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In my experience, among the countless strategic decisions that software CEOs must make, the decision of which end markets to serve doesn’t seem to command the time, attention, and level of thoughtfulness that it probably should. Leaders who run mature and established companies often take comfort in the product/market fit that their companies have seemingly already achieved, and as a result tend not to thoughtfully scrutinize the industries into which they sell their products.
More specifically, substantially every small or medium-sized software company must answer the following two questions:
- Should I sell to SMBs or to larger enterprises?
- Should I sell my product into a single industry vertical, or multiple industry verticals?
Though these are of course not the only questions that software CEOs must answer with respect to the markets that they serve, they tend to be among the most important and most frequently posed ones. The purpose of this blog is to speak to both of these questions in turn.
As with most things concerning running a company, neither of these questions are subject to any universal truths. Different contexts and circumstances often dictate different answers for different companies. Because of this, the purpose of this blog post isn’t to suggest that there is a singular right or a wrong answer to these questions, but is instead to ensure that the decisions you’ve made have been made on the basis of thoughtful and deliberate choices, not on the basis of what your company has always done.
Question 1: Should I Sell into SMBs or into Larger Enterprises?
The importance of thinking through this question isn’t necessarily based on the fact that one strategy is superior to the other (depending on circumstances, both can and do work). Instead, the importance of this question truly comes to light when you’re selling into one type of company but wish to expand into the other (for example, you’re currently selling into SMBs but want to expand into enterprises, or vice versa). As I will argue below, one of these transitions is much more likely to fail than the other.
Before we get there, it’s likely worth evaluating both sides of the SMB-vs-enterprise debate. What follows is a non-exhaustive list of why enterprises can make for great customers, and why SMBs can make for less desirable ones:
- They tend to have much larger budgets than their SMB peers
- Though there are exceptions to this, on average, I’ve found that enterprises tend to be sticker than SMBs. This could be due to their inertia, their unwillingness or inability to change quickly, their long and complex decision-making processes, or the fact that they tend to go out of business less frequently (most likely some combination thereof)
- There are more “land and expand” opportunities within enterprises: Often, the sale of a single product or module can lead to future sales of complimentary products or modules, so long as those customers continue to derive value from your products. What’s more, many large enterprises feature individual departments with unique decision makers that can also represent incremental revenue opportunities for you that would otherwise be much harder for you to access
- Your company’s proven ability to serve large customers often has value in the eyes of your smaller prospects (“if they can serve Big Company XYZ, then they’ll have no problem serving us”), and in turn can help you acquire a larger number of them
- Relative to SMBs, a smaller number of larger sales can hit the same revenue goal
- SMBs tend to have smaller budgets than their enterprise peers
- Though there are exceptions, on average, I’ve found SMBs to be slightly less sticky than enterprise customers (perhaps due to their faster and less bureaucratic decision-making processes, or perhaps because they’re statistically more likely to go out of business in response to things like external economic shocks)
- Fewer “land and expand” opportunities than enterprise customers
- Little if any “signaling” value to new prospects that you have the capacity to serve very demanding clients
- Very few SMBs possess “brands” that would be valuable in the eyes of prospects
- Relative to enterprises, a larger number of smaller sales is required to hit the same revenue goal
Of course, depending on the circumstances, the inverse may be true as well: Below is another list, though this time it attempts to support the opposite argument: Why SMBs can make for great customers, and why enterprises can make for less desirable ones:
- All else being equal, SMBs tend to have quicker and simpler sales cycles
- When you sell into a company much smaller than your own, you’re at least likely to have more leverage than your customers on things like payment terms, legal documentation, SLAs, and etc.
- From a product perspective, SMBs tend to be less demanding than enterprise customers (requiring fewer – if any – features & functions highly specific to their own use cases). SMBs are much more likely to use your products as they currently exist “out of the box”
- SMBs tend to be less demanding than enterprise customers post-sale, and as a result often command fewer of your internal implementation, support, and customer success resources
- Though this is admittedly an oversimplification, all else being equal, serving SMB customers is at least slightly less likely to produce customer concentration relative to the option of serving enterprises
- Sales cycles tend to be longer and more complex
- When you attempt to sell into a company much larger than your own, you often have less leverage on things like payment terms, legal documentation, SLAs, and the like
- In order to buy your product, enterprise customers often require non-standard features and functions, highly specific to their own individual needs, which can create technical debt within your code base over time (and if you’re unwilling to accommodate those requests, the proverbial competitor across the street almost certainly will)
- During implementation, onboarding, and ongoing support processes, enterprise customers tend to be very demanding, and often command more of your internal resources as a result
- Though this is admittedly an oversimplification, all else being equal, serving enterprise customers is slightly more likely to produce customer concentration relative to the option of serving SMBs
Which Type of Expansion is More Likely to Succeed? SMBs into Enterprises, or Enterprises into SMBs?
Though I usually tend to shy away from speaking in highly definitive terms, my opinion on this question is an atypically conclusive one: I think companies who currently serve SMBs and wish to eventually expand into enterprises are much more likely to succeed than companies who currently serve enterprises but wish to expand into serving SMBs (though note that neither transition can or should happen overnight. These transitions are usually reasonably gradual ones).
At the risk of overgeneralizing, the former type of expansion appears to be much more aligned with the natural progression of a company and its capabilities than the latter type: As companies grow and mature, so do their internal capabilities, and as a result, their ability to serve the needs of increasingly large and complex customers. In some cases, this transition is so natural and gradual that it can happen in the absence of much deliberate thought or effort.
This is true not only with respect to the company and its internal capabilities but also with respect to the products that they offer: In my experience, it is far easier and more logical to steadily build and expand a software product’s capabilities over time than it is to start out with a large monolith and pare down features, functions and capabilities to serve the needs of smaller companies with more homogenous use cases.
I learned this lesson the hard way when, in 2017, my company attempted to begin selling into SMBs despite our company’s DNA as one that sold into enterprises:
My company had operated for 20 years selling software to transportation companies that had, on average, 200 trucks, but typically ranged anywhere between 50 – 500 trucks. Everything about our company (our product, marketing, sales cycles, employees we chose to hire, etc.) was built upon the foundation of serving these larger customers. However, we eventually grew to become very excited about the smaller end of our industry, namely the 1-30 truck market. Specifically, we liked the size of it (it was orders of magnitude larger than our existing target market due to the unfathomably large number of small trucking companies that exist in North America). At the time, we thought: Didn’t it make sense to sell a smaller, simpler, cheaper product into a smaller, simpler and more price-conscious market (1-30 trucks)? If we already had developed the technology and internal capabilities to serve the sophisticated needs of large trucking companies, smaller trucking companies with simpler needs would be a breeze, wouldn’t they? And we wouldn’t even need to build anything new, all we’d have to do would be to remove the advanced features and functions from the products that we already had on hand!
What we eventually came to learn was that the 1 – 30 truck market was completely different from the market that we had spent 20 years serving. Even though both markets were engaged in fundamentally the same business activity, we learned that the smaller end of the market experienced completely different business problems from mid-market and enterprise customers. Not only that, but seemingly everything else was different too: The sales cycles, the decision makers, the approval processes, the levels of technological sophistication, the financial resources and wherewithal, the most pressing problems that they needed solved, and so on.
On top of all of that, we had an impossibly difficult time paring down the features and functions of our existing product suite, originally designed to serve the needs of enterprise customers: So much so that we were forced to effectively rebuild a new solution from scratch, which commanded far more resources that we were originally anticipating. It turned out that removing features and functions from an existing product was actually more difficult than starting from scratch and building them up over time.
In our pursuit of selling into a larger SMB end market, we ended up “over-reaching”, and pushed ourselves so far down market that we effectively violated the product/market fit that we had spent the past 20 years cultivating.
I recognize that one cannot and should not extract broad & generalizable lessons from a single experience, but I believe our experience was representative of the typical one when attempting to move down market.
Question 2: Should I Sell my Product into a Single Industry Vertical, or Multiple Industry Verticals?
Similar to our first question, there is also no unambiguously correct answer to this question that is true in all circumstances. However, as I will argue below, I believe that in the majority of cases, small and perpetually resource-constrained software companies are likely better off focusing all of their efforts selling into a single industry vertical as opposed to diluting those efforts across multiple verticals.
When I first took over my own company in 2014, we sold our document management software into 5 separate verticals (Healthcare, Financial Services, Insurance, Education, and Transportation). By the time we sold the company approximately 7 years later, we sold into only one (Transportation). Focusing the business to just serve this single vertical might have been one of the best decisions that I made as CEO. We did less so that we could achieve more.
Below, I walk you the variables that I considered in making this decision, in case some of them are applicable to your own experience. Note that none of the variables below, in and of themselves, is likely to suggest that you’d be better off focusing on a single vertical. However, if 2 or 3 of the following 5 variables suggests that you might, it’s at least a question that is worthy of your consideration.
(1) In Which Vertical is Product/Market Fit Most Apparent?
One way to quickly test the product/market fit that you’ve achieved within each of the verticals that you serve is to look at your existing customer base, and calculate what percentage of revenue (on a dollar basis) you’re deriving from each end market. You can complement those efforts by doing the same calculation on a simple count basis.
To take it one level deeper, you can do the same exercise for only those customers that have been acquired over the past 2-5 years (this will strip out the effect of having “legacy” customers acquired 5+ years ago who may be unlikely to purchase your product if faced with the initial purchase decision again today).
Do any of these calculations suggest stronger Product/Market fit in one vertical versus the others (i.e. is one vertical over-represented)? In our case, almost 80% of our customers and revenue were derived from the Transportation industry, so it became clear that despite the company’s attempt to diversify its revenue base across multiple verticals over many years, no other vertical managed to achieve the level of Product/Market fit that had been achieved within Transportation.
(2) Is There Evidence of Asymmetric Resource Allocation?
The resources that you allocate to each of the verticals that you serve should be roughly commensurate with the revenue that each of those verticals generates (1). Resources can include people, marketing dollars, sales efforts, product features, and so on.
In our case, transportation was delivering ~80% of our revenue, yet was only receiving approximately 20% of our resources, as we divided our efforts roughly evenly across each of our 5 industry verticals. Without even opening a spreadsheet, this was highly suggestive of Transportation being our most profitable vertical, and similarly suggestive that the other 4 industries may not have been profitable at all (by each demanding 20% of the company’s resources yet producing less than 20% of the company’s revenue).
This “back of the envelope” math was sufficient for our purposes at the time, but ideally, you’d want your CFO to set up your accounting system to allocate costs and revenues across each of the end markets that you serve so that you can get a much more precise view of the profitability of each. I recognize that many SMBs don’t yet have this level of sophistication within their accounting systems, but this is a goal to which you can eventually strive if nothing else.
(3) Can you Compete Against Increasingly Specialized Competitors?
If you operate within a growing industry, you can be sure of one thing: It will become more competitive over time, until such time as it becomes so competitive (and so low margin) that new entrants will be dissuaded from entering said industry. With more competition comes more demands from your customers and prospects for the product features, functions, and specs that they just saw from your competition. If you’re selling into multiple end markets, it’s likely that you will have competitors operating within each end market on a dedicated basis, and hence over time, their product features, functions, and specs will become more tailored and more attractive to customers in that industry. Do you have enough resources to be the best (or close to the best) in 5 different end markets, each of which may have a growing ecosystem of competitors who may be focusing only on one of those markets?
In our case, through a series of win/loss analyses with prospects, we learned that we were losing deals outside of Transportation because software vendors across Healthcare, Education, Finance and Insurance had become increasingly specialized within each of those specific verticals. It thus became increasingly difficult for a “generic” document management software provider like us to compete against these increasingly specialized vendors. If we did want to compete in these other markets, we would have to be able to offer comparable product features & functions, as well as comparable marketing and sales efforts. In order for us to do that, we’d be required to invest massive amounts of capital (that we didn’t have) into our product, sales, marketing, and product management efforts. And these investments would have to be made in the context of reasonably limited traction in each of these markets historically.
We strongly suspected that, in our specific circumstances, we couldn’t win 5 simultaneous fights. But we were pretty confident that if we chose just one, we’d have a puncher’s chance at the very least.
(4) Does Your Current Approach Scale?
It is often (rightly) said that it takes one skill-set, strategy, management team, and mindset to build a business from, say, $0 in revenue to $1M in revenue. It takes a different skill-set, strategy, management team and mindset to take that same business from, say, $1M to $5M in revenue. And an entirely different one still to take that same business from, say, $5M to $25M in revenue. And so on.
It’s perfectly reasonable to expect that when an entrepreneur first creates a business from nothing, she chases every dollar that she can find, says “yes” to whatever customers ask of her, and doesn’t discriminate much between end markets (after all, nothing is more thrilling in the early days of a company than a customer who is willing to pay for what you’ve built). In this early stage of her company’s lifecycle, she’s iterating on both her product and her market, and may not care much where her revenue is coming from.
However, if that same entrepreneur were looking to grow her company from, say, $1M to $5M (or $10M, or $20M) in revenue, that mindset simply doesn’t scale any longer. As a CEO, she must operate and think differently in this phase of her company’s lifecycle relative to how she thought and operated when the company was still in its infancy. If she’s interested in exponential growth, she needs to find a product/market mix where she can build one product and sell it many times, as opposed to building a product once and selling it only once or twice (linear growth).
The rigor, discipline and intestinal fortitude required to say no to customers is often a good sign that a company is ready to scale. Simply saying yes to anything that can bring in money is often evidence that a company is likely to stay exactly as large as it currently is.
(5) Consider the Potential Positive Impacts of Focus Across All Departments
When we made our decision to focus only on a single industry, we quickly found that a lot of other things within our business became a lot easier. Our Marketing operation served as a good example: Our website became simpler, with greater clarity and more cohesive messaging. We went to fewer tradeshows, but had a bigger and more meaningful presence at higher impact, “must attend” Transportation events. We knew which prospect lists to purchase, what type of new collateral to create, which relationships we had to foster, which blogs we should write, and what user and buyer personas we should target. Within our sales group we had a clearer hiring profile, a more focused (and thus compelling) value proposition, easier territory creation & alignment, and most importantly we were asking our salespeople to become experts in only a single industry, not five industries simultaneously. Our new product and R&D efforts were simpler and more streamlined, we had more clarity around the new things that we should be building, we spent less time customizing things for specific customers, and spent more time on building products that we could “build once and sell many times”.
Consider the various areas within your own company, and ask whether they would experience any similar benefits from a greater degree of focus.
Risks (and Potential Mitigants) of Focus
The decision to focus only on a single end market should not be made lightly, and should include a very careful analysis of the risks in doing so. As mentioned above every company, industry, and circumstance is unique, and this may not be the best strategy for your company. Below are two of the more frequently cited risk factors, their potential mitigants, and some additional considerations to think through:
Risk 1: Why would we want to limit the size of our addressable market?
The size of one industry is likely much smaller than the combined size of multiple industries. Hence, one could argue that the size of the addressable market decreases if a company chooses a vertical market strategy characterized by focus. However, in choosing this strategy, the idea of course is that you will aim to achieve a larger share of smaller pie, instead of an infinitesimal slice of an enormous pie. Plus, any Business 101 textbook will tell you that when you attempt to sell all things to all people, you generally end up selling very little to very few
If you do choose to focus on a given vertical, you must gain comfort in:
- (1) Market Size: The industry in which you want to specialize must sufficiently large to support your revenue and profitability goals. Nothing kills a great idea faster than a small market.
- (2) Market Attractiveness: The industry in which you want to specialize must demonstrate attractive structural characteristics like a favorable competitive landscape, high barriers to entry, favorable regulatory dynamics, significant growth tailwinds, low capital requirements, and so forth.
Risk 2: What would we do with existing customers from other (non-focus) industries?
This is a trickier one: If you’re currently serving multiple industries, but wish to focus on a single one, it’s highly likely that your existing customers operating in other (non-focus) industries will begin to depart.
There is some element of an inescapable reality to this. However, below are some things that should make you less worried about rapid customer attrition. The more things on this list that apply to you, the less worried you ought to be:
- You generate a stream of recurring revenue from each of your customers (not just a simple one-and-done sale). This is one of the most important considerations of all, as many of the other considerations below flow directly from it
- Customers from non-focus industries are either not profitable, barely profitable, or significantly less profitable than customers from your focus industry
- Non-focus industries account for a higher percentage of total resources (time, people, etc.) relative to the percentage of total revenue that they generate for you
- The number of lost customers from non-focus industries will be met or eclipsed by the new customers acquired within the focus industry through more focused efforts across sales, marketing, and product (to name just a few)
- Historical customer attrition levels have been low (less than roughly 5%-7% annually on a gross logo basis)
- Your customers use your product very frequently (daily or weekly)
- Your product has high switching costs: It would either be very time consuming and/or very expensive for an existing customer to seek out another vendor (or build your product themselves)
- Customers in non-focus industries are in “maintenance mode” with your product, and rarely if ever request new specs, features, or functionality
- Your product is mission-critical for customers in non-focus industries, and any outage or disruption to your product would cause them material financial or operational harm
Among the countless strategic decisions that software CEOs must make, the decision of which end markets to serve doesn’t seem to command the time, attention, and level of thoughtfulness that it probably should. However, in my experience, being thoughtful about these two fundamental questions is likely time well spent.
Though a company can achieve success selling into either SMBs or enterprises, be careful about moving from one into the other, especially if you’re currently selling into enterprises but wish to expand into SMBs.
Similarly, though some software companies successfully sell into multiple end markets simultaneously, it is my opinion that, in the majority of cases, small and perpetually resource-constrained software companies are likely better off focusing all of their efforts selling into a single industry vertical as opposed to diluting those efforts across multiple ones.
(1) Note that this assumes that you have a relatively established presence within each of the markets that you sell into. If, for example, you’re trying to grow your presence in a brand-new vertical, it’s perfectly reasonable to be spending more on that vertical than the revenue that it’s generating for you – but over time, as you become more established within that industry, you should expect that equation to at least even out
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