22 (And Counting) Truths About Vertical SaaS

Our goal is to help you move past jargon and be purely pragmatic. I’ve been moving through concepts quickly in the Vertical SaaS Knowledge Project, so I wanted to create a common language and establish key concepts as a foundation for our discussion. With that, I give you the truths:

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#1-6: The Players

Because I am going to use these terms a lot as I talk through various slices of the value chain, I’ve standardized and abbreviated the different players.

• #1 Vertical SaaS Vendor (VSV): In the diagram below, 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 our diagram, 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 below, 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, I will use the term Targeted Stakeholder to refer to a stakeholder that isn’t the merchant.

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#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 #9 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. Owning the control point is so important that I dedicated a piece specifically to ways to think about control points.

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#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 a significant user of the software. This is an important and positive dynamic in Vertical SaaS: because the software buyer is also the user, 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.

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#9 Single Point of Accountability

Small business owners are busy people, who run complex businesses and live busy 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.

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#10 Time to Value

Busy owners on a tight budget have little patience for seeing a return on investment. These customers require easy-to-use products, and they are more likely to buy a product that is built for their industry and problem set. Functions that touch either the customer or product tend to be more “verticalized” than others; complexity, regulation, and specialization often require too much customization to work with a horizontal product. By maximizing how quickly you get to value, your growth rate will be better.

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#11 Multi-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.

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#12 Deskless Worker 

Because of the Single Point of Accountability, an initial offering might need to replace, work with, or substitute for multiple offerings simultaneously. Vertical SaaS vendors may even need to sell hardware, networks, 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. 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 (restaurants, hotels, 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. This growth equation is one of the most exciting opportunities in Vertical SaaS, as VSVs are 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 for more on why having a smaller market in comparison with horizontal SaaS isn’t necessarily a bad thing.
• #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: Most vertical markets are local, and local merchants talk. Once a vendor reaches a certain threshold in local market share—I’ve found it to be roughly 10%—it becomes easier to grow.  With local brand awareness, ​​you can capture a higher market share, and the market also gets bigger as a result. Top-of-funnel leads and conversion rates increase, customer acquisition cost (CAC) decreases, and local markets get deeper. 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. I’ve seen extreme forms where customers or suppliers will mandate systems, which can really amplify the network effect.

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#20 Limited Lead Pool

An important concept in Vertical SaaS is the Limited Lead Pool. Because of the finite end market, you should avoid creating 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 have to build rapport.

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#21 Value Chain Extension Opportunity

As Vertical SaaS companies reach high market share, they have a unique opportunity to extend beyond their customer, up and down the value chain (see our essay on Patterns of Extension). Extending forward refers to expanding closer to your merchant (e.g., ZipRecruiter extending from recruiting software to a branded consumer job board). Extending backward refers to following the money and moving towards suppliers (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. If you pull this off, you become the single most important company in an industry, and turn into a pillar of growth and profitability. Some examples we have seen include:

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• Multi-party payments escrow and reconciliation 
• Multi-party communications and collaboration
• Multi-party purchasing 
• Multi-party reporting

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Those are all the truths we can handle for now… let us know if there are any we missed!

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