By Alexandros Bottenbruch
The opinions expressed in this blog are solely the authors' and do not reflect the views of PayPal.
In today's rapidly advancing technological landscape, software-as-a-service (SaaS) has become a crucial
driver reshaping industries globally. Within the broader SaaS realm, it’s important to appreciate the
differences between vertical and horizontal SaaS, as each has distinct implications and offers unique
opportunities.
We’ll delve deeper into the distinct advantages that vertical SaaS can offer. We’ll then explore the
transformative influence of vertical SaaS in catalysing the rise of small and medium-sized businesses (SMBs),
and how the integration of embedded fintech is further changing the economics of vertical SaaS and – by
extension – SMBs. Lastly, we discuss and share key considerations on what makes an interesting vertical
SaaS investment, while also highlighting as an illustrative example one of PayPal Ventures’ latest
investments.
What is vertical (and horizontal) SaaS?
Vertical software-as-a-service (SaaS) focuses on developing software solutions tailored to the needs of
specific industries or niches, such as healthcare, finance, construction, shipping, automotive dealers, retail,
hospitality, etc. These solutions address industry-specific challenges, such as client appointment scheduling,
reservations management, employee (shift) management, and many more. Examples of vertical SaaS
include:
In contrast, horizontal SaaS offers general-purpose software that can be applied across industries without
meaningful customization. These solutions target a wider audience of businesses that span a broad array of
industries. As these solutions are characterized by more generalized features, they generally do not address
industry-specific challenges, so they may lack the depth of specialization that typically distinguishes vertical
SaaS solutions. Examples of horizontal SaaS platforms include:
How vertical SaaS has fuelled the rise of Small and Medium-Sized Businesses
The steep, upfront costs historically associated with building SaaS products from the ground-up meant that
in prior decades, Small and Medium-Sized Businesses (SMBs) were largely left to either fend for themselves
with manual workarounds or resort to generic, horizontal SaaS solutions that offered limited utility to SMBs,
let alone those with sector-specific needs. As scalable acquisition and monetization models remained scarce,
there simply was no clear path for such SMB-focused SaaS platforms to achieve viable unit economics.
Over the past 15 years this dynamic has shifted dramatically. The emergence of APIs has enabled software
firms to capitalize on existing solutions to augment their technology and product stack, eliminating the need
for costly, ground-up development in their quest to serve SMBs.
How embedded fintech has changed the economics of vertical SaaS and – by extension – SMBs
While the initial wave of API-based solutions allowed SMB-focused platforms to tap into third-party solutions
to enable specific functionalities like offering online payment acceptance, the economics associated with
that functionality largely accrued to the third-party API provider. In recent years, we’ve increasingly seen
API-based fintech solutions that allow platforms to not only offer certain functionality (e.g., online card
acceptance), but also enable them to capture a portion of these economics (e.g., payment fees).
These embedded finance solutions have created opportunities for SMB-focused platforms to capitalize on an
ever-increasing scope of new functionalities above and beyond their core, subscription-based models. SMB-focused
platforms can now monetize new products like payment, lending, or insurance flows – all without
building the underlying technology in-house. With embedded finance broadening the scope of potential
ancillary services, combined with the ability to develop new products inexpensively, SMB-focused platforms
are now able to create new revenue sources in ways that were inconceivable in the past. In fact, some
vertical SaaS platforms are now generating more revenue from their embedded finance offerings than their
core subscription products.
Below is an overview of use cases and examples of enabling partners that illustrate the breadth and
profound impact that integrated fintech solutions can drive for vertical SaaS platforms (and beyond)
Graphic modified to include PayPal and Zettle - source & reference of original graphic: The fusion of SaaS and
Fintech
through embedded finance (available at SaaS Alliance)
and How Fintech Scales Vertical SaaS: Use Cases and Examples
(available at JatApp)
In terms of the actual market opportunity that embedded finance represents, estimates from the SaaS
Alliance put it at $3.6T by 2030 (in line with the market caps of US Big Tech platforms). Toast and Shopify,
where financial services drive 76% and over 80% of total revenues, respectively, are emblematic of the
broader embedded finance opportunity. Irrespective of where the exact numbers shake out, the opportunity
is and remains massive.
Source: The fusion of SaaS and Fintech through embedded finance (available at SaaS Alliance)
and How Fintech Scales
Vertical SaaS: Use Cases and Examples (available at JatApp)
What makes an interesting vertical SaaS investment
Our team at PayPal Ventures has been closely tracking this next generation of platforms and we’re
particularly excited by vertical SaaS platforms that address the underserved needs of historically largely
offline sectors and SMBs, while also leveraging embedded finance to drive and accelerate monetization.
The industries that we believe are particularly ripe for vertical SaaS solutions exhibit some of the following
characteristics:
- Sector-specific needs and unique use-cases: Industries with sector-specific enterprise resource
planning (ERP) software systems or underlying complexity that a sector-agnostic tool cannot mirror.
Think of industries like restaurants, construction, beauty and wellness, trucking, automotive dealers,
real estate, shipping, etc.
- Sizable market segments: Whether that’s the number of market participants and/or the number of
transactions or the dollar-volume processed (preferably a combination of these factors). Think of
restaurants for example and the estimated 23M1
foodservice establishments globally, of which 700K
are situated in the U.S.
- Industries with comparable needs across geographies: Comparable needs across geographies
increase a platform’s ability and probability to monetize its product beyond single markets. Think of
the needs of automotive dealers, the hotel and service industry, restaurants, etc. – despite some
local nuances the core set of needs tends to be similar across geographies.
- Low digital maturity: This manifests itself in inefficient and manually managed back offices
operating generally on thin margins (e.g., restaurants, automotive dealers, construction, etc.)
- Comparably thin margins: Segments operating on comparably lower margins tend to be most
incentivized to driving efficiencies via software-first solutions that substitute for manual labour /
work-arounds. Those segments tend to also be most keen on identifying adjacent revenue /
monetization opportunities, for example, by leveraging embedded finance solutions as the impact of
those solutions tends to flow directly to a company’s bottom-line
Bearing the above in mind, PayPal Ventures recently invested in NX Technologies
(“NXT”), a Cologne,
Germany-based company that operates the payment management platform bezahl.de,
and specializes in
digital payment processes for the automotive industry.
NXT’s solution addresses the massive divide between digitized showrooms versus the largely inefficient and
manually managed back offices that can cost automotive dealers up to two-thirds of their margin. They also
result in clunky consumer experiences involving paper invoices, manual processing and reconciliation of
payments, analog communication, unavailability of payment status, etc. Such experiences stand in stark
contrast to what consumers purchase: automotive vehicles that are increasingly loaded with the latest and
greatest tech. NXT has been able to establish its highly differentiated positioning in Europe as a leading
automotive industry focused platform with deep integrations into 30+ ERPs that are specific to the industry.
Concluding thoughts
It's evident that the SaaS landscape is continually evolving, presenting both challenges and opportunities for
businesses. From the nuanced differences between horizontal and vertical SaaS and embedded fintech
applications on SMBs, the industry continues to be dynamic. As we look to the future, it's clear that
understanding and embracing these changes will be vital for businesses – be it platforms servicing SMBs, or
SMBs themselves – that are seeking to thrive by positioning themselves at the forefront of innovation,
driving growth, and unlocking new possibilities in the realm of vertical SaaS.
We, at PayPal Ventures, are actively digging deeper into the space and would love to engage with founders
building in the space, and/or investors bullish on the global opportunity.
Sources
1According to Statista (“Number of food service establishments in selected countries worldwide in 2020”)