Building an end-to-end service or product in vertical markets will capture a greater portion of the economic opportunity.
Ian Rountree at Cantos wrote in 2022 that:
“If established industries were to be transformed, selling tech to the incumbents wouldn’t be enough. You needed to become the new incumbent.”
At Levante we agree, but argue that this model isn’t confined to deep tech or physical products. Vertical markets have seen large software outcomes in markets with high margin or high ACV end customers like Veeva in pharma, ServiceTitan in HVAC and CCC in insurance. These companies did well building and selling software to large incumbent players in their industry.
However, startups targeting the longer tail of more fragmented industries with less spending power and / or high margin customers that have lagged in cloud transition find themselves with long sales cycles, high structural churn and an inability to capture meaningful customer GMV through SaaS pricing. At Levante we believe vertical companies can unlock large transactional volumes by building end-to-end solutions that directly touch the end customer, instead of selling to intermediaries.
Two years ago I angel invested in Talkiatry, building a full-stack, technology-enabled psychiatry practice. If Talkiatry had been trying to sell monthly SaaS solutions for the 56,500 psychiatrists in the US to manage their operations, we’re looking at a tiny capture-able revenue opportunity. Maybe they could offer payments solutions, a patient portal or some other upsells to try increase ACV, but that would come at the cost of longer sales cycles and expansion of their competition base. Just look at Clover Health for how this model can go so wrong.
Instead, Talkiatry hires psychiatrists full time as W-2 employees, and builds out a full stack operations system including billing, scheduling and tele-health solutions. This allows them to capture the entirety of the billed insurance claims which averages $300,000 per psychiatrist, implying a $1.7B revenue opportunity. The company has scaled to >$150M run-rate in three years.
Similarly one of my first investments at Hummingbird was into OneCard when it was pre-revenue, and is now a $1.4B company. OneCard is a consumer credit business for underserved Indians. Instead of selling better underwriting software to incumbent banks, outsourcing its credit engine, transaction engine or customer sourcing, the company decided to build everything in-house, full-stack.
As you can see above, OneCard does everything. From building the consumer facing app, issuing cards, underwriting customer risk and handling disputes. This is both a more capital intensive approach and meant OneCard took longer to get to market than traditional consumer FinTechs, However, OneCard is able to control the entire customer experience by doing many things well at once. As a result it’s able to generate higher activation rates, higher interchange rates which drives more revenue capture than the industry average, with lower CAC through it’s free scoring app OneScore.
What Would This Look Like In Vertical Markets?
For example, roofing is an obscure but large market where vertical software companies like Roofr have tried to digitize the industry. Roofr is a great business, but again hard to see how they can capture meaningful share of the $28B roofing market in the US using SaaS. With 79,000 roofing contractor businesses and Premium pricing of $149 per month, that implies a $141M revenue opportunity at full market penetration: 0.5% of industry GMV.
Instead of selling software to contractors, what if you became a full-stack contractor yourself? An end-to-end roofing company, powered by technology, serving end-customers directly. That’s what Renovate Robotics is looking to do. Their first product, Rufus, is an automated roofing robot that installs asphalt shingles 3X faster than a human roofer. The initial GTM is a subcontractor, licensing their technology to roofing contractors.
As hardware and robotics costs continue to decline, there’s a future where Renovate can take on the job themselves as the contractor, but with superior unit economics given their reduced labor requirements and faster job completion rates. Instead of charging $149 per month for software, Renovate can capture the full $16k average roofing job contract. With 1M new homes being built a year, Renovate would need to capture only 6.3% of this work to generate $1B in annual sales. That number isn’t even possible with the SaaS model in that industry.
This would require them to take on a lot more as a company beyond just hardware: licenses, permits, insurance, customer acquisition (and trust building to leave the work to a robot), materiel procurement, invoicing, collections and much more. Only the most ambitious founders will be drawn to these kinds of challenges, which makes it easier to filter as an investor.
Price Dislocations In Full-Stack Approaches
Similar to Cantos’ thesis that successful hard and bio-tech companies experience step functions in revenues, at Levante we believe growth in end-to-end vertical startups will be irregular and difficult to value at the pre-seed and seed stage.
For hard and bio-tech companies this dislocation is driven by the fact that companies may have no revenue for 4-5 years before securing nine-figure contracts or purchase orders after solving for technical risk on product. For vertical startups, it will be driven by the fact that initial wedge markets look small until their end-to-end approach begins to unlock the larger profit pools in the industry.
Levante portfolio company Scotch is starting by selling point-of-sale systems into liquor stores. There are only 45,000 of these in the US, which turns a lot of VCs off. Even though Jake is a second-time exited founder, who was previously backed by Tier-1s, Levante led the deal at a $9M post.
What happens if Scotch starts to acquire the long-tail of alcohol distributors similar to Odeko in the coffee shop space ($0-$150M revenue in 3 years)? Now we’re looking at an additional $260B of TAM, better pricing for retailers to compete against the incumbent oligopoly of National Republic and Southern Glazer’s, who do between $10-$25B of top-line revenue each. Once this playbook starts to work, we think there will be a step-function in revenue driven by take-rate on procurement and the market opportunity will become clearer to VCs the way it did for Odeko who have now raised over $200M to build an end-to-end solution in the coffee industry.
It’s not a pure end-to-end play since Scotch wouldn’t be touching the end customer, but that’s a regulation problem rather than an ambition problem, given the three-tier liquor regulations in the US.