Market Structure Drives Strategy

When considering market sizes, the knee-jerk reaction is to think that bigger is better. For new founders, I’ll often see a slide in their pitch deck showing some gazillion-dollar TAM, and “all they need to do is capture 1% of that” to have a billion-dollar outcome. From there, they’ll wipe their hands of the whole market-sizing affair and get back to work.

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The wily Vertical SaaS founder, the one who knows what they are doing, understands that the market drives the strategy. Understanding merchant fragmentation and total location volume is critical because this will dictate everything from what type of capital you need to raise to your eventual expand and extend product roadmap.

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Vertical SaaS is a technology category that hosts many different business models, and which strategy is correct depends on your end market. Some markets are big, like restaurants, and some are small, like auto insurance. Size and structure matter for how you build your business and what capital providers you partner with.

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To be clear, you can build wonderful companies anywhere on the above map, but how you do so will be very different.

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The market size can be viewed as a two-by-two grid, with one axis representing the total number of available locations and the other representing ARPU.

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The important thing is that venture-scale businesses can be built in everything but the lower-left quadrant. We have invested in companies in every other group. But knowing where you are is crucial. When you expand or how you use capital to extend to adjacent ecosystems—these choices are all vastly different depending on the market. Companies may start out in that lower-left quadrant but then need to drift to the right and drive ARPU or find adjacent verticals to increase locations. We have found that an emphasis on bootstrapping/properly financing a business in that quadrant is high.‍

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To illustrate the tradeoffs between ARPU and locations, I’ll use Toast and CCC, two equally successful but wildly divergent Vertical SaaS companies, as an example.

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Big and Fast (Toast) or Slow and Steady (CCC)

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Toast serves one of the largest and most fragmented markets—restaurants. This fragmentation means that an “enterprise” sales motion will have you only selling to chains with <1% of the market.

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This single fact dictates your entire strategy. Toast’s early strategy was to grab as many locations as possible as quickly as possible. (Disclosure: I am currently a board member at Toast). If you occupy a control point, you want to capture as many locations as possible. It’s not ideal, but it is rational even to be slightly sloppy to win the market. In a big market like restaurants, locations can scale for many years, and the prize is, well, big! Only once you have a toehold with a sufficient volume of merchants do you go multi-product and start really dialing in your ARPU and CAC.

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If this is your market, you want the more typical growth-round strategies. Toast raised $850M+ so they could grab as many locations as possible. They were still disciplined, but they were willing to use capital to accelerate.

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In contrast, CCC began with one product: helping insurers determine the value and cost of repair for a car that has been in an accident. This is a useful, great product. The only problem is that there are maybe only 100 insurers that matter in the U.S., and many of them are quite large. This product alone would not be enough to build a billion-dollar-plus company.

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To solve this, CCC slowly expanded its product suite to cover more of insurers’ needs. From there, they extended to working with the ~20K repair facilities to which insurers sent their business. After that, CCC integrated more products around car parts. After 30 years, the company now connects every industry participant. This remarkable achievement was reached by only raising $175M before they went public in 2021.

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If your initial end market isn’t all that big, you can still make a lot of money. However, you do it by raising far less money, and what you invest in changes. Rather than hiring 100 salespeople and quickly burning out the 100 locations you must serve, you scale ARPU through product mix and extending through the value chain. When you raise capital, it is for M&A, not huge teams of cold callers. Avoiding raising large venture rounds early in the company’s life can help you dodge jumping on the VC treadmill, chasing milestones that your market may not be well equipped to support.

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Instead, slowly scale until you have your toehold. From there, raise from more patient capital to consolidate your industry or to buy a key expansion/extension opportunity. After all, Veeva, a now ~$28B market cap vertical SaaS for life sciences, raised only $7M in venture capital on its way to IPO with a customer count in the 100s.

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How to Operate in a Small TAM

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If you are in a small TAM, my advice as an investor may shock you: raise less money. Your best fundraiser is your customers. Use excess cash flows to build out incremental product lines quickly. To help achieve scale, don’t shy away from adding on service lines with small amounts of consulting/customization to increase your market share. You can check out our Bootstrapped Legends series for examples of folks who did this right.

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Expand

Expanding is not only about increasing your ARPU and making the merchant’s life easier. It is also about looking for expansion opportunities that help grow the TAM.

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Founders need to identify the key limiters of the TAM. Is there a constraint around the supply of skilled labor? Is the supply chain too complicated? Access to customers or broad distribution difficulties? Or is it that the margins are bad?

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Your task as their VSV partner is to figure out how to solve these problems for merchants and make money while doing it. For skilled labor, you could build out online training models so employees can receive credentials. If the supply chain is too complex, you can create a group purchasing organization allowing merchants to buy critical goods en masse. If distribution is the problem, you can build out channel management tools that help merchants plug into additional online sources of demand.

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Even if all these actions only slightly expand TAM, you will certainly expand ARPU and, equally importantly, win hearts and minds. Industry-wide trust is just as important of an outcome as financial improvement. A trusted partner is significantly more likely to extend through the value chain.

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Extend

Small markets mean you will be able to achieve network effects earlier. Marketplace theory dictates that you start with a narrow band of geography or customers. For a case of the narrow band theory being true for software, see my interview with Rod Drury, founder of Xero, about starting in New Zealand. Building density and network effects will allow easier extension through the value chain.

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CCC expanded and extended by moving into adjacent vertical markets with a different market structure.

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The most crucial point is that you are not just selling a product. You are selling trust. Even with sufficient density, if both sides of the transaction don’t have absolute trust in you, this will never work. For CCC, this was the work of both product excellence and a decade-plus of acting with integrity:

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Gitesh (CEO of CCC): Before us, the industry didn't have a consistent way of making decisions for these hundreds of microtransactions. Let's give an example. I’ve got a car in front of me that needs to be repaired, and the cost is, let's say, $3,700. I'm not making one decision; I am making dozens of decisions. Should I replace the bumper? Should I put in a new headlight? Should this panel be straightened out and re-sprayed and repaired, or replaced with a new panel? What we did, right at the start, was make it easy for frontline people to use their judgment and our tools to make hundreds and hundreds of decisions. The trust we developed was the degree of precision, the ability to make reliable decisions. Frankly, because so many dollars are flowing through our platforms, making sure we're highly reliable is crucial…

Dave: One important thing that you didn't mention is having a long-term history of integrity: showing up the right way and doing what you say you're going to do. That isn't in any McKinsey framework, but it’s fundamental to building the trust needed to create this business.‍

Githesh: And people dramatically underestimate the long-term power of that. In the last 20 years, I can tell you that we are reporting faster organic growth rates than we’ve ever reported. Part of it is like you said, the power of the absolute integrity with which you operate (as opposed to what I call the conditional truth). That integrity wasn't free. It bounded what we would even consider, but it’s the basis of our reputation.

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You can even build a vertical SaaS winner without changing quadrants.

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Veeva built a multi-billion dollar company by tripling down on the same few hundred customers. When the company started, they were a CRM for life science companies. Veeva’s highly concentrated end market, with potential customers in the thousands, meant a different approach to strategy—you need to have a scarcity mindset. Veeva founder Peter Gassner characterized it like this, “Scarcity of capital can help you. You have to have enough, but you shouldn’t have too much. You have to have enough to hire people to dedicate to it… Don’t waste any hire, don’t waste any money, be frugal.”

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The company started selling its CRM quickly. They leaned into product-market fit with incremental add-ons and didn’t risk it big on expanding and extending until they were ready. The best path to increasing TAM could simply be having higher net dollar retention.

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In contrast, with the grow-fast strategy, you’ll never want to trade the last dollar of revenue for efficiency and deeper relationships with your existing accounts. Your sales reps' natural tendencies will be to push beyond what the customer is comfortable with so they can close their quarter strong. You want to give your existing sales staff room to work. When hiring, you want to find the Pareto optimality for efficiency and not optimize for just revenue.

When you do this right, a small customer volume doesn’t have to hold you back. Veeva enjoys the highest revenue per customer of any publicly traded vertical SaaS company:  back-of-the-napkin math puts them at over $2 million in average contract value.

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If they had done things the traditional venture capital way, we’d probably be looking at a very different business, and I’d venture (hah) to say one that isn’t nearly as fundamentally strong as Veeva is today. Their market drove their strategy, and it does for you, too.

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How we can help

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If you want to analyze your TAM, place yourself on the 2x2, or think through your capital strategy, Tidemark can help. We are sector specialists with a strong focus on Vertical SaaS. We can cater our approach to TAM, whether you want to go big or build efficiently.

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We can be growth investors (i.e., traditional VC), buy significant portions (or even all) of your company, allow for de-risking through secondary liquidity, or help acquire another company in your space. We make our investment suit your company, not the other way around.

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For additional resources, we have frameworks in the VSKP, people (Tidemark Fellows), playbooks (VSKP Collective), and benchmarks to help you expand and extend. These people and resources represent the knowledge from building some of the greatest vertical SaaS companies ever.

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Whether you want to be Toast or CCC, we can help get you there. After all, our team invested in both. You can find us at knowledge@tidemarkcap.com.

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*Photo Source: https://twitter.com/gunsnrosesgirl3/status/1751903770659709095?s=20

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