on Traditional ‘Stack’ Solutions Revisiting the Standard for 'Stack' Solutions with Vertical SaaS

Jeffrey Bussgang, partner at Flybridge and Senior Lecturer at Harvard Business School, collaborated on the writing of this article. The worldwide SaaS market is believed to be worth $250 billion per annum and is showing no signs of slowing, reportedly increasing up to 20% annually as estimated by analysts. As attention is turned to vertical SaaS -- with a focus on niche or industry-specific operations that mirror the SaaS model — there are now nine public Vertical SaaS companies that have exceeded the $1 billion revenue mark. These companies have identified and grasped plentiful opportunities by modernizing lingering analog realms and inactive business processes. Vertical SaaS businesses have been a worthwhile prospect for entrepreneurs and investors. High gross margins of 80–90% combined with recurring revenue - with numerous cases of net dollar retention rates beyond 100% - and cost-effective sales and marketing, have created an incredibly lucrative market. In comparison to those leading in horizontal SaaS markets who find it hard to reach 20%, vertical SaaS companies regularly obtain over 40% of the market share, enabling them to have considerable pricing power and appealing unit economics. The size of vertical SaaS can be important. It can affect how the software functions and how users interact with it. Therefore, it is essential to consider this factor when selecting SaaS for a particular need. For years, there was a concern that the market sizes for vertical SaaS were too small to elicit venture capital investment. However, two concurrent trends changed this. To begin with, the markets were larger than initially forecasted, with technology adoption rates skyrocketing (as seen with Crossing the Chasm Is Due for a Refresh). Companies are seeing the benefits of technology in terms of a competitive edge, so nobody wants to fall behind. Secondly, vertical SaaS companies have managed to enlarge their Total Available Market by offering additional services to pre-existing clients. The strategy for vertical SaaS is now widely understood: to begin, secure a presence in a specialized area using conventional methods of initial distribution (GTM): acquire a few "lighthouse customers" and customize the product to fit their needs, supply them with ample resources for success, and use them as reliable references in the market to acquire more customers. Once the company has been integrated with an enterprise and demonstrated its necessity, it can develop its product portfolio to serve the same customers, typically offering supplementary products and some kind of fintech product. Finally, vertical SaaS companies become full-fledged platforms and systems of record. This case study focuses on the success of Toast, a vertical SaaS and Fintech provider. Toast is notable for its innovative approach to providing customers with a streamlined experience by combining their software-as-a-service (SaaS) capabilities with financial technology (Fintech) services. By providing these services together, Toast has been able to provide an unparalleled customer experience. This approach is widely regarded as "SaaS + fintech" and Toast, based in Boston (NYSE: TOST), was a pioneer in it, eventually amassing a total market value of $13 billion. When they launched, many didn't think their point-of-sale order management software for restaurants was a big enough niche (including a certain foolish VC! 😜). However, its speedy success revealed that there was much more to the offering than originally thought. Kent Bennett, a Bessemer partner, wrote in his Series A investment memo that there are limitless potentials for expanding the product offering. This prediction has already been confirmed. Toast has integrated a variety of fintech products like payment and credits into their “Lego stack” or “layer cake”, which are both positively impacting their business model. According to their Q1 2023 earnings release, the gross profit that Toast earned was $174M, of which, $71M came from their SaaS offerings and $150M was attributed to their financial technology solutions. The company had a deficit in hardware and professional services, thus making up the difference. Inverting the paradigm: Fintech combined with Vertical Software-as-a-Service The execution of the traditional Vertical SaaS + fintech strategy can prove costly. Developing a SaaS product compatible with enterprise requirements plus creating an effective go-to-market motion, even with product-led growth (PLG), requires time and money. These challenges are becoming greater as the market and channels grow more crowded, thereby making go-to-market more intricate and pricey - all at a time when the cost of capital has markedly increased. The Vertical SaaS + fintech playbook was created prior to the onset of the AI Age. Back when the worth of SaaS platforms was principally concentrated on workflow and business procedures streamlining, the data accumulated was only slightly beneficial. Now, with the AI Age, AI is reshaping vertical software. Daniel Porras Reyes, from my Flybridge team, comments that Vertical SaaS is becoming AI-friendly, leading to a data stronghold as industry-specific networks and databases furnish a potent data set for ML models. The quicker a firm can secure and use this exclusive data set, the more effective the algorithms - and eventual extent of the customer value proposition - will be. Flybridge has thus created an investment strategy that is an inventive way of looking at vertical Software as a Service (SaaS). We are seeking companies that are changing the customary cycle and beginning with fintech as the primary product option and afterward formulating the second or third act as a vertical SaaS platform. Basically, Fintech + Vertical SaaS instead of Vertical SaaS + Fintech. When identifying what products or services to offer customers, it is essential to focus on their unique requirements. Specifically, it is wise to address their most urgent needs, such as the need for working capital. For example, if customer demand for working capital is high, a company should present direct solutions to this problem (a “must-have”) ahead of any software solutions (a “nice to have”). By doing this, businesses will not have to expend time or additional resources trying to convince customers to purchase software or allocate budget, thus shortening the buying process and reducing customer acquisition costs. We are of the opinion that businesses can drastically reduce the challenges of adoption by taking a financial product as the initial step and then additionally offering a SaaS product that becomes an integrated part of their system. By inverting the standard SaaS process, startups can enhance adoption and reduce customer acquisition cost rather than relying on their financial offering to fund the customer acquisition cost for their SaaS offerings. Moreover, a finance-first strategy facilitates the conversation with cost-sensitive CFOs who typically pose a significant impediment in corporate sales. An analysis was conducted on ZestAI, a business software company. A study was done on ZestAI, a business software corporation. Flybridge invested into ZestAI, an LA-based technology firm, as part of their flipped playbook. The company uses AI software to power credit underwriting and increase accuracy. They plan to advance their vision by initially lending capital to consumers off of their balance sheet, collecting data to refine credit models and then releasing their own platform as a SaaS offering which provides state-of-the-art, AI-driven underwriting for financial institutions. This strategy's realization has been slower than anticipated primarily because we had a head start on the ML applications (we established the company in 2009!), necessitating us to shift the company and platform from servicing end-users to delivering an ML-based underwriting platform to members of the financial services industry, while also constructing a B2B sales team from nothing. Furthermore, working in a tightly regulated setting hindered our efforts. All that being said, the firm has achieved remarkable accomplishments - having doubled its clientele in 2022 after tripling it in 2021, and most recently concluded a $50 million investment round (a phenomenon of late 2022). Fails to Launch An examination of the short-lived Finkargo company's unsuccessful launch This analysis will focus on the short-lived Finkargo company and the reasons behind its unsuccessful launch. An illustration of our upended methodology is our portfolio firm Finkargo. The startup, based in Colombia and Mexico, created a trade finance system for SMBs in Latin America that import goods. Finkargo intends to use cutting-edge underwriting calculations based on import/export details to lend money to SMEs, and afterwards, offer Software-as-a-Service (SaaS) software to link importing SMBs with supply chain services and overseas sellers, giving better intelligence and fiscal administration. Finkargo was drawn to the combination of fintech and vertical SaaS, as the industry and market they serve require. In Latin America, there is a big gap in capital access for SMBs as commercial banks are monopolistic with high profits and little desire to develop or take risks. There is an annual inflow of over $1 trillion, 40% of which is from SMBs (roughly $400 billion). Finkargo calculates that only 17% of these SMBs can obtain working capital. Moreover, this deficiency is exacerbated by the rise of overseas transactions. Most companies in the same area and sector are owned and run by families, still using manual methods and rudimentary spreadsheets, and they show reluctance in accepting technical solutions. Envision yourself as an importer with a background of selling a product that is sought-after but unable to scale due to a lack of finances or imbalances in cash flow. A technology solution that focuses on the front or back-office may not be able to resolve this pressing problem and ought to be at the highest point of your to-do list. Finkargo has managed to make new financial arrangements for importers, consequently leading to a quicker adoption rate and a Customer Acquisition Cost (CAC) payback period of less than six months (something not usually seen in the SaaS sector) creating a platform for a more encompassing SaaS solution. Difficulties faced by Fintech and Vertical SaaS In our experience, five major challenges exist that must be tackled while implementing a Fintech + Vertical SaaS strategy. These issues are discussed in more detail here. We are passionate about the prospects that the reversed approach of Fintech + Vertical SaaS can present for entrepreneurs who are able to conquer these challenges. Let us be informed if you are a founder pursuing this strategy. We would be delighted to get more details about the product you are creating!

Source: https://medium.com/@cristina.castellan/vertical-saas-flipping-the-playbook-1bfbfbfaf108?source=rss------fintech-5