SaaS is Just Getting Started
The Catalyst team has been investing together for 20 years. While the fundamental strategy has remained consistent (growth-driven returns, enterprise technology focus, research-based approach), Catalyst’s areas of interest have evolved over time as a result of ever-changing technology and the competitive landscape. One sector that has been and continues to be of particular interest is cloud software – SaaS. The SaaS business model has gained a tremendous amount of acceptance, both within the business world and the investor community. With the amount of success the SaaS business model has had to date and many of the large markets already staked out, it’s easy to conclude that SaaS has matured. We disagree with that narrative.
Looking at it objectively, it’s clear that we’re in the second or perhaps third inning of this exciting cloud software story. Per the 2018 Morgan Stanley CIO Survey, only 22% of application workloads are in public cloud environments at Fortune 500 organizations. Smaller organizations are even further behind in adopting SaaS than enterprises; businesses with fewer than 50 employees spend less than 42% on SaaS per employee as those with 1000+ employees. Moreover, the integration of new technologies like Artificial Intelligence (“AI”), voice recognition, Machine Learning (“ML”) and the decreased cost of cloud-based workloads are making the shift even more compelling.
A few emerging themes in B2B SaaS we’re excited about now include:
- The Verticalization, and Sub-Verticalization, of SaaS: Catalyst has invested and continues to invest in software companies that focus on niche, vertical markets. The rapid increase in cloud software adoption and mobile broadband connectivity have made markets that we and other investors previously overlooked become interesting. Catalyst recently partnered with eSUB, a SaaS business catering specifically to subcontractors within the construction industry. We believe we will see an increasing number of businesses that not only focus on specific verticals, but on specific players within those verticals.
- The Local Economy: While the progress in the fields of information technology over the last few decades has had a profoundly positive impact on society, one negative aspect is that a handful of Internet giants have leveraged their monopolistic market presences to extract more margin from their local business customers than the value they provide. There is a massive market opportunity to right this wrong by building tools and software that enable local businesses to wean themselves from their dependency on the Internet giants. One Catalyst investment along this theme is ChowNow. By unbundling online ordering from lead generation and charging its customers a fixed, monthly fee rather than the take rate model of most of its competitors, ChowNow creates a “win-win” scenario for its quick service restaurant customers.
- Penetrating Enterprise Outside of IT: One implication of the cloud is that it renders the large software incumbents’ primary strategic advantage – their existing relationships with their customers – less meaningful. In the on-premises era, software giants such as Oracle and SAP offered customers integrated solutions, simplifying management for them. This in turn empowered IT departments to push software down to business users. As enterprises increasingly embrace the cloud, business users are getting greater say over the applications they live in. SaaS companies that appeal to business users, such as Slack and Zoom, can take market share from incumbents by growing virally throughout organizations.
- Going Down the Stack: As Catalyst highlighted in our recent API Economy research piece, we’re seeing an increasing amount of opportunities to invest in businesses that go “down the stack” by providing either infrastructure that enables disparate software systems to speak to each other, or otherwise delivering their technology as a platform for partners to build on top of.
- Building on Platform as a Service (“PaaS”): The other side of the coin of the above is building applications on top of third-party middleware and web services. Catalyst portfolio company Fusion Risk Management operates on Force.com. Leveraging Salesforce’s technology on the backend allows Fusion to focus its development resources on productization. Salesforce’s reputation for world class data governance enables Fusion to sell to otherwise startup averse risk departments.
- Rethinking Subscription: A critical element of the SaaS business model is that, unlike with the perpetual license model common for on-premises software, revenue is contracted monthly or annually. More and more SaaS businesses have broken from that convention and are instead charging for their services on a per API-call basis (see Twilio) or otherwise generating a significant portion of their revenue from overages or processing fees, therefore mimicking a transactional business model (see Shopify).
- AI Enabled: The term “AI” has become a buzzword over the last few years. We believe Catalyst’s opportunity to benefit from the emerging class of technology is less so to invest in the businesses seeking to plow tens of millions (or even hundreds of millions) of dollars into R&D to design the algorithms, and more so to find businesses that implement third party AI services into their software to improve existing processes. Catalyst portfolio company Envoy Global is doing just that by leveraging the Azure Machine Learning web service to power its case automation.
We believe SaaS is just getting started. We are excited to continue finding and investing in B2B SaaS companies, particularly those that are taking advantage of the themes described above.