Vertical SaaS Founders Need to Think Big and Start Small

In the world of venture financing, market size is king. Investors look to a startup’s total addressable market (TAM) to gauge its growth prospects and this factor weighs heavily on their decision to invest and the cost of that capital. Because most companies in a VCs portfolio will fail, the winners must be successful enough to offset all the losses and generate a healthy return for investors. TAM serves as a good way to estimate the size of the jackpot if the company turns out to be one of the rare successes.

The question investors ask themselves is simple: what is the size of the revenue opportunity in the market and how can it be captured? A vertical SaaS founder’s answer will have important implications for their startup’s go-to-market strategy and long term prospects.

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In general, it is in the interest of both startups and their investors to target large addressable markets. The problems arise when founders assume that a large TAM must be attacked directly to fuel growth. This not only exposes them to more competition, it also results in a lack of focus that can undermine the usefulness of their MVP and reduce the chances of finding product-market fit. Instead, a founder should focus on dominating a clearly identifiable market niche that can serve as a foothold for attacking the larger market.

This is a pattern that can be seen in the trajectory of many of the most successful startups in recent years. Tesla didn’t start by building a generic consumer car that would compete for a slice of Ford and GM’s pie, it built a luxury EV targeted at a dramatically smaller market. Uber didn’t start by trying to dismantle the taxi industry, it launched a black car service that was closer to a limousine rental than mass transit. Their initial TAMs were a drop in the bucket compared to the TAM of consumer automobiles or intracity transit. But it was only by starting small that these companies became the juggernauts they are today.

In ecology, a niche is defined as an environment that has all the inputs a species needs to thrive — it has the right shelter, the right nutrients, the right climate, and so on. It is imperative for vertical SaaS startup founders to identify a comparably suitable niche in their market that will give them room to grow so they can eventually compete in the wider market. This means finding a relatively homogenous customer segment that has clearly defined product needs that can be serviced with the modest feature set of an MVP. This segment should be large enough (both in terms of ACV and the number of customers) to support the startup’s sales machine and no larger. That is the startup’s minimum viable market.

Launching an MVP into a market niche has several benefits. First, there is less competition because competitors are focused on serving a larger market rather than any one customer segment. Second, it creates focus around the product features because they are designed around the similar needs of a clearly defined customer segment. This, in turn, is likely to lead to higher customer satisfaction and lower churn, which will create network effects — customers in the same industry talk to each other — and help the startup gain traction in the market. Third, it provides the startup with the opportunity to eliminate bugs in its MVP and establish internal processes that will allow it to efficiently sell into a larger market.

It is a strategic decision for a vertical SaaS founder to launch their MVP into a market niche. But this does not mean they should ignore the larger TAM. The current opportunity in vertical SaaS is largely the result of VCs consistently underestimating TAM in many industries. Now the misconception that vertical SaaS TAMs are too small to lead to venture-scale outcomes is fading. That means vertical SaaS founders must still be able to demonstrate that they have a compelling pathway from their niche market to the larger TAM. And the best way to get big is to start small.

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