By Itay Sagie, co-founder of VCforU.com.
It is known that vocabulary simplifies our understanding of rather complicated matters. In the case of SaaS companies, we quickly understand by SaaS that these are centrally hosted software-centric products or services with monthly or annual subscription business models. We don’t have to say all that, we just use SaaS.
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However, when I hear entrepreneurs and investors say things like “You need to focus on a single industry, that’s how you succeed,” I think it could indicate the speaker is simply not aware of the two valid SaaS approaches: vertical and horizontal.
SaaS companies can differ on several fronts
When creating your own SaaS company you immediately choose to build a product using a specific type of tech that caters to a need of specific audiences in a specific industry or industries. Each choice you make will greatly affect your future in terms of product design, go-to-market strategy, marketing and sales budgets, funding options, growth potential, financial planning, exit potential and more.
Technology type: Are you a cyber SaaS company or a CRM SaaS company, or are you a communications SaaS company or an ERP SaaS company? This is the easiest decision to make from the start, and is usually not debatable. However, some technologies are “hotter” than others and get more attention from investors in ongoing hype cycles.
B2B vs B2C: Are you catering to businesses or consumers, or both? This decision will affect your go-to-market strategy, pricing model, product features and capabilities, as well as your fundraising process. You simply have to choose what type of company you want to be and go with it. In my experience, venture capitalists today prefer to invest in B2B SaaS companies, as their customers should have a clear business model and clear willingness to pay. Consumers’ willingness to pay is low, their churn levels are high, and their customer acquisition cost is also high; the key ingredients to a nonsustainable company. These basic financials make B2C companies less attractive to VC investors these days.
Vertical vs horizontal SaaS: Are you targeting clients in a specific industry or are you agnostic to your customers’ industry? The former would be a vertical SaaS, the latter would be horizontal SaaS. For example, nCino, which offers a cloud-based operating system for banks and financial institutions, is a vertical SaaS company. On the other hand, Salesforce1, a horizontal Saas company, does not target specific industries so it could have clients in banking, health care, cyber, retail or any other industry.
My experience also shows that some VCs tend to prefer vertical SaaS, as they require less capital to quickly capture a market share of a specific industry. The marketing and sales budgets are lower, the messaging is simple, their product is laser-focused to cater to a specific industry, and the competitive landscape includes smaller companies with a lower barrier to entry.
Horizontal SaaS companies, however, have their advantages as well; they have a much bigger addressable market which means they can grow to very large-scale companies with much higher company valuations upon exit.
The choices you make will affect your trajectory
Product Design. Should you make a separate product for each use case or create a single product to cater to all use cases? Supporting multiple products means high R&D costs. At this point you may want to choose a specific vertical and run with it, or you may want to become a horizontal SaaS company and create a single platform to cater to all industries.
VC fundraising potential. The lower capital requirements for scale of vertical SaaS make it a good fit for mid-market funds.
Financials. Sales and Marketing Budgets: The Sales & Marketing (S&M) to Revenue (LTM, Median) ratio is 19 percent in vertical SaaS vs 41 percent in horizontal SaaS. EBITDA Margins (LTM, Median) are 13 percent in vertical SaaS vs 0.8 percent in horizontal SaaS.
Written by Itay Sagie, a lecturer, contributor, and strategic adviser to startups and investors. He is also co-founder of VCforU.com, which helps over 18,000 startups with their Investor One Pager while hundreds of investors use the platform for deal flow. Itay is also the Israeli adviser at Allied Advisers, a boutique investment bank from Silicon Valley. You can connect with him on LinkedIn and follow him on Twitter at @itaysagie.
Illustration: Li-Anne Dias.