The Brave New World of Vertical Cloud Business Apps

By Special Guest
Andy Stinnes, Venture Partner, Cloud Apps Capital Partners
  |  September 03, 2019

Today, there’s a whole new category of cloud software companies to reach public scale -- those targeting specific industry verticals.

Historically, software companies offering unique vertical solutions rarely reached critical mass. Their markets were often too small and customer access too limited and expensive to achieve hyper growth. As a result, vertical software companies tended to stay small and focused regionally and were therefore rarely venture-backed. Some very large verticals like financials and healthcare were rare exceptions to this rule.

Recently, however, this dynamic has changed. Companies and business leaders in all industries now realize that effective software is a significant source of competitive advantage in an increasing global marketplace. Cloud has enabled software to reach many more customers and workers globally than previously possible and has provided significant cost advantages in scaling and maintenance.

Cloud platforms also enable companies to replace legacy technologies and rapidly deploy new functionality in a matter of days and weeks, rather than years. As a result, vertical cloud software has emerged as a venture-backable, global opportunity.

One great example is the real estate vertical. Fifteen years ago, there weren’t any public scale software companies in the real estate vertical. But today there are two public SaaS (News - Alert) companies in this space, Realpage and Appfolio.

In fact, we would argue that the business model of vertical SaaS has some unique advantages that make it a highly profitable market -- as good as or even better a bet for entrepreneurs and investors than horizontal SaaS apps.

The first advantage is the ability to significantly expand annual contract value (ACV). Vertical SaaS entrepreneurs start with a meaty, industry-specific and mission-critical problem and solve that well, winning anchor customers. Then they not only expand the customer base across the industry but also realize that the ACV per account is growing 5-10x over time.

How does that happen? Often, these verticals are technologically underserved, and there are a multitude of adjacent business problems to solve. A strong product team will devise a roadmap that leverages strong customer relationships and delivers incremental value over time. Additionally, a sales team with strong cross-selling skills will be able to grow the ACV per account substantially.

Interestingly, this path is often impossible to anticipate at the outset, a fact that makes it harder for investors to “run the numbers” on the market opportunity at the point of investment. Instead, it takes investors who have experienced that dynamic to see the full potential and guide the entrepreneur along the path.

Another highly compelling element of the industry cloud model is that most buyers in a given vertical know each other and run their businesses in similar ways. Industry conferences and networking create informal peer benchmarking, and it is not uncommon for staff to change jobs between companies.

As a result, successful vertical cloud companies can quickly build a strong reputation in an industry and leverage that reputation for reference selling to create a winner-takes-most dynamic. When you combine that with effective cross-selling of new products within the existing customer base, the resulting customer acquisition cost and overall sales and marketing expense is measurably smaller when compared to horizontal SaaS companies. And, by extension, vertical cloud companies tend to be more capital efficient.

Savvy vertical SaaS entrepreneurs facilitate this by investing heavily in strong product leadership and deep industry domain knowledge and by having a manic focus on customer success -- from day one of the startup. That might sound simple and obvious, but it takes resolve and a lot of discussion in the board room to make it happen, particularly if your investors are new to vertical SaaS.

Underpinning these positive dynamics is a basic but important human tenet: trust. Vertical SaaS companies often become more than a vendor -- they become trusted advisors. That trust is built on credibility, which in turn is highly related to a deep understanding of the vertical.

The founders of vertical companies tend be located in the geographic centers specific to the industry and often have years of experience with the problems facing their respective industries. They know their industries’ key players, many of whom are unknown in traditional Silicon Valley circles. In fact, founders of vertical SaaS are more likely to be industry experts than Silicon Valley types looking for “the next industry to disrupt.”

This trend is real. Public vertical cloud companies are growing in size and number, and the public markets no longer penalize vertical software companies. Traditionally, the conventional wisdom was that vertical markets were too small to build a successful business. Now, on the back of several huge IPO successes like Veeva Systems, Medidata, and RealPage, the market has realized that vertical markets are ripe for disruption, and the winner-take-most dynamics of a vertical market offset the smaller total market size.

The opportunity in vertical markets is significant, with Forrester (News - Alert) projecting the global enterprise vertical application market to total more than $96 billion by 2020. What’s more, M&A in vertical software really received a boost in 2016 when a number of private equity buyers like Bain Capital, Vista, Thoma Bravo, and EQT -- as well as strategics like IBM, Verizon, Oracle (News - Alert), GM, and Siemens -- made significant acquisitions in the $500 million-to-$2 billion dollar range. And this year we saw the blockbuster acquisition of Medidata for $5.8Bn and 8.8x EV/Rev multiple by Dassault Systems. We are confident this broad universe of buyers and exits are here to stay.

This is just the beginning. We’re convinced that many more industries will be opened up and transformed as they migrate to the cloud, and we’re excited about the opportunity to partner with great entrepreneurs to build a new generation of vertical cloud companies.

Edited by Maurice Nagle