The Big Enterprise SaaS Squeeze

and the case for vertical enterprise SaaS

Horizontal SaaS players like ServiceNow, Workday, Salesforce, Hubspot and others were category defining businesses through the 2010’s benefiting from huge tailwinds around a platform shift to the cloud. Those tailwinds are changing dramatically. Multiple pressure points are creating some interesting dynamics.

Downward pressure — Investors & The Street

• The end of ZIRP. Cost of capital and pressure to deliver profits as interest rates rise dramatically has been increasing materially. SaaS promised high gross margins, but most of these incumbents have been sacrificing bottom line for growth.
• The chatter on SBC (Stock Based Compensation) has increased a lot. Most tech companies caught up in a cycle of compensation inflation for a talent war. Any illusion that this practice wasn’t dilutive to existing shareholders has now been clearly dispelled and is becoming part of mainstream chatter.

Some companies are starting to target it already.

• Perceived bloat in the organisations. The Elon effect of stripping Twitter to the bone has everyone looking over at main street tech businesses wondering why they’re so big. Are the RIF’s they’ve done enough?

Pressure from below — Customers

Their public customers are under the same scrutiny around profits and bottom line. That cycle will create much more pressure on renewal cycles around pricing. Customers will increasingly look for larger pounds of flesh on discounting & be willing to haggle longer.

A second dynamic with customer purchases will be increased scrutiny around add-on SKU’s, upsells, bundled this and that. Was there value delivered here? If the ROI isn’t clear, renewal pressure will mount. This is mostly a housekeeping / hygiene exercise by customers but one that could create pressure on Net Revenue Retention metrics.

Roadmap pileup. As these big horizontal players have dozens and dozens of markets they serve, there will be market specific roadmaps for those customer segments that just get longer and longer. These are no longer shiny Cloud systems. Hiring more engineers to deliver roadmap does not produce linear returns. The bloat in the engineering organisation gets bigger. Things get slower. The core gets overwhelmed. Zuckerberg talked about some of this phenomenon recently in Facebook’s Q4 earnings.

We closed last year with some difficult layoffs and restructuring some teams. When we did this, I said clearly that this was the beginning of our focus on efficiency and not the end. Since then, we’ve taken some additional steps like working with our infrastructure team on how to deliver our roadmap while spending less on capex. Next, we’re working on flattening our org structure and removing some layers of middle management to make decisions faster, as well as deploying AI tools to help our engineers be more productive. As part of this, we’re going to be more proactive about cutting projects that aren’t performing or may no longer be as crucial, but my main focus is on increasing the efficiency of how we execute our top priorities.

The AI Expectation Effect & the AI Tax

Whether ChatGPT et. al are ready for primetime just yet for enterprise SaaS is still a big question. I am mostly there on AI/ML as a big platform shift that’s happening, although I would agree that we’ll collectively over expect in the near term.

However, those raised expectations are shared with customers. The toothpaste is out of the tube. There’s no putting it back.

All of the big SaaS players have had internal AI efforts but I’m not aware of a single one that comes close to delivering on some of the promise of ChatGPT. OpenAI’s improvements look like at least a step change or two ahead of where most of these folks are with improvements coming rapidly.

This is going to force an AI tax on these SaaS players to compete. OpenAI (via Microsoft), Google (who is now in red alert mode) and whatever other players emerge will be the biggest beneficiaries. One would assume Amazon will get it’s act together and acquire something.

We’ve already seen gross margin pressure as a result of the shift to public cloud.

This is now going to be compounded with an impending AI tax. They have no choice but to pay to meet expectations or invite competition to win on differentiated high leverage tech. All the while, margins and efficiency are meant to be improving.

The second impact is roadmap impact. There are many markets and market segments these providers need to now defend. They’ve tackled these problems to-date with incremental roadmap improvements in most. and focused energy in building for net new to unlock. The issue is the step change in AI may require them to defend on too many fronts all at once.

If you’re in these shoes, you have two choices — you peanut butter across your entire market segment or you double down on your biggest and most profitable segments. That’s going to invite new entrants.

Enter Verticalized SaaS — Unbundling the incumbents

HR for Healthcare. CRM for Financial Services. IT Workflow for the Automotive industry. OK, maybe not the last one.

The ability to drive deeper more valuable product experiences is simply much richer in Verticalized SaaS.

Customers are left with a few different problems in todays world:

• Implementing on generic core systems is much more time consuming and expensive
• The promise of SaaS was reducing operational complexity and handing it off to the vendor. There is increasing reliance on custom and homegrown solutions adding features that the core vendors aren’t delivering on

The challenge for the big players will be how do you deliver competently in market segments with very different requirements. Consider a HR system that has to cater for mostly desk working technology companies on monthly salaries vs a healthcare industry with a huge percentage of deskless workers & a huge set of workers with a much more complicated set of variable pay requirements.

History rhymes more than it repeats

We’ve seen this before. Many times.

So, do you end up like Coca-Cola and Walmart with verticalized competitors alongside you like Red Bull and Home Depot? Or do you end up like Sears, which withered before COVID even got it’s hands on it.

We’ve seen this even more recently in tech. The craigslist unbundling maps are popular in techland to show what happened the original classifieds homepage on the internet.

But how do you behave if you’re the incumbent? I don’t think there’s a silver bullet. But “maturity” and starting to value operational excellence feels like it’ll become critical if not existential. There are many amazing examples of big horizontal operators — Walmart and Amazon to name two. They don’t look or operate anything like the current set of horizontal SaaS darlings.

This feels like it needs to come back to fundamentals. How ready are these players to embrace that?

AI will be the difference

Conventional wisdom in large enteprise tech was 80% is in the core, 20% industry specific. That 20% would often be managed by the customer in ancillary systems under their control.

The 20% though. That’s often the industry specific bits. Those are the bits that are going to create differentiation with AI. So, ignoring those in the future is a liability.

So what happens if that 20% is the most important bit?

It feels like vertical players will be invited in to gobble that up. And the 80% as well.