The top metrics for vertical SaaS companies
The beauty and chaos of vertical SaaS
Horizontal vs Vertical
You can’t be everything to everyone. I’ve tried - just ask my in laws.
In all seriousness though, that’s kinda what Horizontal SaaS promises (or tries) to be. You can think of Horizontal SaaS as broad-based tech that is industry agnostic; a sales person at a Cybersecurity company can use HubSpot the same way a sales person at a Health Supplements company might use it. It literally tries to make all industries happy.
Vertical SaaS, on the other hand, takes a specific industry and caters its offerings to hyper-specific use cases: When a Hollywood director needs to process payroll for the cast, they don’t use ADP, they use Wrapbook.
Just as Vertical SaaS is purpose-built for a specific end consumer, the application of metrics must be deliberate as well. This is due to the nuances in Vertical SaaS go to market models, end consumer buying habits, and underlying data structures.
The beauty and chaos of vertical SaaS
If a a Vertical SaaS provider owns a control point, like a CRM or quoting software for a merchant, it can build an unfair opportunity to sell multiple products to the same customer overtime.
And that’s, like, super cool and stuff, since multi-Product companies enjoy higher ARPU, LTV, and net dollar retention rates as a result.
When done right, what may have initially appeared to be a small-ish TAM becomes much, much larger.
And better yet, that now big-ish TAM has less competition than Horizontal SaaS (speaking of that - I heard there’s a 74th competitor to Monday launching next week… but (wait for it!)… this one incorporates AI). Although cornering the market can take a longer time (vertical SaaS abounds with “ten year over night success stories”), it can result in healthier unit economics and durable long term total market share compared to Horizontal SaaS.
This guide covers the metrics you’ll want to keep a close handle on when scaling a Vertical SaaS company. Some of these metrics you’ve probably heard of before, but we’re looking at them today specifically from the perspective of a Vertical SaaS operator.
Quick rant - if I have to deal with one more FP&A black box that thinks my GMV is Revenue, I’m going to flip the game table and just go home.
Vertical SaaS companies have long been left by the wayside when it comes to software for strategic planning. Yes, there are a myriad of horizontal FP&A tools, but to a hammer, everything looks like a nail.
That’s why I believe Abacum is doing it right when it comes to understanding the nuances of how you sell whatever it is that you sell, and whom you are selling that ‘ish to.
Abacum is empowering finance teams across several industries (e.g. Vertical SaaS, marketplaces, mobility, fintech, health-tech) to create that aha moment of when you seamlessly integrate all your business systems. So before you embark on the annual planning cycle for 2024, create your single source of truth today!
1/ AOV (Average Order Value)
AOV = Total revenue / Number of transactions
Many Vertical Software companies are involved in high velocity transactions with smaller basket sizes. For example, a Horizontal Software company may sell a productivity solution for product managers with an AOV of $15,000 (e.g., Asana, Monday, Clickup). But a Vertical software company like Toast may only charge the end merchant a few hundred dollars to the end merchant per month, and make the bulk of it’s revenue from a take rate on a high volume of $100 dinner orders.
There are two ways to increase average revenue per user - increasing average order size (more taquitos) and increasing velocity of orders (more customers buying taquitos). The first is harder to do - to use another example, Mindbody might not be in a great position to get people to buy higher priced gym memberships, but it sure can help the gym sign up more people, faster.
2/ ARPU (Average Revenue per User)
ARPU = Total revenue / Total users
How much wallet share can you gobble up per customer? This metric aggregates the AOVs across multiple products. It’s important because vertical SaaS companies are inherently multi-product and can stack multiple AOVs from one customer.
And when you own multiple sides of the equation, you can measure ARPU for both sides of the transaction:
Average revenue per supplier
Average revenue per customer
You can increase ARPU by getting a customer to buy more of the same product, increasing the price of the same product, or selling them additional products.
Stack ranking customers by ARPU is a healthy exercise, as it points out any customer risk you may have; a large portion of your sales may be reliant on just a few nodes in your network. This can be a potential point of friction when it comes to negotiations (“give us a better price!”), and presents execution risk to hitting your plan (“OMG, Customer x got hit by a bus!”).
3/ Product Attach Rate
Product Attach Rate = Total Products Sold / Total Customers
In contrast to their Horizontal peers, Vertical SaaS companies are well positioned to capitalize on a product “layer cake” strategy. The goal is to get customers fully embedded on one core product and “attach” to others in the portfolio over time.
Most vertical SaaS companies start by solving one specific use case for one industry persona, and then expand their offerings to cover other aspects of their day to day workflow. The thinking is that if you become the trusted source for one core job-to-be-done, you can more easily cross-sell other products, some of which will appear free to the end user (like payments).
The most common products vertical SaaS companies attach to their initial “Control Point”:
Consumer Payment Processing: Toast helps restaurants get a better credit card processing rate and then keeps a percentage of the interchange from each bill.
Lending: Mindbody will help gyms pony up the cash to buy that expensive Lats machine so you can get those massive gains.
Data, Analytics, and Benchmarking: The initial product a vertical software company offers is usually sitting on a treasure trove of industry specific data. And data is the new oil. For example, if you’re already helping schedule what jobs gets done on the auto bays, you can probably help the mechanics get a better grip on the labor required to complete the job, and maybe even the prices they are paying for the parts. Guidewire does something similar, where they’ll use the data they gather to help insurance companies benchmark their insurance claims.
Payroll: Procore helps contractors pay everyone contributing to the job site. Payroll is largely looked at as a commodity service, and if businesses can save time, consolidate vendors, and have a slightly better experience, it’s an easy cross sell. According to Bessemer, there’s $10 - $25 per employee per month up for grabs on the payroll side of the equation. That’s a lot of dough at scale.
4/ Take Rate
This is your commission from each transaction you facilitate.
Take rate = Net Revenue / Gross Merchandise Volume
In general, intermediaries that facilitate frequent, lower-cost transactions tend to charge a lower take rate across a lot of transactions, Kayak. While intermediaries that facilitate infrequent, high-cost transactions, like Airbnb, charge a lower take rate on a higher order value.
Some general ranges:
Marketplaces: 10% to 30%
Platforms: 5% to 15%
Aggregators: 0.5% to 5%
You are rewarded for the level of work you have to do, the risk you take on, and the network effects you generate.
Keep an eye on take rate - it defines the power dynamic between company and customer.
Many vertical SaaS companies depend on payments. MindBody actually makes more off processing gym payments compared to the monthly subscriptions facilities pay to use the cloud based service. Vertical SaaS companies may also charge a take rate to suppliers they connect to end merchants.
Vertical SaaS companies eventually are pressured to bring their take rate down over time as volume scales, unless they can find a way to demonstrate their value through other mechanisms - like advanced analytics or bringing more end merchants to the supplier (net work effects).
Overall, the more tasks the marketplace takes on in creating the match, the higher its take rate. Here’s a visualization of these processes and the ever-expanding role of the marketplace:
5/ Month 1 Churn
Month 1 Churn = (# of 1st time customers from Month 1 who buy again in Month 2) / (# of total 1st time customers in Month 1)
For paid users, how many try you in one month and then come back within the next 30 days to purchase again?
If you have 100 new customers in January, and 85 come back to purchase again in February, you have a month 1 churn rate of 15%.
You want to drive this down as low as possible so you don’t burn through your market. Since vertical SaaS users are not inherently technology buyers, they don’t come up for new purchasing decisions that often (maybe every 5 or 10 years). So if you get them to try, you really want them to stick around so you can eventually sell them even more products.
You unfortunately don’t have as many at bats as a Horizontal Software company. But the upside is if you can get them to fundamentally change their user behavior (e.g., put down the phone and start ordering online) they are very sticky.
6/ CAC (Customer Acquisition Cost)
CAC = ($ Last Period’s Sales and Marketing Costs) / (# This Period’s New Customers)
How much money do you have to put out into the world to land a customer? Different marketing channels will have different CAC’s.
7/ CAC Payback Period
($ Previous Period’s Sales and Marketing Expenses + $ This Period’s COGS) / (This Period’s New + Expansion ARR) x 12
($ Previous Period’s Sales and Marketing Expenses) / (This Period’s New + Expansion ARR x % This Period Gross Margin) x 12
How many months does it take to recoup that initial cash outlay. Ideally this is in the single digits if you a vertical SaaS business serving independent merchants. The smaller your customer’s AOV is depending on their segment (SMB, Midmarket, Enterprise) the lower you want your payback period to be.
8/ LTV (Lifetime value)
$ Average Annual Revenue per Account / % Average Account Churn Rate x Gross Margin
Traditionally Vertical SaaS buyers have high lifetime values because they don’t churn. If someone is only making a technology decision every 10 years (think: the car mechanic down the street from your house), you have a high customer lifetime value, and they keep paying down their original CAC over and over again. Speaking of that…
9/ LTV (Lifetime Value) to CAC
LTV / CAC
This goes up as you upsell more products to the same user and gobble up more wallet share. It estimates the total amount of money you’ll get from a customer before they churn out.
If you have expanded your layers to cover both the end merchant and customer, you’ll want to measure CAC and LTV on both User and Supplier sides.
10/ Net Dollar Retention
NDR = (Total ARR to start measurement period + Expansion Dollars from those Customers Onboard at start throughout measurement period - Churn from those customers - Shrink from customers those customers) / Total ARR to Start the measurement period
A Net Retention of 130% essentially tells you,
“If I packed up shop and didn’t sell another thing for the next year, I’d still grow by 30% ”
That’s pretty powerful. Anything over 100% is future growth embedded into your business model. Net retention plays itself out as either a dividend or a tax on every customer you acquire, and the more customers you acquire over time, the more this stacks up.
The simplest way to think of it is selling either more licenses or more products. We can actually decompose Net Retention into four distinct levers:
You decrease churn (Gross Retention)
Your customer buys more products (Cross Sales)
Your customer buys more licenses (Product Penetration Pricing)
You drive more usage of a product they already bought (Volume Pricing)
NDR is inherently higher for usage based products where the end merchant tries in smaller increments and then scales their spend month over month as the product becomes a part of their core workflow.
11/ Royalty COGS as a % of Revenue
$ Royalty and Data Payments / $ Revenue
Vertical SaaS companies typically pay for data from other industry players. This could be from a supplier (what are inventory levels?) or from a manufacturer (what are the correct part measurements we need for quoting?). This can add up over time, and can become a run away train if it scales directly with revenue.
That’s why it’s important to decompose your COGS into buckets so you can track each individually. For Vertical SaaS companies, I think of gross margin in three buckets
People: Customer support
Cloud Infrastructure: AWS or GCP
Data: Data feeds
Qualitatively this also reveals where you have platform risk and reliance on third parties.
12/ Customer Activation rate
Your product activation rate is the number of users who do something specific to extract value out of your product. Following user acquisition, product activation is one of the most important concerns you should have when running a marketplace.
You want to make users "successful" as fast as possible, since 66% of new users abandon apps within the first week of install.
Etsy encourages brand new users to begin browsing and favorite items they find interesting. Etsy’s onboarding flow is centered around doing this particular action. The flow makes it clear to the user that favoriting items is linked to better recommendations.
The faster a user is to book a ride, update their user profile, and make a purchase, the lower the probability they'll churn (or forget about you). Define your "aha" moment and get users there as fast as possible.
According to OpenView and:
Each company will need to create their own definition of activation that fits with their specific product. In my experience it should be something that:
(1) is easily achievable by somewhat committed users,
(2) can be completed within the first week from sign-up,
(3) is predictive of future conversion/retention, and (4) is correlated to business performance. 20-40% activation rates are common.
13/ Quarter-on-quarter change in net new ARR (Annual Recurring Revenue)
QoQ Change in Net New ARR = Gross ARR Adds in Current Period - Gross ARR Adds in Previous Period
This metric indicates to what extent a business is growing linearly versus exponentially. Hyper-growth companies will see the change in net new “ARR” getting larger and larger each quarter.
If you went from $8M to $11M in Q2 and churned $1M, your change in Net New ARR would be $11M - $8M +1M = $4M.
You could also just look at the net new + expansion deals your sales team added
You want to raise a round of funding after coming off a quarter of increasing additions.
This demonstrates non-linear growth
So if in Q3 you go from $11M to $15M while churning $1M, your change in Net New ARR accelerated from $5M to $4M, or plus +$1M
$15M - $11M + $1M = $5M vs $4M in prior quarter
14/ ARR (Annual Recurring Revenue) per FTE (Full Time Employee)
Total ARR / Total Employees
The SaaS industry seems to love complicated metrics. I’d be lying if I said I don’t love a few of them, too. But increasingly important one is dead simple: ARR per FTE. This is a metric you can’t hide from.
Vertical Software companies are often encouraged by their investors to be more efficient than their Horizontal peers on a per employee basis, since they collect less dollars per transaction serving SMB merchants, and may be limited in TAM if they can’t stack products.
15/ Growth Equation
Growth Equation = Locations x ARPU
This is one of my favorite new metrics to track, and comes from the smart people at TideMark Capital. I think it’s important because many Vertical SaaS companies are dependent on hyper local network effects, which means they need to have sufficient liquidity in a specific geographic area.
Locations is a more atomic metric than customers because it takes into account how many actual retail storefronts (hotels, restaurants, etc.) exist. Scaling locations can be challenging because small businesses have fewer resources and tend to be local. Having strong product-led growth, performance marketing, or an efficient salesforce (inside and local) is critical. ARPU (Average Revenue Per User) is the dollar value that the VSV can charge its merchant customer. It is one of the most exciting opportunities in Vertical SaaS, as a VSV is often well positioned to cross-sell multiple products and financial services to the same merchant customer. A great VSV has multiple products being utilized at multiple locations, all by the same SMB customer.
16/ Cumulative Churn
Cumulative Churn = (January Cohort’s # of previous customers who have not purchased in the last 12 months) + (February’s Cohort’s # of previous customers who have not purchased in the last 12 months)…. etc.
How many merchants have tried you and haven’t come back within the last year? You should track this every month to see if that month’s cohort is going up or down compared to previous periods. And then you should sum up the total of all months over your company’s lifetime to see what percentage of your TAM you have penetrated and churned. You want to be careful you aren’t burning through your market.
17/ Trailing 4 Month Lead Conversion Rate
Lead Conversion Rate = (# of month 1 leads converted in month 1 + # of month 1 leads converted in month 2 + # of month 1 leads converted in month 3 + # of month 1 leads converted in month 4) / (Total Number of Month 1 Leads)
An important concept in Vertical SaaS is the Limited Lead Pool, since the end market is finite. You want to avoid building a GTM engine that burns through leads, as stated above.
Most Vertical SaaS companies rely on high velocity, inside sales motions with short sales cycles. That means that you should have a pretty good handle on how many of a specific month’s leads were successfully converted or not after the fourth month.
500 total leads are generated in Month 1
100 of the leads buy in the same Month (wow!)
50 of the leads buy in Month 2 (needed a little more love)
25 of the leads buy in Month 3 (the laggards)
10 of the leads buy in Month 4 (better late than never)
4 month lead conversion rate = 185 / 500 = 37%
Track if this goes up or down each month
18/ Estimated Market Share
Here’s the rub when it comes to Vertical SaaS companies - detractors will quickly point out that the total addressable market (TAM) is smaller compared to horizontal SaaS companies, which can gobble up similar customer personas across multiple industries.
However, there’s usually less competition in these “smaller ponds” for a consumer specific solution. For example, ServiceTitan wasn’t exactly in a knife-fight over HVAC workflow when they first started out. So the idea here is you can get a higher percentage of a smaller market if you stick with it.
There’s also the argument to be made that you can own multiple layers of the value chain, such as payments and payroll. So in essence, vertical SaaS companies are eating up market share by going, well, vertical, instead of horizontally across multiple industries.
Anecdotally, in most horizontal SaaS markets, the industry leader taps out around the mid-teens when it comes to total market share.
ACV Auctions is on pace to capture 14% already, and has a real shot at aggregating more than 20% of their auto auction market. In fact, for vertical SaaS, the industry leader may be able to get to 40% or more.
Quote I’ve Been Pondering:
“Victory to me is when you spend your time right,
Victory to me is when you get your grind right.
Victory to me is when you get your mom’s right”
-Face the World by Nipsey Hussle