Scaling vertical market software businesses

6th December 2023
Web capture 6 12 2023 153049 1 - Scaling vertical market software businesses

Tom Matthews

Vertical market software (VMS) businesses operate within specific, defined end markets, often with relatively limited addressable markets.  However, by focusing on a vertical market, VMS companies are able to trade market size for market share and in some cases achieve 50%+ market penetration.

The challenge is that once a VMS company has gained a mature market share, it can be difficult to see where future growth will come from. With over 10 years of VMS investing at Pemba, this article shares our insights on how vertical software businesses can maintain enduring growth rates and build market-leading companies.

Organic growth

1) New customers. As mentioned in my previous article, the goal of every vertical software company should be to find a pathway to market leadership.  Over the past decade, we’ve seen a number of successful paths to market leadership:

  • Attack an underserved market. Historically, the most valuable vertical software businesses have been built by serving industries that have lacked access to software. It is much easier to capture market leadership in an underserved market without strong incumbents
  • Unseat sleepy incumbents. Unseating incumbents is difficult but with a product that is better or cheaper (or both), new entrants can overcome the switching costs that give VMS incumbents their advantage. However, this is the most challenging pathway to market leadership because it requires the new solution to be significantly cheaper and / or better than the incumbents’
  • Integrate and surround. By integrating into the incumbents’ legacy software and providing surrounding functionality that is best of breed, a VMS company gets the end customer used to using its product. Over time, the customer will often add additional modules.  This “land and expand” strategy can work well to displace legacy providers
  • Push up into larger enterprise-sized customers. Vertical software companies often start by servicing the small to medium-sized enterprise (SME) market.  In some verticals, there are enough SME customers to build a large business. However, in many verticals, there are too few logos to build a large SME focused vertical software business. The only way to sustain high rates of growth is to move upmarket and service larger, enterprise-sized customers.

2) Increasing share of wallet of existing clients.  Most customers in a VMS market are not natural software buyers, so once they find a product they like they tend to stick with it; usually only about 5% of the market re-evaluates their software every year.  Accordingly, it can be very difficult for a VMS business to sustain growth over the long term by winning new clients alone.  Given the sticky customer bases of VMS businesses, there is a significant opportunity to increase revenues from these clients from the following initiatives:

  • Pricing and packaging. Most vertical software companies rarely make changes to pricing. However, pricing and packaging is the biggest missed opportunity in vertical software.  Pricing efforts are effectively free ways to drive revenue growth, requiring no incremental research & development or go-to-market investment.  In vertical markets, where new logos are sparse, getting the most value out of each customer is critical
  • New modules / functionality.  There is one key thing that separates the good from the truly great VMS companies – a “layer cake” strategy of building additional products / modules to cross-sell into their “sticky” customer base
  • Integrated payments.  Some of the best layer cake opportunities are integrated services like payments.  The benefit of this strategy is the VMS company is replacing something that customers are already paying for, which makes the cross-sell feel “free” and therefore lowers sales friction
  • Data. Data remains one of the most under-exploited opportunities in vertical software.  Data plays were very difficult to pull off in the old on-premise software world, where data lived in the customer’s server.  Nowadays data resides in the cloud and is accessible to VMS companies in a way that was not possible before. To date, few VMS companies have built data businesses.  But we, at Pemba, think this is one of the underserved opportunities to grow revenue and build deeper moats for VMS businesses.

Acquisition-led growth

Vertical software lends itself well to M&A.  M&A can help consolidate the market and accelerate the pathway to the coveted market leadership position.  Acquisitions can also be used to accelerate the vertical software layer cake strategy. Given the vertical focus, VMS businesses are in a good position to buy additional products / functionalities, which they can then cross-sell to their sticky customer base.

Closing remarks

If you are looking for assistance with scaling your VMS business, please email to discuss how Pemba might be able to help.

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