allow for the investments needed to build out industry specific solutions. There’s the R&D costs associated with the integrations, industry documentation, specific training, etc not to mention the additional gtm costs from repositioning product messaging, marketing, and enabling the salesforce/channel partners.
Why “certain maturity of the market”? Because until the market has enough competitors vying for the same customers, the calculation to make the investment just described above doesn’t make sense. If you are n of 1 in a massive horizontal market, then why would you change from continuing to serve that whole market to focus on a narrower slice. That doesn’t make sense since you have limited competition to have to demonstrate differentiation to customers.
However, when both the above conditions hold, the transition to vertical solutions makes tons of sense. The reason being that the largest enterprises in the world are trying to easily get their problems solved so they can continue executing on the core of their business, delivering the services consumers expect. Coca-Cola and Pepsi don’t want to have to spend years hiring, training, and then maintaining various digital systems. They’d rather focus on optimizing their supply chain. If AWS or Azure comes around offering a fully tailored solution that includes integrated supply chain modules that map to inventory tracking that map to digital and in store orders, that then offer automated cash collections and vendor rebates, this is well worth it to pay a premium to adopt.
Meanwhile, for the software vendor, they can now hone the messaging, training, and software solution to specific pain points they know matter in that industry. This leads to decreased sales cycles, lower customer education since you are already speaking the same industry language, and therefore higher free cash flow to reinvest back into improving all of this!
As you read the earnings transcripts of the large software providers, I would recommend regularly using Control+F “vertical” or “industry” solutions to listen in to how they are talking about their respective approaches here and whether it is a trend that is accelerating or abating.
Huge thanks to Alex Banks for featuring Software Snack Bites in this recent Twitter thread. Give Alex a follow for lots of great threads with resources to learn!