Platforms of Compounding Greatness

Huge thanks to  Kevin Salimian and Lone Pine Capital for their data contributions for this series!

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As early as 2018, pundits were incorrectly pontificating that SaaS was dead. With the (justified) valuation correction of 2022, people are once again saying that SaaS has reached the end of its investment value. Investors are now ready to move on to Crypto—oh wait, sorry, now it's Generative AI (couldn’t resist the dunk, we’re actually believers), to seek out returns. 

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These people are simultaneously right and wrong. SaaS, as we know it, is dead. The single-point solution companies, hooked to a never-ending sales and marketing dollars treadmill, are doomed. These businesses are linear: to grow, a company must stuff in as many salespeople and marketing dollars as possible. SaaS companies that remain point solutions will eventually be subject to a brutal tradeoff between growth and profitability, and will require excess capital to grow. In good times, party on! In 2023, when capital costs are high, these companies are hitting a wall. 

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However, the future is bigger, better, and brighter than anyone understands. This current wobble isn't the death throes of an overvalued industry but the struggles of a species moving up the food chain. From our perspective, SaaS is not only evolving—it’s also expanding, to bigger TAMs and stronger business models, right before our eyes. We believe there’s an opportunity for multi-product SaaS companies to create what we call Platforms of Compounding Greatness, or PCG.

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The key difference is offering multiple products that work better in partnership. Lots of other companies have circled around this idea in describing themselves. Rippling calls it “a compounding business,” and Toast calls it “Better Together.” It’s a simple concept but a powerful one. Products that work better together (we like Toast’s description a lot) is one of the most powerful ideas in SaaS today. It creates value for the customer and allows SaaS companies to avoid the profit/growth trap, while adding bigger TAMs and stronger moats. You can look at these charts to see the relative strength of a PCG business. 

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You need two things to walk this path. This is just a quick overview, but don’t worry, we’ll go in-depth on each one of these concepts in subsequent essays.

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The Ingredients of Success 

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Control Point

When a startup builds a product that owns crucial data, finances, or workflows that a customer cannot live without, then they have a control point. If implemented correctly, you become a system of record through “data gravity,” “workflow gravity,” or “account gravity.” For more on gravity types, you can read our deep dive here. Done well, the control point product gives you an unfair right to expand. 

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Patterns of Expansion

‍Once you have earned that unfair expansion right, you can start to leverage gravity in your favor. Account gravity gives a good starting point—if you’re an important vendor to your customer and you’ve served them well, they will be open to hearing you out on new products. However, the real magic happens when workflow and data gravity lead to products that work better together. Workflow gravity sets up “Follow the Workflow” and “Follow the Money” patterns of expansion. Data gravity sets up “Single Source of the Truth” and “Data Enriching Data” patterns. 

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Follow the Workflow (FTW) is the most natural extension. Here, startups build collaborative workflows between multiple parties and then expand to adjacent steps. The canonical example is ServiceNow. It started with IT Ops workflows but was able to branch out through the company by expanding from where it started. 

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“The thing about workflow is that it’s software that helps people work together, so it naturally helps you spread to adjacencies.” Kevin Haverty, former CRO of ServiceNow

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Follow the Money (FTM): This is a specialized version of Follow the Workflow that focuses on money. The stakes are higher here—customers tend to be annoyed if you lose track of their dollars—so getting things like transaction integrity right is crucial. As a bonus for your hard work, startups doing FTM can typically glean relationship hierarchies from the data sets—e.g., between buyers and sellers. We have frequently seen this from procurement vendors like Ariba and Coupa; they follow the money from procurement to then expand with payment offerings.

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Single Source of the Truth (SST): The goal is for customers to always ask, “Did you check [YOUR PRODUCT HERE]?” When you are the single source of crucial data, everything goes through you. You have an unfair right to build other apps (particularly analytical apps) that leverage this data and serve other functions or constituents. Salesforce is the absolute best in the world at this. By becoming the single source of truth about the customer, they’ve expanded from simple salesforce automation to a holistic service center.

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Data Enriching Data (DED): This is exactly as it sounds. Applications have embedded data, and two data sets combined are dramatically better than one. Frequently, these are two views of the same entity (for example, sales data enriching service data on your customer). Of course, compounding data takes on a whole new level of importance with the prominence of AI—but that is a topic for another day. 

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Cross-Compounding Frontiers

But wait, there’s more! If you expand correctly, you may be able to build compounding products not only within a customer but across your customers (cross-customers). In doing so, you can potentially create data co-ops and network effects, which are the holy grail of companies and investors alike. 

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Taken to an extreme, you use FTM and SST to sell products across stakeholders (multi-stakeholder)—people like your customer’s customers, suppliers, and employees—and transform an industry. In doing so, you’ll opened up an entirely new TAM that is unavailable to anyone else in your competitive set. This is a special position to occupy because it cements you into the industry you serve.

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For now, know that we call all of these strategies “cross-compounding.” Forgive me for beating this term to death, but it is important: cross-compounding expands across multiple enterprises versus within a single enterprise. This is an audacious step for a business to take, but one we believe is necessary for multiple decades of dominance from a SaaS company. We’ll take a deeper look at each of these concepts in upcoming essays. 

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Why Now?

We believe that there has been a tipping point in business strategy and technology that makes this possible. 

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On the business side, Darwin is always at work, pushing companies and industries towards greater efficiency. Concepts such as straight-through processing and Six Sigma have been canonized, driving huge emphasis on automated workflows, data, and analytics-driven management. This drive to efficiency, in turn, pushes industries towards increased specialization and coordination as predicted by the Coase theorem (we profile its impact on supply chains in our essays on Supplier Networks).

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Simultaneously, new software architectures have enabled these movements: 

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• There has been a decades-long build shifting us from object-oriented computing, to service-oriented structures, to today’s composable/headless architectures. This underpinning allows application components to work better together and build off of each other (as an example, you can review our essay on the importance of composability in ecommerce.) 
• The consumerization of IT has made UIs and workflows far more intuitive and native. 
• Whenever an existing software can’t do what you want, no/low code technologies can now help fill the workflow gaps. 

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The advancement of business processes and software powers makes magic possible. 

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So What?

Software companies who seize the opportunity to build compounding products can break through the moribund fate of a single-point application and build Platforms of Compounding Greatness. Cross-compounding allows companies to even escape the bounds of a single customer set. PCG offers a bigger TAM and improved incremental economics, and they are also worth a lot more money (always a nice bonus). Based on Lone Pine’s work, multi-product companies are worth 58% more even in the nadir of 2023! Further, if you want to be worth $5B+, you generally will need to be multi-product. 

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As of this writing, again according to Lone Pine’s work, 78% of public companies with > $5bn of market cap are multi-product.

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Those that aren’t will multi-product will have to resign themselves to bounded outcomes and acquisition by a PCG. Based on Lone Pine’s research, approximately ⅓ of the public single-product companies as of the end of 2016 were acquired by the end of 2022. 

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The last twenty years of digital proliferation and cloud have allowed a field of a thousand point-solutions to flourish. We think this era is ending. Becoming a compounding SaaS company makes a startup much, much harder to replace. This lock-in isn’t through predatory data practices or legal malarky, but through providing a product that is immensely more valuable than any of its peers. 

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For the last year, we’ve written about how PCGs are developing in vertical SaaS in our Vertical SaaS Knowledge Project (VSKP), but this is much, much bigger than that. The strategies and business models we’ll argue for hold true for all software applications. 

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This essay is the first in a series on becoming a PCG. We’re going to get a whole lot deeper! If you want to come explore with us, make sure to subscribe below.

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Are you building a platform of compounding greatness? If so, we’d love to talk. We can share more detailed proprietary research and benchmarks and geek out on the power of this approach to SaaS. You can reach us at knowledge@tidemarkcap.com.

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Huge thanks to our advance readers: Gokul Rajaram (Square exec, prolific early stage investor, board member: Coinbase, Pinterest, Tradedesk), Avanish Sahai (former ecosystem executive at Salesforce, ServiceNow, and Google; Board member: Hubspot), David McJannet (CEO of HashiCorp), Nick Mehta (CEO of Gainsight), and Cameron Deatsch (CRO of Atlassian).

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