Vertical Aggregation

I’ve written in the past that I think returns for SaaS won’t be as attractive over the next decade. This view is focused on enterprise software. I am more bullish on SMB SaaS, primarily on vertical-specific players which I will discuss below.

Vertical Aggregation

Businesses have an array of suppliers: employees, financial services, insurance, software, marketing/advertising, in addition to a long list of industry specific suppliers. In most cases, the supply chain is pretty fragmented, particularly for SMBs. You may get your credit card from your bank, but you might not. You might use QuickBooks for accounting, but Gusto for payroll. You use Facebook for advertising, but also place ads in the local paper.

This is starting to change for a variety of reasons, the biggest being the emergence of APIs for everything.

APIs for everything

Everything maybe a bit of an exaggeration, but over time maybe only a slight one. There are APIs (or elegant white label offerings) that touch most parts of the supply chain for a business:

• Financial services: payments, insurance, financing & BNPL, loans

• Employees: payroll, background checks

• Marketing: website builders, loyalty, gift cards, email marketing

• Software: video & streaming, phone, analytics

Most services have been or will be rethought as API-only offerings, allowing for a reshuffling of how services get distributed and bundled together.

Vertical SaaS as Beneficiary

SMB focused vertical SaaS companies usually start with a core workflow that has been tailored to the needs of their target industry. Often that workflow is customer facing. Shopify (ecommerce) and Mindbody (Fitness/Wellness) started with online storefronts builders and checkout. Toast with a POS. ServiceTitan with booking and estimation.

 Leveraging APIs, these companies and others like them have pivoted around the core workflow to expand their offerings and value to customers. Today, this happens rapidly because the complexity is abstracted away by a vendor. Want to offer payroll? Use an API offered by Check. Financing for customers? Use Behalf. Gift cards? Use Tango Card. Toast, Mindbody, and ServiceTitan have brought to market dozens of SKUs despite fairly average R&D spend relative to revenue and market cap.

Breadth of offerings from ServiceTitan and Toast

The value for the merchant is pretty clear - a unified and straightforward platform to run the business. And due to the payments element of the revenue model, incentives are tightly aligned between the merchant and vertical SaaS provider.

Vertical SaaS vs Marketplaces

As the size of the customer base grows, some vertical SaaS companies will also become marketplaces. Shopify is in the vanguard here, and is building toward marketplaces on both the supply side (developer and expert marketplaces) and the demand side (Shop app). Mindbody has a customer facing app for discovery and booking. Toast is increasingly competing with Doordash and Uber Eats. Vertical SaaS can be somewhat disruptive to marketplaces because they start with onboarded supply and margin built in from payments volume. Toast, as an example here, charges a fat flee per delivery vs the take rate model employed by marketplace pure plays.

Vertical SaaS as Banks

The above is already happening and has been recognized by the market over the last year. But, I don’t think it is yet consensus that some of these SaaS companies will become banks over the next decade. Square has paved the way here. But there is nothing unique about Square (other than they were early in seeing the potential of getting a banking license). If you are processing revenues via your payments offering and have access to more data about a vertical than any other company, then providing capital to the space becomes a logical next step. As a customer, banking with your SaaS provider is the most convenient option and in many verticals the only place where capital will consistently flow. 

Vertical SaaS as Vocational Training

If your business is levered to an industry, you want that industry to grow. If your industry is restaurants or HVAC or construction or mechanics the biggest potential headwind to industry growth over the next 30 years is a lack of qualified labor. So, training and accreditation become logical expansion points eventually. 

Who blows away the umbrella?

SaaS+Fintech has created a very attractive economic umbrella. It is likely new entrants will try to exploit this. A longer-term risk to any payments-touched vertical is whether there is a price for software longer term greater than zero. For the core POS workflow in each industry, my view is no. To maintain pricing power, vertical SaaS leaders are bundling (or will bundle) in adjacent vertical specific offerings that are harder to replicate for a payments-only new entrant. Success with marketplace offerings also likely creates a barrier to entry for any new entrants.

Who is exposed?

In the public markets: APPF, EVCM, PCOR, TOST, CCCS. I own some of all excluding TOST. In the private markets there are many direct and picks and shovels plays on this trend.