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With a current global market valuation of $251.17 billion in 2022 and an estimated compound annual growth rate of 19.7%, the SaaS sector has been identified as one of the most dynamic and profitable industries in the world.
By offering software services to users through a periodic subscription model, SaaS firms allow their clients to access software through external servers via the internet to avoid the costs of storing softwares on their own servers.
In today's ever-changing economic climate, market leaders such as Salesforce and Amazon Web Services (AWS) have capitalised on the growing dependence on SaaS solutions across industries ranging from healthcare to insurance by offering a variety of applications and tools that will assist businesses in achieving targets such as minimising costs or improving scalability.
For this reason, it is important that firms understand the difference between the two SaaS business models that divide firms within this industry: Vertical SaaS and Horizontal SaaS. A strong understanding of these models and their corresponding case studies will allow businesses to determine which of these two models would be a more suitable fit for their company.
Horizontal SaaS firms provide software solutions to “common” problems that can be found across a spectrum of industries. Therefore, this model caters towards a highly diversified client base, consisting of clientele reigning from different sectors who are exploring solutions for a particular issue.
The contribution of SaaS giants such as Salesforce and Microsoft to the creation and growth of the SaaS industry established the horizontal SaaS model’s domination of this sector. Consequently, smaller SaaS firms that adopted this model face the threat of increased competition.
This challenge is exacerbated by the diversity of this model’s customer base, as using the software offered by horizontal SaaS firms should require little to no industry-specific knowledge. This greatly restricts the extent to which these firms can differentiate their product to make their solution “stand out”.
However, the size of the horizontal SaaS market also means that there will always be new issues emerging within various industries. It is simply up to SaaS firms to identify them and offer a solution.
Due to the highly competitive market structure of the horizontal SaaS sector, firms that adapt this model frequently exhibit low retention rates. Furthermore, the abundance of software solution alternatives available to clients may force horizontal SaaS firms to dedicate a larger proportion of their expenditure towards securing new clients, which leads to high acquisition costs.
For these reasons, growing SaaS businesses have become increasingly dependent on marketing and pricing strategies to improve their customer retention and acquisition rates.
Slack, a business messaging platform, marketed their horizontal SaaS solution through a “customer stories” blog. This blog explored how Slack provided an efficient solution for communication across a variety of industries, ranging from banking to ride-sharing, through diverse business case studies that explained how Slack improved the productivity of their individual operations.
Alternatively, the note-taking workplace known as Notion presents a features-based pricing model. This pricing strategy allows users to access the core functionality features for free (via their basic plan) whilst offering other paid plan options that are priced according to the features they offer. This pricing model allows new users to test their product while segmenting their services according to the feature preferences of their consumer base.
Conversely, vertical SaaS firms specialise in providing software solutions to “specific” problems experienced by a specific target market.This attribute, allows the model to cater towards a relatively smaller consumer base, consisting of clientele reigning from a particular industry or niche market segment.
This sector of the SaaS market is a comparatively recent development, as unlike the horizontal SaaS model which has existed since the creation of the SaaS industry, the vertical SaaS model was first introduced between the late 1990s and early 2000s alongside the emergence of cloud computing. Investors like Constellation Software saw this trend early and started investing in this space quickly.
Despite its youth, this model has showcased exceptional growth within recent years, with more vertical SaaS companies going public in the first three quarters of 2021 than any previous year.
As a result of the specialised solutions offered by this model and the comparatively small number of competitors, it is unlikely that firms within the market will encounter any direct competitors. Even when vertical SaaS firms target the same niche, it is probable that the SaaS solutions offered by each firm may target different issues. Hence, vertical SaaS firms are assumed to face an uncompetitive market structure.
However, the forecasted growth rate of this market suggests that it is highly likely that vertical SaaS firms will encounter greater competition in the upcoming years.
The scarcity of alternative solutions for a specific issue has resulted in the demand for the average vertical SaaS firm exceeding that of the standard horizontal SaaS firm. Therefore, vertical SaaS firms expend less time and resources on acquiring new clientele, resulting in lower acquisition costs.
Moreover, vertical SaaS firms prioritise customer satisfaction to secure stable annual recurring revenue, thereby leading to high retention rates amongst these firms.
To achieve these objectives, firms tailor their marketing campaigns to emphasise the industry-specific expertise they hold within their niche target market.
Guidewire is a cloud platform for property and casualty (P&C) insurance providers that offers an efficient solution to processing insurance payments, resolving claims, generating reports and producing customer analytics.
The platform dedicates over 35% of their product revenue towards research and development, while utilising the expertise of over 800 insurance consultants and 10,000 partner experts. This ensures that they hold a stronger understanding of the specialised issues faced by P&C insurance firms and are able to produce a more efficient solution than their competitors. For this reason, Guidewire has become one of the most demanded platforms in its field, with over 500 clients across the world.
Clio presents software solutions to legal firms that focus on enhancing the efficiency of their management methods. The tools offered by their software assist these firms with retaining and engaging with clients, overseeing billings and collections, and managing cases.
Through their consultant programs and partnerships with law societies, Clio interacts with and sources information from professionals in the legal field. This allows Clio to formulate solutions to the primary issues faced by legal firms of various sizes, ranging from solo practitioners to to mid-size or large firms.
As an entrepreneur hoping to break into the SaaS sector, it is essential to know the difference between horizontal and vertical SaaS models. By comparing the markets for both these models to the software services your business has to offer, entrepreneurs may determine which model would be more profitable to pursue based on where they may hold a greater competitive advantage within.
On the other hand, founders searching for software solutions must examine the respective advantages and disadvantages of engaging with either SaaS model, in the context of the specialised or general issue they hope to resolve. This will allow businesses to determine which SaaS model is more likely to offer a better fit for their search.
In summary, the SaaS industry is forecasted to present strong earning prospects for individuals who hope to enter it, while providing efficient solutions to a plethora of issues that will allow business owners to optimise their performance. Hence, it is as relevant as ever that we hold a comprehensive understanding of these two models which embody this lucrative sector.
Further resources: Why is SaaS the sunrise sector for this decade, Are you considering vertical and horizontal SaaS as a consumer or creator?, How Notion is Winning at Enterprise SaaS by Building Community, Vertical SaaS 4.0 - The Great Game (Theory)
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