When Should Vertical SaaS Founders Build a System of Record?
The product roadmap for every new vertical SaaS company begins at a fork in the road. One of the branching paths leads to a system of record. The other to a system of engagement.
The direction a founder chooses will have far-reaching effects on their business. It will determine the complexity and build time of their MVP, the cost of capital, access to customers, and future expansion opportunities. If a founder selects the wrong starting point for their product, it can be a significant drag on the company’s prospects due to wasted time, capital, and labor. But the tradeoffs between building a SOR and a SOE are not always obvious.
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A SOR is typically defined as a software platform that serves as the single source of truth for a company. A SOR handles core business processes and data, which means that employees spend a significant amount of their day interacting with it. The first wave of SaaS SORs included companies like Salesforce, Workday, and Marketo, which were founded around the new millennium and have come to dominate their core workflow niches (CRM, HR, and marketing, respectively).
Systems of engagement are software tools that facilitate interactions between a company’s employees or between employees and customers. It is the software that sits between or on top of the core workflow software. SOEs frequently interact with a company’s core SOR and are in some sense dependent on its data.
SaaS companies can have great outcomes regardless of whether they’re building a SOR or a SOE. But it is critical for vertical SaaS founders to recognize the characteristics of their industry that tilt the balance toward building one type of system instead of the other.
One of the main reasons that vertical SaaS is such a lucrative opportunity is because many — arguably most — industries in the US lack adequate software built for their specific needs. This means that it often makes sense for vertical SaaS founders to build the SOR for their industry. Because a SOR covers the core workflows of its users, it has a natural stickiness and allows software companies to leverage workflow data and their strategic position between users and counterparties to build additional features that expand the market opportunity.
SORs are much more complex to build than SOEs. This can make a SOE look like a more attractive go-to-market strategy, but there are some important caveats.
- Most companies that launch with a SOE and plan to expand into an SOR never make that transition. The reason is simple: Engineering productivity drops precipitously after a company ships its MVP. Instead of focusing on building a SOR, engineers are servicing tickets from customers and incrementally adding features.
- SOE’s typically have a smaller TAM than a SOR for a given industry. This means that a vertical SOE must have a sufficiently large addressable market to justify building a more limited platform.
- A vertical SaaS SOE may require integrating with the incumbent SOR provider. That means that the new vertical entrant is fueling its future competitor’s growth while limiting its own competitiveness due to the previously mentioned engineering challenges.
Does this mean that launching a successful vertical SaaS SOE is impossible or that a SOR is always the right solution? Certainly not. It all depends on the characteristics of the industry.
In verticals where incumbent SORs dominate the market — such as hospitals — it can be reckless for a seed-stage company to go head-to-head with the existing providers. If the incumbents are sufficiently large (a $1B market cap is a fine heuristic), there is likely an opportunity for a new vertical SaaS company to build a SOE on top of the existing SORs. We’ve seen this happen in the construction industry, where Procore has established itself as the dominant SOR, which has given birth to a robust ecosystem of SOE companies such as Bridgit, Assignar, and Inertia.
Another important consideration is the size of customers in a given vertical. If the average ACVs are too large, it can be nearly impossible for a new vertical SaaS startup to sell a fledgling SOR. The customers will demand a more sophisticated platform before they are willing to go through the hassle of ripping out their existing software. These same companies may be willing to purchase a differentiated SOE, but this will require more industry expertise from the founder to identify relevant pain points in their customer’s workflow.
The main takeaway for vertical SaaS founders is that context matters when it comes to choosing between a SOR and an SOE. In industries that have plenty of small and medium-sized businesses that lack modern workflow software, new vertical SaaS companies should seize the opportunity to build a SOR for the industry. Otherwise, they should look for opportunities to build a SOE on top of dominant SORs as their main product or to gain a foothold in the market before launching an SOR.
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