How SaaS Founders Should Be Thinking About Competition
For SaaS founders, success largely comes down to their ability to understand the competitive dynamics of their category and make the correct decisions on how to position their company. And for some looking to enter certain categories, that decision should be to simply not enter that category at all. The fact of the matter is, that the software market has become fiercely competitive. In many categories, a select few will dominate while the rest will struggle to gain market share and thrive. These variables all lead to one very obvious point, and that is positioning and competitive strategy must be a core element of a SaaS company’s overall strategy to succeed.
The Competitive Forces At Play
One of the hallmark traits of industries with unfavorable competitive dynamics is a low barrier to entry. And the software industry is one that has come to exhibit that trait. Getting a software company off the ground and a minimum viable product into the marketplace has become one that typically requires little capital, and an MVP can be released in fairly short order by a small number of developers.
Secondly, well-defined use cases and subsequent categories in B2B software have created a feature war and a price war. In a never-ending race to build a better product and win new customers, SaaS companies are constantly pushing out new features to build a more comprehensive and “better” solution. And are also at times providing deep discounts to win new customers and gain market share. In crowded categories, the aftermath is over-engineered products, downward price pressure, and commoditization.
A War Chest Game
In many instances, SaaS has become a war chest game, and companies that have access to the most capital usually win. In emerging categories, that capital gives companies the ability to roll out new features quickly, aggressively scale their sales and marketing efforts, and gain and retain market share at a faster pace. Furthermore, once they've reached a certain level of scale and continue to access that war chest of capital; they are able to build on their early success, establish brand awareness in their category, and set themselves up to be the only or one of a few dominant players leaving the laggards who were not able to access enough capital or move fast enough to perish. This has created a need to raise sufficient capital and do so at the right time to dominate a category and really thrive.
This is a harsh and unavoidable truth that many founders need to accept and quite frankly embrace. Either a company can access that capital at the right time and win the war chest game, or they need to pivot and plan accordingly. Venture capital firms and the fundraising process are major components of the competitive dynamics that are at play in the software industry. When founders are looking at their overall strategy, this needs to be taken into consideration. And while the easy answer is "Go raise money, and a lot of it," that's not always the best answer.
Leaders and the Long Tail
Given the competitive forces at play and the impact capital providers have on the software industry, it's often inevitable that a select few companies will dominate a major category. Take, for example, two very large and competitive categories: CRM and ERP. The global CRM software market is valued at $47B, and there are approximately 1,500 different solutions in the market. The top ten vendors account for roughly 60% of the overall market share, and the top 3 account for 34% of the same share. This means that the remaining 40% of the market is divided amongst roughly 1,490 companies. And if we are to take a look at the ERP space, it's a similarly sized market valued at roughly $45B with approximately 1,600 different solutions that are available in the market. Here, the top ten vendors account for roughly two thirds of the total market share, and the top three accounted for just over 50% of total market share. So, we’re looking at a scenario where 33% of the market share is available to the remaining 1,590 competitors.
Looking at the market dynamics in the examples above, it's not unreasonable to assume that the smaller players competing in the long tail will really struggle to succeed or even survive. What we can say definitively, is that players in the long tail in these scenarios will be trying to acquire market share with significantly less capital and resources and little to no brand identity. The fact of the matter is, that many software categories have these traits and are red ocean environments.
Stop Following The Herd
Trying to win business against the incumbents without a strong point of differentiation will be an uphill battle at best. Founders need to embrace this reality and devise a strategy that will enable them to realize a meaningful degree of success. They need to stop trying to compete with the larger players, stop trying to build a solution that the entire market can use, and rid themselves of the notion that they will build a $1B company. Because if you're playing in a hyper-competitive category and are underfunded, it's never gonna happen.
In order to succeed, there needs to be a significant mindset shift. The goal shouldn't be to build the biggest company possible or to dethrone the largest players. The line of thinking needs to shift towards focusing on strong points of differentiation and building a solution and value proposition that is highly compelling to a segment of the market. And the good news about this approach is, it's typically one that larger players won't embrace. Don't go out and try to build a “Better” CRM or ERP solution than the incumbents. Build a CRM or ERP solution tailored specifically to a niche that has unique needs when it comes to managing customer relationships or back-office operations and own that niche. Be maniacally focused on developing features, case studies, and marketing messaging that is highly compelling to customers in that niche. Over time, you will build a moat and defensible competitive position.
You don’t need a massive TAM to succeed. You certainly need one that is relatively substantial, but in highly competitive industries like software, building a solution that can be used by “Everyone” is a recipe for failure.
How To Differentiate & Own a Niche
Identifying a niche to go after or building compelling points of differentiation is not easy and certainly doesn't happen overnight. When we talk about niches and developing a solution tailored to a specific niche, there is more than one way to look at what defines a niche. The first and most obvious path is an industry vertical displaying a unique set of needs. The second less obvious path is a group of companies that exhibit a common set of characteristics or challenges to build a solution around. Of these two paths, the former is usually a better path to pursue. The reason is that marketing to and building strong brand awareness in one or a very small number of industry verticals is a much more feasible endeavor than marketing to and building brand awareness in a more loosely defined target market that spans numerous industry verticals.
Outside of differentiation driven by catering to the unique needs of a niche, differentiating and disrupting a category via a different type of solution is incredibly difficult to achieve. Yes, Salesforce was able to disrupt the CRM space and dethrone incumbents by building the first truly cloud-based CRM system. And yes, Magento was able to disrupt the eCommerce software space with their open-source platform. But these are rare occurrences and incredibly difficult to achieve. An attempt to disrupt and differentiate is great and I'm all for thinking big at times. But sound strategy requires pragmatically looking at things, and almost all of the time, the effort to own a niche and play in a somewhat insulated pocket of a broader category has a much higher likelihood of success.
It's also important for founders to understand what differentiation is not. “Cool” one-off features are not a point of differentiation. Having a more user-friendly interface is not a point of differentiation. Nor is having “Better” customer support. None of these are meaningful points of differentiation, and all of them are subjective. I've had conversations with dozens of founders playing in the long tail of a software category who truly believe that, in many respects, their solution is better for whatever reason than the large established incumbents in their category. What they fail to realize is their opinion of their software doesn't matter. The only opinion that matters is the market’s. So, unless there are truly meaningful points of differentiation that are highly compelling to buyers, the other attempts at differentiating and competing won't move the needle.
Thoroughly understanding the competitive dynamics of a software category should occur before anyone decides to enter a market, and should be an ongoing exercise over the life of a company. You cannot change the existing market forces, but you can change your strategy and how you embrace and think about competition. A sound competitive strategy, or lack thereof, can ultimately mean the difference between success, mediocrity, or even total failure.
I'm the Founder of Drive Equity Advisors, an investment bank specializing in M&A advisory for sellers and acquirers of IT and management consulting firms in the digital transformation space. You can learn more about the work we do at driveequityadvisors.com