Software-as-a-service (SaaS) companies continue to be admired by both investors and businesses (of all sizes).

Enterprise companies first got on the SaaS train in the early 2000s as they looked for tech solutions that automated tasks and improved operations. These large, institutional players appreciated the horizontal, broad approach of solutions that applied to various needs (regardless of a company’s industry).

Small and medium-sized businesses (SMBs) require a more customized path to solving their painpoints. This where Vertical SaaS first arrived — platforms focused on a specific industry and the needs of small scale companies. These businesses were in search of an ‘all-in-one’ operating system that made running their company both simpler & easier.

Coming off of a high-level discussion last week on Vertical SaaS incorporating more financial services, we’ll dive in deeper into why there’s such a spotlight on this area now, expansion being necessary for long-term success, and how adding fintech makes for a compelling play towards Embedded Finance.

Why the time is now for Vertical SaaS?

Historically, Vertical SaaS has been looked down upon by VCs and investors due to the smaller market size, complex sales process, and likelihood of churn (i.e. a business not renewing their contract).

SMBs are smaller in terms of volume when compared to enterprise clients, so there’s a reduced revenue opportunity on a per customer basis. A constant amount of sales work + account management is being deployed for a less profitable segment.

Despite this poor outlook, the notable success of vertical-focused companies over the last decade has turned the tide in terms of industry perception.

There are now established brands as leaders in specific verticals (with numerous competitors trying to follow suit):

• Ecommerce — Shopify;

• Point-of-sale (POS) merchant processing services for restaurants — Toast;

• Real estate property management — AppFolio;

• Pay-as-you-go insurance — Metromile;

The argument of Vertical SaaS having limited success is no longer a strong one.

Companies that consistently exceed the expectations of their clients (regardless of company size or industry focus) will have success over the long-term. Maybe not immediate, exponential growth — but sustainable performance (especially in today’s economic climate) is more than welcome.

Winning in vertical saas requires expansion

There is an expansion focus within Vertical SaaS once a company establishes product-market fit (PMF).

These companies slowly start to scale additional products & features, as well as leverage network effects from strong partnerships. The combination of the two leads to greater market share within a vertical, which leads to an emerging market leader position.

Vertical SaaS companies tend to have the most success with industries that are known for highly manual processes and a myriad of vendors forming a disjointed ecosystem. Being able to automate workflows, condense functionality, and deliver an easy-to-use business dashboard is the ‘silver bullet’ that SMBs are looking for.

This need for a unified, control center is the same for many small businesses — from consultants, digital marketers, financial advisors, wellness professionals, to construction project firms. Tracking and managing customer activity, revenue & expenses, cashflow in & out, and inventory shouldn’t require multiple platforms that each have a separate login & password.

Having data in one place also allows Vertical SaaS to better understand their clients, deliver recommendations backed by analytics, and offer custom financial products (with additional monetization opportunities).

Vertical SaaS is more compelling when adding Fintech

Subscription revenue is a core business driver in SaaS.

Companies pay a monthly/annual fee in exchange for access to software needed to run/optimize company operations.

This recurring revenue can be a long-term, sustainable model — assuming newly onboarded customers outweigh non-renewing clients AND profit margins continue to increase over time (i.e. operating costs remain flat or decrease, while pricing increases).

Since customer churn and new client acquisition can fluctuate based on market/economic conditions, having other revenue streams to tap into becomes critical. Cross-sells of other products becomes a key barometer to revenue performance.

Adding new financial services provides incremental boosts to an SMB’s bottom line. We clearly see this play out with top brands like Shopify and Toast, who gain significant revenue from payment volume and banking activities. Earning 2% (or more) on payment volumes of $100M+ is a great add-on to monthly subscription fees.

Besides payments, more Vertical SaaS companies are offering credit (such as Buy-Now-Pay-Later for consumers, factoring for businesses), insurance, and employee financial benefits (e.g. emergency advances, student loan repayments). These complementary offerings can become their own sustainable profit centers that come with network effects of:

• Lower cost customer acquisition — these SaaS firms already have an existing customer relationship (through the software provided); it’s a minimal cost to cross-sell a new, financial product to these clients;

• Improving retention among existing clients — adding other products in a customer relationship drives ‘stickiness’ from a client (aka it’s harder for them to switch to a different SaaS platform and start fresh);

• Access to user data — this can be leveraged to customize new offerings that improve customer experience and overall engagement; data is also helpful in qualifying/underwriting clients interested in lending products;

• A boost to customer satisfaction — more products and better, more engaging experience drive long-term loyalty;

A Vertical SaaS firm no longer needs to stay stagnant with only its subscription offering. It can leverage an embedded finance provider to add fintech products that previously required licensing and/or lengthy implementation periods.

A huge win for vertical saas through embedded finance

Vertical SaaS companies being utilized as THE operating system for SMBs have earned the trust of their clients.

This trust comes with increased transaction activity and more data from business clients. These two inputs can be put to good use in offering real-time product solutions to a company’s most pressing needs — (i) minimizing costs, (ii) increasing revenue, and/or (iii) improving operations (which saves on capacity/staffing expenses).

Embedded finance providers can offer these next-gen products in a seamless, in-platform experience. Insurance, lending, banking, and payments can be integrated into a vertical SaaS company’s dashboard by a business client opting in and signing off on disclosures/agreements.

If a business needs emergency cashflow, there’s a button in their management panel to request financing — even better, there would be a pre-approved offer with a specific amount & APR waiting for them to accept!

If a client needs to switch insurance coverage (for cyber, worker’s comp, general liability), there’s an option built-in with their vertical SaaS partner to view quotes, make comparisons, and sign up for a new plan.

Only financial products and embedded providers that fit a vertical would be available. Any customized program would be based on transaction history of a business customer — no need for a cumbersome application or underwriting process.

In current discussions of Embedded Finance, it’s mostly well-established enterprises that are viewed as prospective targets. In Vertical SaaS, now SMBs and growth companies can take advantage of similar opportunities.

OUTLOOK

Despite US banks and infrastructure companies having difficulties working together, the future and market for embedded finance is bright over the next 5-7 years.

This next 12-15 months will be a trial period for financial institutions offering banking services directly to SMBs & enterprises, or through the remaining technology providers (such as Unit, Synctera, Treasury Prime, Bond, and Galileo).

The need for increased oversight & risk monitoring of 3rd parties (such as these providers) will force both sides to work with more risk & compliance vendors. However, there needs to be a program manager bringing all these fragments together and ensure everything is working in unison.

Banks aren’t interested in taking on this responsibility — many partner banks are mid-size, regional institutions and don’t have the staffing to manage multiple platforms.

Fintechs & non-fintechs lack the experience in managing a banking program at scale. There’s no compliance expertise or experience operating a highly regulated business.

If both banks & customer-facing platforms can find a middle ground that bridges the gap, the embedded finance movement will start to take off a lot sooner. A key missing element is support & transparency from regulators — a lack of guidance on how to manage these programs is delaying innovation in the US.

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