Thursday, October 04, 2012

1st DO for SaaS startups, continued

Further to my post about my "1st DO for SaaS startups" (and again, in the spirit of releasing early and iterating fast) I'd like to touch on a few additional points with respect to the right market.

Market size
  • If you want to go big and build a large, successful company it's obviously important that your market is big enough. How big is big enough? Most large VCs would answer that the TAM of a SaaS company should be at least $1B. The thinking is, if it's a $1B market and you grab 5-10% of it and get a revenue multiple of 5-8x, the company will be worth $250-800M at exit. This is where large VCs start to get excited. 
  • We as a small early-stage fund are a little more modest but we also want to see a clear potential for a $100M+ exit, which means there needs to be a clear potential to get to at least $10-20M in revenues. If you assume 5-10% market share, that means the TAM should be $100-400M at the minimum.
  • Note that by TAM I mean your primary market. If there's potential to expand into new products or geographies that's great and can be a big plus, but given the uncertainty of these expansions it's important that your primary TAM alone is big enough.
  • Can't you target a smaller market but aim for much bigger market share? The general thinking is that it's much easier to get to, say, $50M in revenues in a $1B market than in a $200M market. My gut tells me that's right, but it would be interesting to see some real data on this question.
  • Note that I'm answering the question from my biased VC perspective. There are plenty of opportunities to build very respectable companies in smaller markets or niches. They just may not be VC-fundable – which can be completely fine if you don't need that much capital and if your competitors don't get VC funding either.
Fortune 500 vs. Fortune 5,000,000
Should you go after the Fortune 500 or the Fortune 5,000,000? At Point Nine we're big fans of the latter. To some degree that's just a personal preference. We don't have expertise in enterprise sales and we just love consumerized, low-touch sales SaaS businesses. Some of the most valuable software companies have been built based on the enterprise sales model (including SAP, probably the most successful high-tech company coming out of Germany in the last 40 years) and maybe that's still possible. It's just not our thing.

Here are a few of the reasons why we like targeting SMBs:
  • You need less time and money to get a first version to the market. The lean startup approach doesn't work well for enterprise software as you need to invest much more money into product development and sales.
  • When you develop for enterprise clients there's a risk that you become a victim of the law of small numbers: You develop your product based on the requirements of a handful of pilot customers but you don't know if the rest of the market has the same needs. When you target SMBs you'll develop and iterate your product based on the needs of a much bigger sample size.
  • The same goes for the sales side: Because you're dealing with small numbers it's easy to draw wrong conclusions. For example, you may think that you have a great CAC/CLTV ratio and all you have to do is hire more salespeople whereas in reality you just had luck with a few good customer wins.
  • Customer acquisition is much less sales-driven, which means that you need less capital and that you can grow faster.
  • And finally, starting with SMBs doesn't prevent you from going upstream over time. As your product becomes more and more robust and you understand the needs of bigger clients better and better you can target increasingly bigger customers. Much better than doing it the other way round since it's very hard to take an enterprise product and strip down features to make it usable for SMBs.

Horizontal vs. vertical
  • The advantage of a vertical product, i.e. a product made for a particular industry, is that you know exactly who your target customers are. That makes it much easier to find out the precise needs of your target customers and also makes your marketing efforts easier. The downside of a vertical product is that your niche might not be very large and you might struggle to expand into other verticals.
  • For horizontal products it's usually the other way round: Bigger TAMs, but it may not be obvious who the first adopters of your product are and it's harder to reach potential customers in a targeted way.

1 comment:

James Ferguson @kWIQly said...


I believe there is a third approach to the Fortune 500 vs 5,000,000 question for vertical market SaaS.

In almost any vertical market that is dominated by big B2B services (in our case energy performance in buildings), there is usually some aspect of manpower scaling problem. This means that the big players are often (at least in part) resellers of contracted out services, because they cannot hire to reach all geographies.

Most SaaS products directly or indirectly automate functionality of value (plug warning - see our demo here ), This allows early traction through heavily serviced support to be built up with the Fortune 500 - they have the budget and expertise to know exactly what they need to replicate, which helps testing hypotheses and justifies that awkward stage of less scalable direct sales and service business.

Then as the product matures, these same companies become reference points for a more homogeneous "one-size-fits-all, low-touch" service that can reach out to the millions of end user clients who are too small to be served by the big market players.

Naturally we have the advantage of being in the space of the virtually untouched Building Energy Intelligence market (Google it to see if you find us) for energy waste which runs represents an annual US$ 1.5 Trillion TAM.

So if you are looking at a vertical service market in a big space and can help with scaling those services, enterprise sales can be the "high maintenance" proving ground that leads to the SME/SMB market and then (who knows) to B2C.

Finally by using enterprise reputation before going to real growth scaling, you overcome major aspects of the "Chasm" on which I agree David Skok is a great contributor.