Building the operating system of the CFO: SMBs and beyond

The Opportunity Today

The notion that SMBs have been underserved by financial institutions is not a new one – for years, small business owners have complained about opaque pricing, lengthy onboarding processes, overly burdensome compliance, siloed & poorly integrated integrations, and painfully manual customer support. In many ways, SMBs have been a forgotten middle child; harder to serve than retail customers while lacking the deep pockets of large enterprises. It is no surprise then that only 18% of small businesses in the U.S. completely agree that banks are providing them the services they need to run the financial side of their business[1]. The number is likely lower in emerging markets where incumbent FIs are even more underinvested (and often even more profitable). Despite this, traditional FIs have had neither the impetus (owing to limited competitive pressures) nor the ability (owing to enormous tech debt) to change.

In recent years, we have seen this unstable equilibrium rightfully challenged by a number of businesses, several of which we at TCV have been lucky enough to partner with including Qonto, Brex, Revolut, Razorpay, Mollie, Xero, and Toast among others. While many of these vendors have unique landing points into the SMB (e.g. bank accounts / company incorporation, corporate cards, online payments, PoS), their propositions are widening (and increasingly overlapping), and many businesses are vying to become the Financial OS (Operating System) for the SMB.

Why should we care, you may ask? Simply put, the aggregation of these services makes a lot of sense, and the market opportunity ahead is enormous. The financial services stack of the SMB has become increasingly fragmented over time (see below) and dealing with this fragmentation is not trivial. On the other hand, the benefits of consolidation to both the SMB and the vendor are compelling. SMBs benefit from having fewer vendors to manage, improved integrations between applications that reduce human error and save time for already-overstretched finance teams, and the ability to effectively leverage data across their financial flows (e.g. payments processors who are directly in the flow-of-funds are able to both underwrite loans more accurately and collect repayment more seamlessly). On the other hand, vendors benefit from having improved customer retention (notoriously challenging in the SMB space where structural churn is high), increased ARPU, and more strategic customer relationships.

In addition to this, the SMB market is enormous. SMBs typically comprise ~50% of GDP, and comprise ~99% of total business count[2]. B2B payments are ~5x larger than B2C payments with SMBs comprising roughly half of this[3]. That said, we are at an inflection point today driven by a combination of technological & regulatory tailwinds (e.g. PSD2), growing customer acceptance (in part driven by growing B2C penetration), and the mass-migration to online-only services driven by Covid-19.

Furthermore, while SMBs have historically been able to access financial services through traditional FIs albeit in a high-friction manner, access to software has been severely lacking. Most SMBs today use Excel (or potentially even pen & paper) to manage the bulk of their finances. Given finance teams at SMBs are forced to wear multiple hats and notoriously understaffed, the potential ROI from optimising workflows and increasing automation alone is massive, not to mention the value in having greater control & understanding of your financial position. Today, we are still early in the adoption curve, but the direction of travel is clear and the question is when, and not if.

Understanding the landscape

The suite of services falling under the remit of the CFO is broad, encompassing managing cashflow across customers, suppliers, & employees, compiling management and financial accounts, and increasingly producing forward-looking forecasts that help drive strategy. The universe of vendors attacking the Office of the CFO is similarly broad and can be largely segmented along the two axes below:

The software vs. financial services distinction is an important one, with several key differences:

  • Regulation: software products are largely unregulated while financial products require some sort of license (e.g. payment institution license, banking license etc.)
  • Monetisation models: software products are typically fixed monthly subscriptions while financial products are largely volume-driven (e.g. % payment volumes or fixed cost per payment, interest rate on a loan)
  • Incumbent competitors: traditional FIs have largely offered financial products without providing accompanying software tools; next-gen SMB software vendors are primarily replacing excel and other largely manual solutions today
  • Drivers of ROI: software products mostly drive value through automation & workflow efficiencies while financial services is more around enabling a transaction to happen in the first place

While the earliest businesses to emerge typically serviced one function (e.g. accounting software, online acquiring, lending, payroll etc.), businesses are increasingly expanding their offerings across both of the axes above from their initial landing point. While this may seem straightforward, we’ve learned a few things along the way:

  1. The initial wedge will heavily influence the target customer base…
    1. While SMBs are often treated as a homogeneous group, the reality is very different. The needs of a freelancer, 10-FTE, 50-FTE, and 250-FTE business vary significantly and there is a standard ‘roadmap’ of evolving requirements as businesses scale. For example, a bank account and basic payments are mission critical from incorporation, credit is relatively rare among freelancers but becomes increasingly relevant & complex (e.g. corporate credit cards, loans) with scale, accounting software is most relevant for small businesses rather than micro business/freelancers, most other software products (e.g. cashflow forecasting, spend management) are most mission critical for larger SMBs
  2. …and natural product adjacencies
    1. Not all product combinations are created equal; this is driven by both the maturity curve outlined above (e.g. an accounting software vendor may find it challenging to cross-sell a banking offering as the target customer likely already has an existing banking provider) as well as the strength of synergies between the products (e.g. the combination of corporate card issuing & spend management is particularly powerful)
  3. Product velocity is a powerful differentiator…
    1. While rate of product innovation is important for any business, this is particularly true for those executing along the ‘Financial OS’ strategy, especially as competitive boundaries between historically siloed products begin to blur. Particularly amongst SMBs, the benefits of bringing more parts of the finance stack under one roof often outweigh the benefits of going best-in-breed with the exception of a few more complex/regulated products (e.g. payroll). Increasingly, we expect to see a turf war with the spoils disproportionately accruing to those able to offer a broader, integrated suite of ‘good enough’ solutions
  4. …but be practical about the buy vs build vs partner decision
    1. That said, not all parts of the stack need to be built in-house especially in instances where there are clear regulatory barriers (e.g. providing on-balance-sheet lending and acquiring a lending/banking license) or where there are potential win-win partnerships at hand (e.g. GTM partnerships) particularly where customer acquisition economics permit
  5. Verticalised solutions have the potential to extend beyond financial services
    1. For vertical vendors, there is an opportunity to bundle together industry-specific workflows with financial services potentially taking control of multiple systems of record. This in turn drives enormous TAM expansion, competitive moats, customer delight, and with it, economic potential. This is a concept that we, at TCV, have long advocated through our ‘full-potential SaaS’ framework
  6. Let your customers lead the way
    1. Size is not static and (much like my waist size over the holidays) an S today might be an M tomorrow. Similarly, many Ms will eventually graduate beyond ‘SMB’ designation and into large enterprises. Nowhere does this happen more quickly than among tech businesses which, often being early adopters themselves, typically comprise a disproportionate share of the customer base of next-gen financial services disruptors, particularly in their early innings. The advantages of this for vendors are twofold – 1) business models with a volumetric pricing model benefit from organic customer expansion, 2) vendors enjoy a constant stream of product feedback from increasingly demanding customers thereby allowing them to efficiently move up-market and, in an archetypal expression of Christensen’s Innovator’s Dilemma, leapfrog incumbents serving larger & deeper-pocketed customers

One important caveat – while the benefits of aggregation are clear for SMBs, this also needs to be balanced against the advantages of working with a specialist vendor particularly in instances where the problem being addressed is technically complex or highly localised (e.g. as a result of regulation). This dynamic has been particularly apparent in the software layer where we have seen the emergence of multiple standalone categories (e.g. accounting, tax, forecasting & scenario modelling etc). For vendors in these categories, the key pressure points will be in ensuring seamless integration into the rest of the finance stack, seeking out win-win partnership opportunities, and deepening functionality to avoid the risk of being aggregated into another system of record.

What are we excited about?

Despite the progress made over recent years, the Office of the CFO for SMBs remains a largely greenfield market with traditional FIs still controlling the lion’s share of the serviced market. The sheer scale of the market opportunity (99% of all businesses are SMBs!) and the heterogeneity within the SMB base (both by size tier and even by geography) mean there is plenty of room for many seminal businesses to emerge. Furthermore, this is a truly global phenomenon and SMBs in emerging markets such as India, LATAM, and SEA are even more underserved than their counterparts in the US & Europe. We, at TCV, are incredibly excited to continue backing and working with visionary founders across the world who are building for tomorrow.

***

The views and opinions expressed are those of the writers and do not necessarily reflect those of TCMI, Inc. or its affiliates (“TCV”). TCV has not verified the accuracy of any statements by the writers and disclaims any responsibility therefor. This blog post is not an offer to sell or the solicitation of an offer to purchase an interest in any private fund managed or sponsored by TCV or any of the securities of any company discussed. The TCV portfolio companies identified, if any, are not necessarily representative of all TCV investments, and no assumption should be made that the investments identified were or will be profitable. For a complete list of TCV investments, please visit www.tcv.com/all-companies/. For additional important disclaimers regarding this blog post, please see “Informational Purposes Only” in the Terms of Use for TCV’s website, available at http://www.tcv.com/terms-of-use/.


[1] Designing Digital Financial Services that work for US SMBs, 11:FS, 2020

[2] 2020 Annual Report on European SMEs, European Commission

[3] “How the Next Payments Frontier will unleash small businesses”, Goldman Sachs Publishing, 2019


Digitizing One of the Last Unconnected Markets: Built’s Place in the Multi-Trillion-Dollar Global Construction Ecosystem

$1.58T is spent annually in the U.S. construction industry, yet it’s one of the least digitized industries in the world. Paralleling the shift to digital transformation across other industries, this is beginning to change. That’s just one reason we are delighted to announce that TCV is partnering with construction finance cloud leader: Built Technologies.

Construction may be one of the least digitized industries, but that’s not going to last for long. Builders and owners are expecting digital services, just as they do in all other aspects of their lives. When it comes to financing a construction project, customers around the world should expect seamless communication, payments, and procurement through the convenience of their phone. That’s why we are excited to invest in Built, who is seeking to upgrade the functionality and user experience for everyone in the construction value chain. 

Nashville, Tennessee-based Built offers a cloud-based platform solution for construction lenders, owners, developers, and contractors. Its software acts as a digital workspace to allow all parties to collaborate to get projects built and keep capital flowing to the proper destination. The software is used by more than 150 of the leading U.S. and Canadian construction lenders, in addition to thousands of developers and contractors. 

Built is closely following TCV’s thesis for SaaS as a Network – combining software + payments + marketplace, and connecting all key stakeholders on one platform. SaaS as a Network is a strong model for industries lagging in digital adoption, as products are focused on driving solutions, operational enablement, and strong ROI. We’ve seen this at Toast in the restaurant space – where Toast helps businesses operate more efficiently and grow revenue by providing payments, software and services, or with Clio, where law firms are able to manage their employees, and customers, and enable payments.

We believe SaaS as a Network is markedly increasing the possible expected return and economic strength of vertical sector-serving SaaS platforms, given it takes advantage of end-to-end workflows to build “rails” direct to their merchant’s customers, suppliers, and employees. 

When a SaaS provider starts serving a high enough density of merchants, it can leverage that strength to build two-sided marketplaces with the merchant’s customers, suppliers, and employees. That SaaS vendor has now created a marketplace that can enjoy powerful network effects as seen in consumer marketplaces like Airbnb and Amazon. 

Built’s platform started with a Construction Loan Administration offering that improves communication and operations between banks and their borrowers. Built has grown this offering to over 150 lender customers, representing more than $80 billion of unique construction dollars and is the system of record for these lenders’ construction portfolios. In addition, builders use this system to access their capital—the lifeblood of construction.

By following the flow of money from banks into the hands of builders and owners, the Built team realized there was an even bigger opportunity within the construction ecosystem. They started to build more products around payments and value-added services like on-site inspections and other critical support to enable the construction loan process.

Built was able to accomplish all this due to its product-driven team, led by CEO, Chase Gilbert, who has construction industry experience and understands the real-world buyer pain points. In addition, Chase and the Built team have taken a customer-centric approach that informs everything that they do, especially product design. As we spent time with customers, one of the key themes we kept hearing was the operational efficiencies that Built enabled. All stakeholders involved with the Built platform felt that they were able to operate better through their use of Built.

Since its 2015 launch, the platform has been used to manage the financing of over $135 billion in construction, spanning more than 200,000 commercial, homebuilder, land development and consumer residential projects. All these were factors that led to TCV being the lead investor in Built’s $125 million Series D funding round.

TCV first called on Built in 2017, and our team took the time to build a strong relationship with the executive team.  

“We appreciate the great investing experience TCV brings to the relationship. As a result of its deep customer and technical research, TCV understands our vision and can see just how big an opportunity this is for both of our companies. We’re excited for our future together.”

Chase Gilbert, CEO, Built

While the recent funding is a nice milestone for the team, we are even more excited about the tens of thousands of users that access Built on a regular basis to fund their operations, and the opportunity Built has to build more products and do more to help its customers.

We view our investment as a perfect opportunity to add value. We think Built has a superb window of opportunity, as the world moves faster into a recovery being boosted by widespread embracing of digital ways of working. And, finally, we see huge potential in Built’s ability to connect key stakeholders in the construction process, connecting everyone onto a shared system. We’re grateful for this new partnership with Built and Brookfield Technology Partners, 9Yards Capital, XYZ Venture Capital, HighSage Ventures, and existing investors Addition, Index Ventures, Canapi Ventures, GreenPoint Partners, Nine Four Ventures, Fifth Wall, Goldman Sachs, and Nyca Partners among other individual investors. We look forward to supporting Built’s world-class team on their mission to transform a global market. The addressable market is not just the U.S.’s $1.58 trillion, but the world’s annual $10 trillion construction market.

We believe construction finance on a SaaS as a Network footing presents a remarkable future opportunity. Let’s get something great Built here!

If you’re interested in driving change in the construction finance market, Built is hiring!


AxiomSL: A Fintech Franchise Takes Off

The financial crisis of 2008 came as a resounding shock for countless companies, including many in the financial industry itself. But not for AxiomSL, a leading provider of cloud-enabled software for governance, risk, and compliance (GRC) regulatory reporting solutions to the financial services industry.

AxiomSL was founded by Alex Tsigutkin and Vladimir Etkin in 1991. As data management experts they had seen disorganized, unintegrated GRC processes even in highly regarded financial firms. “Everywhere I went, it was the same. The data was all over the place, in different systems and different departments,” explains Tsigutkin, CEO of AxiomSL. “We saw a real need to bring all of this enterprise data together at a granular level.”  Large financial institutions soon began adopting AxiomSL’s software to assemble data they used for assessing risks and reporting financial results to investors and regulators.

Then the repeal of the Glass-Steagall Banking Act in 1999 freed financial institutions to diversify into a wide range of new activities, and GRC processes took a back seat comparatively. The new priority was financial innovation and growth, to extend the United States’ position of prominence in global finance. “For years, the government and regulators didn’t put that much pressure on financial institutions,” Tsigutkin points out. “That changed completely after the 2008 financial crisis, and that’s when AxiomSL really took off.”

By this time, the company’s software data management platform and related algorithms organized operating data to align with the latest requirements of various regulatory authorities in multiple countries globally. These category-leading capabilities spurred AxiomSL’s sales growth into double-digit territory. International business began climbing too. “We were growing like wheat in the fields,” says Tsigutkin, a native of Ukraine.

But growth also brought some challenges. AxiomSL had always given its customers attentive support, especially when they were new to automating GRC processes. With rapid growth, that level of care was becoming harder to sustain; a successful strategy for landing and expanding clients was reaching its limits. “It’s very difficult to do everything on your own, especially dealing with a large and growing client base at the same time,” Tsigutkin says. “I felt this was a great opportunity to put some expert disciplines together. When I got advice on how to do that, it was to bring top notch growth equity into the mix.”

So Tsigutkin invited growth-stage investors to present their ideas for AxiomSL, including TCV, a firm he knew well from regular interactions in the past. With around $2 billion already invested in fintech, TCV understood that AxiomSL’s business could grow even faster for three interrelated reasons: an explosion of data in the financial world, proliferating regulations around the globe, and sharply higher consequences for financial companies that mismanaged them. With tighter financial discipline, more proactive sales efforts and scaling up systems and processes, AxiomSL believed it could become not just a category leader but the global standard for risk management and regulatory infrastructure solutions for the financial services industry.

“As we talked with private equity firms, TCV was distinctive in a number of aspects,” recalls Etkin, the company’s CTO. “They had proven success with fintech and GRC companies, so their long-term vision for AxiomSL and their approach to collaborative business-building really stood out.”

TCV invested in AxiomSL in June of 2017, and the new partnership moved fast. “TCV knows how to focus on what’s key for scaling a company, not just growing in the same way,” Tsigutkin explains. For example, TCV pinpointed the need for industrializing sales, sales leadership as well as more robust processes for planning and budgeting. “They also helped us understand how to use equity to attract and reward people,” Etkin notes, which enabled the company to recruit multiple new executives with significant experience scaling similar organizations.

“TCV saw in AxiomSL a category leading industry-specific software business with next generation technology, a highly satisfied client base, a mission-critical use case, – and most importantly, product-centric co-founders and partners in Alex and Vlad who had deep subject matter expertise and a strong growth orientation.” recalled Nari Ansari, TCV general partner and former board director at AxiomSL.

The collaborative approach between AxiomSL management and TCV helped AxiomSL accelerate growth, increasing software revenue over 150% in three years. Its ControllerView® intelligent data management and analytics platform could provide thousands of reports across dozens of jurisdictions and more than 100 regulatory agencies. From 60 employees during the financial crisis, the company had grown to nearly 900 globally. According to Tsigutkin, “having such a strong team really helped us to build a world-class organization.”

Consistent with TCV’s longstanding investment thesis for governance risk and compliance solutions, change and complexity can provide for significant opportunities for leading software vendors.  Indeed, AxiomSL’s positioning for its offering set has been as a “Platform for Change” given the constantly evolving regulatory environment for financial services market participants.  As the business entered 2020, that change orientation would become even more paramount.

“As COVID-19 started in early 2020, the world changed quickly, and the swiftness of market happenings was adding increased complexity for banks and regulators alike. During this period, AxiomSL’s value proposition in understanding and managing risk continued to demonstrate its importance and the business saw sustained momentum throughout 2020,” remarked Amol Helekar, a TCV principal. 

When the pandemic hit, AxiomSL as an organization had to adapt as quickly as its customers. “Being with TCV during this period was absolutely a blessing,” Tsigutkin recalls. “First they helped us to stay calm and provided very sound advice about our talent strategy and the welfare of our valued Axiom team members. Then they helped us focus on execution and growth. Moving more into digital marketing, for example, really enabled us to keep growing in 2020.  TCV also supported us as we increased our investment in cloud offerings which became even more important in a distributed COVID world for our bank clients.”

AxiomSL’s hyper-growth during the TCV partnership resulted in consistent market share gains. Along with the company’s strong profitability, blue chip client list and technology leadership, these attributes brought interest from outside parties, particularly private equity firms. As Rick Kimball, TCV founding general partner and former AxiomSL board director remarked, “Alex, Vlad, and the team transformed the organization during our partnership while deftly executing a growth agenda that expanded the business on multiple dimensions.”

In the fall of 2020, TCV worked collaboratively with Alex, Vlad, and the AxiomSL management team to assess this external investment interest and prepare the business to explore various alternatives. Ultimately this brought an offer from private equity firm Thoma Bravo to acquire a majority stake in the company.  The new investment closed in December of 2020 in one of the largest GRC transactions of its kind, and Tsigutkin took a moment to reflect, “Our growth is due in no small part to the contributions of TCV, who has been a critical partner for AxiomSL for the past three years as we grew the franchise at a record pace.”


Full Potential SaaS

We believe that SaaS vendors, particularly vertical and SMB, that provide a “system of record” are seeing massive increases in TAM, competitive moats, and economic opportunity. By extending and leveraging their workflow, data, and account ownership, SaaS vendors are delighting end customers while creating platform and networks.

With opportunity comes competition, both from within one’s category (e.g. application area) or from adjacent categories within one’s vertical (e.g. industry). As boards and management teams wake up to the opportunity, they realize that the race is on to capture the full potential of their vertical.

This post is a framework to help leaders of SaaS companies think through the strategic choices and hopefully increase the odds of reaching their full potential.Strategy is implemented by focused alignment of execution, talent, M&A, organizational structure, functional excellence, and financial and governance/board frameworks.

Finally, it’s important to acknowledge that very few companies have reached “full potential,” and this framework is inherently aspirational. However, “most entrepreneurs aren’t building a house, they are putting bricks in the foundation of a skyscraper” (Naval Ravikant). Aspiration is important, so hopefully this is an articulation of what is possible.

Lead the Category

This phase of the SaaS strategy is well understood. A SaaS company aspires to:

  1. build a great product (and service)
  2. over time, build an efficient and repeatable go-to-market model (marketing -> sales -> onboarding)
  3. and then “add capital” and execution to press its advantage against sluggish incumbents or poorly capitalized competitors

This is the playbook that Omniture and our portfolio company ExactTarget pioneered a decade ago. Despite massive capital inflows into SaaS and deteriorating economics, this model generally still works today.

On the product side, scale in data + AI can create increasing differentiation. For example, when you start to have more data than anyone else, you can flip your product from being reactive to proactive — having the product tell users where to look and how to optimize the system. Both Xero and Shopify have done this well.

Five other things to think about in this early phase that don’t get enough attention:

  • Scalable onboarding: Onboarding friction can be unaccounted drivers of CAC and churn. A great onboarding process builds the trust and confidence that are the foundations of virality/word of mouth, future cross- as well as third party channel strategies. Carefully measure funnel metrics and be attentive to new customer NPS. Automate early as “throwing bodies at it” can create process debt that will be difficult to unwind later.
  • Expansion: Expansion drives net revenue retention and most of the strategies we are about to discuss. With all sales processes, it’s a lot easier to learn, iterate, and optimize with fewer bodies and less complexity.
  • UI and Architecture: Like onboarding, these can be long-lead time fixes that compound as your business scales and gets more complex. A specific call out is to plan for an API strategy. It can facilitate future partner strategies and increase the value and stickiness of your offering.
  • Pricing structure/strategy: You will constantly revisit tactics, but it’s important to have some sense of how your pricing structure might change over time.
  • Foundations for global, including a work culture that can support distributed executives and operations, and good product feedback loops that incorporate non-home market needs.

Hyperscale Locations, Feed the Beast

A lot of ink has been spilled on forward investing in sales and marketing, and arguably it’s part of a/the “lead the category” strategy. But, it’s worth a call out as it’s important you don’t take your eye off the ball too early. So much of winning and future monetization is getting location market share. When the wind is at your back, go get it done! Market structures have a nasty habit of shifting, future secular tailwinds may abate, or competitors may leapfrog your product or your go-to-market model. If your churn and sales economics are sound, keep “feeding the beast!”

One particularly powerful unlock is Channel. There are verticals and categories, where influencers in a channel are kingmakers and can help you engage with segments that are otherwise difficult or uneconomical to reach.  Furthermore, Channel partners’ engagement and contributions can enrich your products and increase overall customer value. A great example is in tax software, where Xero’s wooing of accountants proved to be an effective source of customers and a formidable competitive moat (thereby disrupting the incumbent provider). Xero went as far as offering free practice management tools to help accountants run and grow their business on Xero.

Win the Control Points: Own Your Vertical

This is where management teams are faced with a paradox of choice: “Where should we go next? How should we spend the next incremental dollar? On increasing ARPU, acquiring incremental locations, or expanding into new verticals, geos or segments?” At this juncture, it is our belief that you should focus on winning the control points. In vertical SaaS, there are typically one or two control points, “systems of record.” Usually one control point in the front office (e.g. Point of Sale, CRM, e-commerce) – “that drives sales, that grows the business, that serves as the cash register.” And one control point in the back office (e.g. general ledger) – “where everything else reconciles to.” Hopefully, you provide one of the systems of record, so go build or acquire the other system(s) of record and secure the high ground! 

Pragmatically, a system of record is the last software package a customer will “turn off” in a tough economic time.

We also like to think about the concept of “gravity”:

  • Workflow gravity – the system that all other systems integrate to – it’s where the most users spend the most time. Not all workflows deliver the same value; in my experience the system of record workflow tends to deliver the most value.
  • Data gravity – the system that creates and holds the most critical information and is the hardest to migrate. That data can be critical to a client for a wide range of applications, from understanding their customers (e.g. CRM) to managing risk (e.g. compliance). Data also can be critical in two-level situations, such as loan underwriting (e.g. a bank underwriting a merchant’s risk via POS data) or supplier information management (e.g. a client managing risk by validating supplier capabilities and quality). Data depth and scope also create gravity where AI technologies can be highly productive.
  • Account gravity – the user/sponsor of the system is the highest-ranking individual in the customer organization; it’s the system that requires the biggest financial outlay, etc.

Winning the other system of record is not easy. By definition, a system of record is hard to displace and unless the market is greenfield pen and paper, competition can be challenging. You may be able to do it organically with product innovation, but M&A can be the more desirable path if “integration debt” is manageable. If M&A is not possible, a slow winnowing of your competitor may be the only approach available to you.

If you own multiple systems of record in a vertical, the benefits are enormous:

  • Customer delight: automation from integrated workflows and potentially unified data and data models allow efficiencies and offerings unavailable before
  • “SaaS as a Platform and SaaS as Network” opportunities
  • Stronger account ownership to capture incremental spend and drive more efficient growth
  • A new level of durability and stickiness

A good example is Veeva. The company started in 2007 with the launch of a CRM and a sales automation platform for pharma sales reps (e.g. record their activity, keep track of the doctors they meet with or drop off samples for, etc.). After becoming the dominant player in that category, Veeva saw an opportunity to move backward into research and development for their life science customers (developing new drugs, conducting clinical trials and bringing those drugs to market). In 2011 Veeva launched Vault, a suite of applications that first centered on the core content management needs for clinical trials, regulatory submissions, and quality documentation. The company then expanded to include a series of core data applications that help manage clinical trials, quality processes, safety processes, etc. Veeva is expected to finish 2019 with $1.1B in revenue (26% YoY Growth) and 37% EBIT margins. Vault represented 51% of total revenue and grew 38% YoY. Analysts also estimate Vault meaningfully expanded Veeva’s addressable market. 

Another recent example might be front office player Shopify’s $450M acquisition of 6 River Systems to move into back office fulfillment and warehouse management. Some financial analysts estimate that merchants spend up to ~10-15% of their GMV on logistics which could potentially provide multiples of Shopify’s current take rate.

Expand Headroom

With category leadership comes high market share and potentially high saturation. Long-term growth is driven by location growth, as there’s generally a finite share of wallet you can access. It’s important to invest in the S-curves of geos, segments, and adjacent verticals that can unlock new location TAM. This can take a couple of tries before you’re successful, so start this during your growth phase when there’s less pressure on maximizing profitability.

Extend Through the Value Chain

This stage of growth can be transformative. By leveraging the strengths of your core customers, you can expand into a new market with a new set of customers. Typical patterns include moving from front office software to extend to your customer’s customers, or from back office software and extending to suppliers. These can be riskier bets, but success can pay out big here:

  • Increased TAM
  • Workflow that spans multiple parties and creates increased customer value and vendor stickiness
  • Two-level network effects

Supplier

Extension seems to work best by “following the money” and leveraging purchasing power. TCV portfolio company Ariba articulated the “golden rule”— He with the gold rules! By using their leadership in procurement software at large corporate buyers, Ariba extended to build a robust suppliers software business for merchants that serviced those corporate buyers. More recently, Avetta has followed a similar path in the supplier information space by building a strong two-level network effect. We believe corporate clients want to be on Avetta because it has the largest network of suppliers, and suppliers want to be on Avetta because it has the most corporate clients. Avetta’s advantage gets stronger as it scales. Moreover, Avetta has an opportunity to help suppliers do more than just manage compliance information. As a result, Avetta sees growth in helping suppliers grow and operate their business.  

CCC is on the third generation of this approach. They started by serving large auto insurance carriers and then extended into autobody repair shops that serve the carriers. CCC is now in the process of expanding to parts suppliers. By getting all the key constituents on its software platform, CCC is able to leverage AI and automation to massively reduce friction and provide a great customer experience across all steps of the auto insurance process.

Employee

The employee opportunity is similar to the supplier opportunity in terms of “following the money.” Companies can use integrated payroll or time & attendance offerings to establish a relationship with the employee. Employees are also consumers who represent significant B2C opportunities such as consumer lending, insurance, etc. There are big dollars here, but perhaps less opportunity to build significant network effects.

Consumer

The consumer/demand opportunity is the white whale. We believe that SaaS companies tend to capture ~ 50-100bps of GMV for software subscription, whereas online demand channels can take 15-20% of GMV in categories such as hotels and restaurants. In addition to the massive revenue opportunity, Consumer also represents a strategic flank worth monitoring carefully. Online marketplaces have large competing salesforces that engage with your merchant customers and have strategic interests encroach on the software layer to try to control supply.  Booking.com bought Buuteeq and Hotel Ninjas to vertically integrate into hotel supply. Uber is rapidly expanding its driver offering to over-draft protection, a debit card, and likely lending over time to manage driver churn. This is another example of increasing marketplace + SaaS convergence.

That said, success stories of extending SaaS to Consumer are rare. Few SaaS companies have consumer product DNA, the funds, or the skills to build a consumer brand. While a SaaS provider can have a high market share of merchants in a vertical, it’s rare that it has the supply ubiquity that an online marketplace would require. Eventbrite is one of the few companies that has landed as a software tool for creators, built liquidity, and created a marketplace.

Some derivative Consumer monetization models include:

  • Consumer pay: FareHarbor approaches tour and activity operators with a free to merchant, consumer pay model: “We’ll build your website and booking engine for free, with no work on your part; you just pay us for payment processing and the customer will pay us a booking fee.”  
  • Channel management: SiteMinder offers channel management to help hotels manage existing channels in real time. SiteMinder has extended that value proposition to “Demand Plus,” an offering that helps hotels easily expand into new channels to scale demand.
  • Existing customers: While 15-20% marketplace take rates may be sensible for new customer acquisition/discovery, companies such as Olo are looking to move existing customers to lower cost channels through their dispatch offering while taking a much lower percentage of GMV.
  • Customer Co-opt: By seeing consumer data pass through their systems, some SaaS vendors are building consumer profile databases that they might monetize over time. In the recruiting market, we’ve seen players leverage job distribution tools to build a candidate database. Shopify similarly has built a large shopper profile database across all their merchants. While Shopify hasn’t monetized directly, the uplift in conversion rate is likely significant. This model is the most capital efficient but can create conflicts with the vendor’s core merchant customers.

The biggest benefit of extending through the value chain is that it gives you a beachhead and a right to win in a new vertical to start the “full potential” growth cycle again. As you do this, it’s important to reconsider your end market and focus. When Ariba transitioned from procurement software to supply network, they started to represent a front office “system of record” for their suppliers. In doing so, Ariba was both a large enterprise “procurement company” and an SMB “supplier enablement company.” The question was: “Which priority should dominate?” When extension leads to conflicts, there are no easy answers. As such, it is important to acknowledge that this growth strategy is ever-evolving.

Deepen Functionality/ Monetization

Deepen Functionality/Monetization doesn’t literally mean waiting to pursue this step until all other strategies have been completed. It’s more a reflection of priorities. Acquire as many customers as you can, win the control points, and you will likely have many of these profit pools locked up to pursue in the future.

In winning the key control points, for the same reason a single system of record has a lot of “gravity,” you now have an even stronger opportunity to turn your product into a channel. This enables entry into adjacencies with data, workflow, and account ownership advantages for you as well as for the end customer. The most extreme example is the “platform/ecosystem” play, where you monetize third party vendors that want access to the channel your product has become (e.g. Salesforce, Intuit, Shopify). However, most commonly a SaaS vendor will pursue additional monetization with in-house or white-labeled products.

Another key consideration in prioritizing adjacent function/monetization is consistency with your core go-to-market channel and proximity to key decision makers. Go-to-market will determine the financial leverage of the cross-sell and often the overall success. The core advantage of SMB software here is that often the decision-making is relatively consistent and concentrated across software purchases.

Every vertical is different, but there are some common functionality/monetization patterns emerging. Each of these patterns deserves its own write-up, but for the sake of brevity here are some highlights:

  • “Integrated payments -> integrated banking”: The attachment of payments to SaaS has been well covered. That trend is expanding to the attachment of integrated banking. We had an opportunity to interview two of the smartest people in the business, Tim Barash and Jackie Reses. Square is out front here with broad based merchant and consumer plays. To understand the magnitude of the opportunity, Square’s Subscription & Services (most of which are financial services) are expected to reach $1.3B in 2020. This represents 23% of 2020 total GAAP revenue and 47% of 2020 Total Gross Profit (incremental gross profit is ~90%). Brex is earlier in its progression, but we’re excited to see how the company leverages its initial corporate card and expense management offerings to extend into broader financial services.

  •  “Follow the workflow”: At times SaaS companies have actually observed customers at work or mapped out the physical sites to understand all the areas their workflow touches as areas of expansion.
  • “TAM shark”: HashiCorp CEO David McJannet describes expansion as “TAM Shark,” constantly circling the biggest, fastest growing (most change/opportunity) markets. He requires product managers to report on market size and growth of all adjacent categories to make sure they are focused on the biggest opportunities. Generally, over a 2-3 year period companies have one, maybe two opportunities to build distinct add-on businesses. Make sure you’re picking the biggest markets and therefore the biggest payoffs.

Summary

If the typical SaaS playbook is “Lead the Category” and “Hyperscale Locations,” clearly the full potential for vertical SaaS players is dramatically larger than conventional SaaS wisdom would suggest. We’re excited to work with — and hopefully invest in —the frontier players as they explore the “Full Potential of SaaS.”  

If you found this useful, let us know, and we’ll continue to publish and explore the topic. We look forward to hearing your adds, edits, and challenges.

Caveats

  • There’s a tension between aggregating as big a profit pool as quickly as possible vs. “winning the market.”
  • This framework is characterized as a sequential strategy. In reality, most companies are pursuing multiple steps concurrently, and the sequence is more a reflection of prioritization.
  • Time horizon: this approach is a long-term strategy to winning, which may often be at odds with short-term maximization of valuation multiple and financial performance.
  • This approach is informed by a U.S./western/mature approach. In emerging/more greenfield markets, less focus and value chain expansion earlier in company development may make sense.

The views and opinions expressed are those of the authors and do not necessarily reflect those of TCMI, Inc. or its affiliates (“TCV”). TCV has not verified the accuracy of any statements by the authors and disclaims any responsibility therefor. This blog post is not an offer to sell or the solicitation of an offer to purchase an interest in any private fund managed or sponsored by TCV or any of the securities of any company discussed. The TCV portfolio companies identified above are not necessarily representative of all TCV investments, and no assumption should be made that the investments identified were or will be profitable. For a complete list of TCV investments, please visit www.tcv.com/all-companies/. For additional important disclaimers regarding this document, please see “Informational Purposes Only” in the Terms of Use for TCV’s website, available at http://www.tcv.com/terms-of-use/.

[1] See TCV’s SMB and Vertical SaaS investments at the end of the document.