Vertical Is The New Horizontal: How The Cloud Makes Domain Expertise More Valuable In The Enterprise

Editor's note: Gordon Ritter is a founder and general partner at Emergence Capital, focused on cloud companies. 

In the days before the cloud, on-premise software providers that focused on selling into a vertical market were considered second-class citizens to the "big guns" selling into the broader horizontal marketplace. The real "win"—in market share, wallet share and ultimately, profits—was the broadest approach. The notion of specializing in solutions that serve a market niche or specific industry was considered limited unless it was just the start of something more horizontal.

However, with the advent of the SaaS model, the tables have turned. Focusing on niche verticals or specific functional areas may be one of the most successful strategies of the enterprise cloud software era. While there are still a few providers for whom the "all-things-to-all-people" approach is quite successful (Microsoft, Oracle), the vast majority of successful cloud solution providers have struck gold by picking one thing and doing it extremely well. Mass customization by vertical or functional slice with a purpose-built solution that meets your customer's unique needs is becoming the new key to success in the software industry. Why?

The Obvious Benefits

Some of the drivers are fairly obvious. Going vertical dramatically lowers customer acquisition costs (CAC). Refining your audience reduces the sheer number of potential targets, enabling you to reach customers more quickly with fewer sales people and increasing word-of-mouth recommendations, thus significantly improving sales and marketing efficiency. In most traditional models, CAC is typically equal to or twice the annual contract value. In other words, you might spend $100k to land the customer and see only half that in recurring revenue the first year. Many times it takes two years just to break even and three years to turn a profit. But, with vertical-focused companies in our portfolio, CAC can be as low as one-fourth of the annual contract value, delivering immediate ROI in the first year alone.

Going vertical also enables you to capture a larger market share more quickly. With a horizontal solution, there's so much ground to cover, in both geography and business sizes, few can achieve more than 5 to 10 percent share. However, focusing on a specific vertical or functional area enables you to achieve much greater penetration—up to 60 percent share in some cases—and solidifies your solution as the industry standard. In a vertical, become the standard and the whole industry adopts your peer-approved and recommended solution. Capturing the lion's share of the market enables you to gobble an even larger piece of the pie.

Case in point: In just four years, Veeva Systems has eclipsed Oracle as U.S. market share leader for life sciences CRM platforms, simply by specializing in the life sciences industry.  Others have also garnered sizable share in their respective verticals: OpenTable claims 12 percent share of the North American market for seated diners and WebMD commands more than 40 percent of all web traffic in online health, according to Compete.

New Benefits Emerging

While lower cost and larger market share might be "old hat," new benefits of going vertical are emerging that may be even more powerful. Cloud platforms enable innovative companies to replace competing technologies or entire swaths of functionality in just a few quarters with an ultra-rapid deployment model, whereas such a feat would have taken years in the old days of on-premise, installed software. This unprecedented new paradigm allows companies to capture a much larger share of wallet and leverage the inherent data gathered to deliver impressive value-added analysis.

Delivering Layers of Value

The focused approach enables you to garner a larger share of wallet by deploying software modules tuned for both the taxonomy and regulatory issues of a given vertical. As new customer needs come to light, the unique infrastructure of the cloud model makes it much quicker, easier and less expensive to develop and deploy new modules of value, offering new layers of functionality specially tuned for the given industry. Veeva (an Emergence portfolio copmany) has mastered this layer-cake approach, taking a slice of a number of horizontal solutions (i.e. CRM, content management, marketing automation), and focusing them specifically for the deep regulatory issues of the life sciences industry. In fact, in just one year, the company has twice rolled out entirely new functionality that entire companies were once built upon. Its Veeva Vault content management solution was quickly followed by its Veeva Network marketing and data platform—all built from scratch and deployed in the span of just 18 months. Another great example is RealPage (Ticker: RP), focused on property management solutions. With a market cap of $1.6B, the company has expanded into adjacent segments, including apartment complexes, student housing and senior communities among others.

Leverage Data to Become an Invaluable Advisor

One of the fundamental advantages of the cloud model is its ability to capture data at an unprecedented granular level. With an installed solution, you may know how many seats are provisioned on the system; with a SaaS solution, you know exactly how many active users there are, and more importantly exactly what they use (and don't use) on your platform. In the cloud, you can capture, archive and analyze user data, as well as virtually every other piece of data that comes into the system. This ability to analyze and draw correlations across various layers enables you to discover insights your customers may have never known existed.

Social software provider Lithium Technologies (another Emergence company) leverages its depth of knowledge in building successful consumer communities to help its customers realize a "Community Health Index" (CHI), a detailed usage analysis that is highly predictive about whether a community will succeed or fail. Lithium has been able to streamline this process, automate the creation of CHI reports and bundle them with up-sell versions of its service to monetize this valuable data. Zillow (Ticker: Z) is another great example. While the company tracks every click to deliver a more tailored experience to its users, it also leverages the power of crowdsourcing to augment their data vault by allowing owners to add detailed information to their properties such as description, photos, etc.

Leveraging data to help your customers succeed is a powerful and effective way to elevate your company from software vendor to invaluable advisor. This feat is much easier in a vertical or specific functional area. The taxonomy and "schemas" of the data are much easier to correlate than if you are working with, say, pharma companies and retailers on the same platform.

Ultimately, this ability to extract hidden value from inputted and behavioral data is perhaps the most critical component to market success for any SaaS vendor. Serving in this C-level advisory capacity not only makes your solution more valuable to the customer but also enhances your overall position as a trusted business partner. As a result, demonstrating your value as a data analyst and advisor solidifies your role as a market expert—and the market leader.

At Emergence Capital Partners, we've seen this focused approach drive customer acquisition costs down as much as 75 percent. That's a powerful incentive in a business where sales and marketing is often the largest cost of doing business.

[Image via Delish.]