Dave Yuan - A Primer On Vertical Market Software

Key Takeaways

1. The Value and Evolution of Vertical Market Software (VMS): Dave underlines the transformation of VMS perception over 10-15 years, from being a contrarian view to a valuable investment due to its adaptable business models (VMS serving different end-markets vertically). An illustrative example is how Toast, a VMS for restaurants, enabled businesses like Mama Coco to pivot to online delivery during the COVID-19 crisis
2. Key Criteria for Evaluating VMS Investments: Dave pinpoints three factors: TAM, competitive intensity, and industry growth dynamics. For instance, the restaurant sector's TAM in the U.S. is between 800,000 to 1 million locations, additionally, the dynamics of an industry, such as one where only 5% re-evaluate their software annually, dictates the approach to market capture, as highlighted by a CEO's strategy to win 75% of that 5%.
3. The Power of Account-Based Marketing in Vertical Market Software (VMS): VMS offers a unique advantage in marketing due to the clarity of the potential buyer base. However, Dave emphasizes the importance of being judicious with lead outreach; given a hypothetical 100,000 U.S. locations, a city might have around 10,000 potential leads. Overzealous outreach can quickly exhaust these leads. The solution? Capitalizing on the stronger product-market fit inherent in VMS, where products are tailored for specific customer types. In certain verticals with sufficient local density, you get this where capturing key accounts can create a flywheel effect, simplifying customer acquisition in certain regions.
4. Necessity and Nuance of Vertical SaaS over Horizontal Tools: While horizontal tools can serve a broad audience, vertical SaaS solutions address the unique needs of specific industries, delivering immediate value. Dave notes that even minor customizations in VMS can provide significant value.
5. The Unique Attributes of Successful VMS Entrepreneurs: A distinctive trait among top VMS entrepreneurs is their deep personal connection or extensive work experience within the merchant operations they cater to. This familiarity often grants them credibility in acquiring pivotal customers, especially in vertical markets. Another crucial facet is their early adoption of a multiproduct mindset. Unlike the traditional emphasis on mastering a single product, successful VMS entrepreneurs contemplate multiple product stages from the outset.
6. Retention and Cross-Sell in VMS: A recurring theme in vertical SaaS is high gross retention, with aspirations for logo retention rates as high as 98-99%. VMS businesses are inclined to expand their offerings and increase ARPU. For instance, once a VMS platform has captured payment flows, it gains insights into merchant financial health, enabling services like low-risk lending or instant deposits (as seen with Square). Expanding further, companies can explore employee management tools like scheduling and payroll, and even consumer-side features like CRM and loyalty programs.
7. The Current Landscape and Potential of VMS: Despite the increasing saturation of VMS, ample greenfield opportunities remain, particularly in niche or underserved markets. Even in major verticals like restaurants or construction, numerous subproblems await solutions. While some investors may be overvaluing VMS ventures by painting them with a broad brush, there's still significant potential for those who recognize the value in a multiproduct orientation and the ability to cater to SMBs, which employ close to half of the U.S. population.
8. VMS Valuation Requires Specificity: Traditional exit multiples can be applied, but the real distinction is in P&L, especially locations by Revenue Per User (RPU). Nuances such as segments within the verticals are essential, as they influence product-market fit and competitive entry. For instance, while owning the merchant in VMS might suggest capturing all payments, practical nuances can lead to varied attach rates – with some established VMS firms having just a 20% attach rate to payments. Such details can turn seemingly promising deals mediocre or vice versa.
9. VMS markets often evolve slower than horizontal ones

I wonder how horizontal software competes with VMS for SMEs in the longer-term, will there be a normalization towards a one-stop shop with greater consolidation? Does VMS naturally move towards horizontal cross-selling solutions to survive? For example, against Rippling’s approach as a compound start-up and one-stop shop.

Transcript