While the most publicized SaaS stories of the last 18 months have predominantly been about horizontal solutions such as WorkDay and ServiceNow (both whom sell extended product suites into a variety of industries), a second layer of innovation is occurring in many verticals that require more specialized solutions. In the public markets, Textura (TXTR) is a leading example of a vertical-specific SaaS solution that leverages data to improve financial efficiency within the construction industry. Veeva Systems (VEEV) is yet another highly successful SaaS business that has carved out a dominant market position within one vertical – pharma and life sciences.
Although these vertical-specific solutions share many common traits with their well-known horizontal software brethren, there are certain unique characteristics that are worth noting. In the past ~2 years, NVP has invested in a number of vertical-specific solutions across a variety of sectors, including The Retail Equation (brick and mortar retail); The Rainmaker Group (multi-family housing); as well as CareCloud and Health Catalyst (healthcare). Through our experience interacting with these businesses, we’ve developed a number of interesting observations.
PUBLIC ANALYSIS: VERTICAL VS HORIZONTAL SAAS
First, an analysis of publicly-traded Vertical SaaS vs. Horizontal SaaS companies yielded some interesting results (since we primarily invest in emerging growth-oriented companies, we only included SaaS businesses with less than $250M in revenue and 15%+ CAGR)…Despite similar growth profiles (30-40% forecasted revenue growth), our selected public Vertical SaaS businesses field EBITDA margins that are on average 20%-25% higher than our selected Horizontal SaaS businesses. Furthermore, excluding Textura, all other selected Vertical SaaS businesses operated profitably on an EBITDA basis, while only three of the Horizontal SaaS businesses (Cvent, inContact and LogMeIn) could garner such a claim.
A closer look shows that Sales & Marketing expense as a % of Revenue is significantly lower for Vertical SaaS businesses than Horizontal SaaS, and this delta accounts for a majority of the EBITDA margin increase. How are Vertical SaaS businesses able to sustain such rapid growth while expending markedly less on Sales & Marketing? We believe the below attributes are noteworthy contributors to this phenomenon:
VERTICAL SAAS ATTRIBUTES
- “Better” product due to narrower focus – Large, well-known horizontal software providers often seek to design a “one size fits all” product to maximize available market opportunity. In contrast, many vertical SaaS solutions focus on providing “best of breed” features to address more sector-specific problems, leading to a more targeted and often faster sales / adoption process. Veeva (CRM for pharma) was able to rapidly carve out a strong market position because the solutions were superior in addressing specific demands of pharma sales reps (tablet-based apps, compliant and multi-channel data sharing environments for prospects, etc.) versus traditional horizontal systems like Salesforce.com. In our experience, we have also seen horizontal software providers successfully penetrate new verticals by developing (or acquiring) more industry-specific expertise and features on top of their core platforms. NVP portfolio investment 1010data has historically provided SaaS Big Data analytics and warehousing solutions to the financial services industry; however, in recent years the Company has successfully sold into the retail and CPG sectors as well, by developing industry-specific tools, analytics and applications to aid large retailers in gaining greater visibility into their day-to-day transactions and operations. In recent months, even Salesforce has indicated it plans to adopt a more “vertical-focused” strategy.
- Replacing legacy technology / manual processes within “slower” industries – Many vertical-specific SaaS solutions are penetrating markets that have historically been resistant to change and exhibited a “club mentality” regarding technology adoption. However, once a couple of industry participants are sold on the product, the remainder of the industry is quick to follow suit due to word-of-mouth. This allows Vertical SaaS businesses to conserve on Sales and Marketing expense once a product is established, whereas Horizontal solutions need to continuously feed the S&M engine as it sells across multiple verticals. The Retail Equation (TRE), which provides real-time transaction optimization and fraud prevention solutions to Brick & Mortar retailers, has experienced such an adoption cycle within its target industry. Historically, many large B&M retailers utilized exception-based reporting on legacy systems, manual auditing and blanket policies to handle in-store fraud (e.g. returning stolen or used goods for cash). These methodologies were minimally effective in preventing the initial fraud, instead merely recognizing the loss after the fact. Prior to TRE, many retailers were resigned to accept these losses as “cost of doing business,” and were hesitant to adopt newer and more effective technology, leading to long initial sales cycles for TRE. However, once TRE proved its products generated substantial value (multi-billion dollar retailers utilizing TRE’s Verify solution saw an average ~13% reduction in shrink and 1% gain in net sales) and won over a couple of initial customers, many other retailers followed suit in the ensuing years. Today, the Verify solution is deployed in over 27,000 stores across the US, across many different retail verticals.
- Opportunity to collect and leverage vertical-specific data for analytics – Industries that have historically utilized more legacy systems and manual processes have also been slow to leverage big data analytics and business intelligence; often because their existing systems had inadequate infrastructure to collect and communicate the relevant data. Replacing legacy software with these SaaS solutions provides many with significant added visibility to internal metrics and intelligence to drive further business improvement. In addition, vertical-specific SaaS solutions have the advantage of serving a variety of customers within the same sector and are well positioned to understand unique sector-specific pain points and develop additional value-added benchmarking / data tools for industry participants. The Rainmaker Group, whose core LRO product helps multi-family residential apartment properties maximize rent revenue, has recently developed a new MDX product that looks to benchmark historical property performance across the entire US rental market; this data is compelling to apartment owners for a number of reasons but would be much more difficult to acquire and aggregate without the expertise garnered through the adoption of Rainmaker’s software across a broad swath of multi-family customers.
- Revenue growth within existing customers – Due to the “best of breed” nature of vertical SaaS solutions, many of these businesses are deeply entrenched within their customers’ workflow upon adoption. This helps not only to minimize revenue churn (due to high cost of switching) but also enables many vertical SaaS providers to grow revenue within their existing customer base through deeper adoption over time, or up-sell of incremental value-added modules. In addition, most vertical SaaS solutions that we have encountered have variable pricing based on the number of users or sites that a customer has, and as the customer increases in scale, the associated revenue naturally grows as well.
We believe emerging private SaaS businesses seeking to gain share in specific verticals will look to take advantage of these unique attributes, with many adopting a subset of the following action items:
VERTICAL SAAS ACTION ITEMS
- Focus on developing “best of breed” products – Vertical-specific SaaS solutions will not be “one size fits all;” instead, we have found the most compelling vertical SaaS businesses have found ways to address a handful of sector-specific challenges extremely well. Similarly, many horizontal SaaS vendors looking to penetrate new verticals will likely need to develop (or acquire) solutions with greater industry depth and functionality in order to remain competitive.
- Once a product is proven to sell, monitor Sales & Marketing expense – public benchmarks indicate Vertical SaaS businesses that have achieved scale but are still growing contribute ~20-30% of annual revenue to Sales and Marketing, while many Horizontal SaaS businesses with similar growth profiles exhibit much higher Sales and Marketing expenditure. For businesses selling specifically into select verticals, an interesting ratio to monitor is a version of the “SaaS Magic Number,” which can be calculated as: (% Annual Revenue Growth) ÷ (Sales & Marketing as % of Revenue). For our featured comp set, most vertical SaaS businesses approach 1x or above on this metric.
- Net recurring user / subscriber / site count is the key metric to sustainable revenue growth – sales prospects should be prioritized not only on existing revenue opportunity but also potential user / site growth. Sales force compensation should similarly be weighted towards acquiring and retaining the maximum users / subscribers / sites (whether within the existing customer base or through new sales) as opposed to merely focused on $ new sales today.
- Leverage “data exhaust” to generate additional vertical-specific insights and products – Due to the entrenched nature of their solutions, many vertical SaaS businesses will be able to better acquire, aggregate and store industry-specific and customer performance metrics relative to their horizontal software counterparts. There is significant opportunity to re-package and monetize this data via innovative value-added solutions such as benchmarking or marketing products.
Ultimately, we believe we are in the early stages of vertical-specific SaaS adoption by many industries, and there are still many markets / opportunities to disrupt and grow into. We are excited at the prospect of continuing to work with many vertical-specific SaaS businesses across a variety of sectors and employing some of our learnings to help accelerate the growth of these industries.