Vertical SaaS business model and its opportunities

From: gregisenberg

Vertical SaaS refers to software-as-a-service tailored for a specific industry or niche, as opposed to broad, horizontal SaaS solutions [00:00:00]. While often perceived as “boring,” this focus creates significant opportunity [00:00:46]. Luke Sfinos, an advisor to Atomic, which builds billion-dollar businesses, highlights the step-by-step process to create successful vertical SaaS ventures [00:00:20].

Why Vertical SaaS?

Vertical SaaS is not a new concept; early software use cases were always tied to optimizing businesses for efficiency, cost savings, time savings, or revenue lift [00:01:50]. However, in the last 10-15 years, there was a shift towards chasing massive multi-billion dollar “unicorn” opportunities in broad markets [00:02:13]. This led many founders away from industry-specific software, as these markets are perceived as “market constrained” by venture capitalists (VCs) who need extraordinary outcomes [00:02:30].

Despite this, there remains substantial opportunity in 2024 to build strong, enduring vertical SaaS businesses with good retention by focusing on a single industry and tailoring software for it [00:03:13]. Luke Sfinos built his own vertical SaaS business in trade schools, an industry he describes as boring, but it now generates millions in revenue [00:03:03].

Identifying Opportunities: A Scientific Approach

Building a vertical SaaS business is more of a science than an art [00:04:32]. The initial steps involve:

1. Focus on an Industry, Not an Idea

The first step is to select an industry rather than starting with a software idea [00:05:37].

2. Assess Market Size and Segmentation

A critical characteristic for vertical SaaS opportunity is the industry’s size and how it’s segmented [00:05:53]. Key considerations include:

• Total Revenue: The overall size of the industry [00:06:15].
• Number of Companies: A high number of companies (e.g., 22,000 for machine shops) indicates a fragmented market, which is ideal [00:06:35]. Industries with few, large companies are “enterprise-driven,” requiring extensive features and being difficult for bootstrapped startups [00:06:48].
• Segmentation: The best markets have a healthy mix of small businesses (doing a few million/year), mid-market businesses (tens to hundreds of millions/year), and enterprise-level businesses [00:07:31]. Starting with small to mid-sized businesses is easier, as they require less product functionality, allowing for incremental feature development [00:07:56].

Example: Machine Shops Machine shops are identified as a prime opportunity, with $240billioninrevenue,22,000companies,anda"beautifullysegmented"marketwithahealthymixofsmall,mid-market,andsomeenterprisebusinesses<aclass="yt-timestamp"data-t="00:09:50">[00:09:50]</a>.Theaveragemachineshopdoes$2 million in revenue [00:10:32].

Domain Expertise Not Required: It’s possible to build a successful vertical SaaS business without prior domain expertise. Luke Sfinos himself had no background in trade schools before building one of the largest vertical SaaS businesses in that sector [00:11:09].

3. Map the End-to-End Customer Journey and Operations

To identify software opportunities, it’s crucial to visualize and map out the entire customer journey and operations of businesses within the chosen industry [00:12:46]. Examples include Toast’s visualization of restaurant operations and Corsky’s map of trade school processes (admissions, training, IT, student services, compliance, placement) [00:13:05]. This process helps pinpoint where software can play a role in increasing efficiency [00:15:16].

4. Analyze Profit & Loss (P&L) Statements

Gathering and analyzing P&L statements from businesses in the industry provides insight into where money is spent [00:16:46]. This helps identify costs that could be reduced or automated with software [00:18:10]. Software should aim to:

• Increase Revenue [00:17:34]
• Decrease Costs [00:17:36]
• Prevent Customer Churn [00:17:41]
• Maintain Compliance (in regulated industries) [00:17:44]

5. Study the Competition

Investigate existing software solutions in the market [00:19:24]:

• Legacy Providers: Identify outdated ERPs or systems that try to do everything but may be inefficient [00:19:35].
• Horizontal Solutions: Look for industries stitching together generic software (e.g., a non-industry-specific CRM, Slack, Gmail) which indicates a need for an all-in-one vertical solution [00:20:01].
• Paper Processes: Surprisingly, many industries still rely on manual, paper-based workflows (e.g., job tracking, inventory, machine maintenance logs), presenting clear opportunities for digitization [00:20:40].

Leveraging AI for Research

AI tools like ChatGPT can significantly assist in the initial research phase [00:23:00]. They are effective for:

• Gathering market size and segmentation data [00:23:25].
• Outlining end-to-end industry operations and workflows [00:25:06].
• Identifying prevalent software solutions and their categories (CRM, ERP, CAD, etc.) [00:26:07].
• Pinpointing areas still relying on pen and paper (e.g., job tracking, tooling inventory, maintenance logs in machine shops) [00:30:00].
• Identifying areas not yet leveraging AI (e.g., predictive maintenance, optimized scheduling, automated quality control, energy management for machine shops) [00:31:12].
• Highlighting where multiple horizontal solutions are being cobbled together (e.g., Trello, Asana, generic CRMs for project management) [00:32:21].

While AI is a powerful research assistant, it’s crucial to validate the information by interacting with real businesses in the industry (e.g., offering to buy lunch to shadow operations) [00:33:06].

Go-to-Market Strategies

Understanding the go-to-market approach is vital before investing heavily in product development [00:35:20].

• Distribution is Key: A great product without users is ineffective [00:35:39].
• Industry-Specific Challenges: Many vertical industries traditionally require heavy outside sales models, involving relationship-building and in-person interactions [00:36:21].
• Product-Led vs. Sales-Led: Venture capitalists often prefer product-led or marketing-led customer acquisition because it’s faster [00:37:09]. Sales-led models typically require much higher average contract values (ACVs) to build large companies [00:37:20].
• Media and Content: Creative marketing approaches like newsletters, industry-specific memes, or engaging content can help acquire customers in unexpected ways, even in blue-collar industries [00:38:40].

Wedge Products

A “wedge product” is a “get in the door” product [00:40:24]. The goal of vertical SaaS is often to become the all-in-one solution, but no one starts there [00:40:37].

• Characteristics: A wedge product should address an area where there’s poor or paper-based competition, be crucial to the customer, be easy to implement quickly, and serve as a “reputation prover” [00:41:17].
• Case Study: Roofer.com: Roofer.com started by offering a free proposal tool that used Google Maps for estimates [00:42:01]. This solved a real problem, allowed for marketing-led customer acquisition (rare in home services), and generated trust [00:43:53]. Once customers adopted the proposal tool, Roofer.com then cross-sold them a CRM and plans to develop an ERP, moving towards an all-in-one solution [00:44:19].
• Building Trust: Wedge products should focus on creating trust with the customer [00:46:07].

Incorporating Payments (Fintech)

Adding payment processing to a vertical SaaS solution is a powerful way to build massive companies [00:46:31].

• Owning the Transaction: Every large industry-specific software company controls the transaction [00:46:44].
• Market Size Expansion: By taking a percentage of transactions, the addressable market size for VCs can expand exponentially compared to subscription revenue alone [00:47:38]. For example, Toast’s market size shifted from $120 million (software subscriptions) to potentially trillions (percentage of restaurant transaction volume) by integrating payments [00:47:08].
• Enhanced User Experience: Integrating payments provides a more seamless and efficient experience for the customer, eliminating the need for external, generic payment processors like PayPal [00:48:24].

Pricing Strategies

Pricing in vertical SaaS, though often overlooked, is crucial [00:49:42].

• Value-Based Pricing: Understand the financial cost or value of the problem being solved for the customer [00:50:01]. Price the product as a portion of the value it delivers (e.g., 20-50% of the ROI) [00:51:50].
• Concrete Example (Retention Tool): For a trade school, a student retention tool was priced based on the tuition revenue saved by preventing student dropouts. If saving five students translated to $100,000 in tuition, the software could be priced to capture a portion of that saved revenue [00:51:01].
• Focus on ROI: Only build products that clearly increase revenue, decrease costs, prevent customer churn, or aid with compliance, as these provide clear, measurable ROI for pricing [00:52:25].