A version of this article originally appeared on LinkedIn.
There are 30 million small businesses (“SMB,” which stands for Small and Medium-sized Business) in the United States and 125 million globally. Small businesses are the heart of the American economy and represent 99.9% of all businesses, employing nearly 60 million people (~50% of the U.S. workforce)(1).
Despite this, the SMB category was considered “off limits” for tech companies for decades—we’ll explain why below—while the majority of VC dollars poured into companies focused on serving large enterprise customers (the “Fortune 500”). Over the past 10 years, that sentiment has shifted dramatically, as companies like Square (~$30B), Shopify (~$17B), Zendesk (~$7B), RingCentral (~$7B), Wix (~$5B), and others have built multibillion-dollar businesses with a strong focus on the SMB category. In fact, our SMB Tech Index(2) of public companies has grown from an aggregate market cap of ~$15B in 2010 (with only Intuit and 8x8 public) to $200B+ in just the last eight years.
SMBTech is a category we've been betting on for many years, and we thought we’d share our perspective on why now—more than ever—it's an amazing category to be investing in. In short, we believe that the current $200B will grow significantly again over the next 5-10 years.
In the 1980s and '90s, as enterprise technology began to take off with companies like SAP, Oracle, and IBM leading the charge, almost all software was sold via direct sales. Venture dollars flowed into companies that were selling a myriad of solutions to large enterprises, as these customers had budgets that were large enough to justify the lengthy and expensive sales process associated with deals that often topped $1 million. I (Jeff) started my career in the 1990s at PWC during the era where large corporations regularly spent $25 million-$100 million+ on SAP implementations, often with mixed results (see this CIO article) and often very expensive lawsuits when things went wrong.
In the early 2000s, Salesforce and others began to pioneer the SaaS (software as a service) model, and we saw early signs of life in selling to SMBs, as Salesforce built its initial business selling into the category. The SaaS model enabled Salesforce to both host its software on behalf of customers (a must for SMBs who weren’t going to buy and host their own software) and charge on a per user per month basis, making it affordable for SMBs. Just four years after product launch, Salesforce posted $96 million in annual revenue (2004), and the race was on. Thank you, Marc Benioff.
Despite Salesforce’s success, investors remained skeptical about technology companies targeting SMBs. The rationale boiled down to a few key points:
The real rise of SMBTech can be traced to four important factors, all of which happened in the same three to four-year window between 2006-2010. Not surprisingly, many of today’s most important SMBTech companies were founded in this time window: Shopify (2006), Wix (2006), Square (2009), and Stripe (2010) to name just a few.
“Before 2008, the software industry was dominated by a few large companies. The App Store opened the door for any developer, from one-person shops to large studios, to come up with a great idea, build a high-quality app and seamlessly deliver it to the growing number of customers around the world.”
- Apple, “The App Store Turns 10,” July 2018
These four factors created a powerful playbook for entrepreneurs to create entirely new markets serving SMB customers, and as we mentioned above—it’s no accident many of our SMBTech Index leaders got their start in the 2006-2010 era as a result.
So…10+ years into this boom, what can we learn from the leaders—and how can we apply it to the next generation of SMBTech players? A few thoughts:
Focus matters. When we first met Jack Dorsey as part of our investment in Square in 2011, a common misperception was that he wanted to go after big enterprise POS (point of sale), and that he would fail. Jack said to us: “I’m not going after enterprise POS. I’m going after SMB cash.” His point—the vast majority of SMBs were still predominantly running on cash, and Square was created to bring them into the digital age. The company strayed a bit from this strategy in its partnership with Starbucks (which did not work out), but the majority of the company’s energy was relentlessly focused on the needs of its core SMB customer. At the time of its 2015 IPO, 89% of Square’s revenue came from businesses with less than $500K in annual sales.
For SM Tech entrepreneurs, it’s critical that everyone in the organization has a laser focus on the same end customer—from product and engineering through to sales, marketing, and customer success. A larger customer may look appetizing from an ASP standpoint, but it can crush your product team with off-roadmap requirements, which will subsequently crush your support/customer success team with nonstandard issues and eventually… churn.
Go horizontal, go vertical. Traditional tech companies sell horizontally, solving functional problems across vertical markets (Salesforce sells CRM across many verticals and many geographies). This approach has worked well in SMBTech as well, with companies like RingCentral (cloud phone systems), Square (POS), Wix (web sites), Shopify (e-commerce), building very large companies selling solutions to all types of SMBs. Increasingly, though, we see a new breed of SMBTech company focused on a single industry vertical. These teams intimately understand the industry ecosystem, how things get done in that industry today, and the SMB customer’s pain points—often solving one very critical pain point, then expanding their offering over time. Most importantly, they have a vision for how to do things better and know how to communicate this vision to the various participants in the ecosystem. Vertical solutions can also benefit nicely from network efforts (more on this below). MindBody is a terrific example of this, having built a $1.3 billion company serving the needs of yoga studios and salons across the U.S. Private companies like ProCore (construction), Toast (restaurants), Brightwheel (education), and Houzz (home remodeling and design) are running a similar playbook.
Deeply understand unit economics and churn. In SMBTech, unit economics really, really matter. It may seem obvious, but it can be hard to grasp in the early days of a startup when a company’s mantra is all about growth and there are no finance execs on board to help drive analyses and metrics. The basic ingredients for unit economics in SMBTech are
All three have to work in synch for an SMBTech business to scale. In the early days of a company’s lifecycle, it is common to invest ahead of the curve on sales, marketing, and customer support—often driving growth at >100% annually—so it can be challenging to develop a realistic view of “steady state” unit economics. We’ll generalize a bit here, but we typically see early stage (seed -> Series B) companies very focused on growth, CAC, and LTV without much data to really understand churn. Given that churn often shows up 12-24 months after a strong growth spurt, we’re big advocates of making a customer success executive an important early hire. In short, if your SMBTech churn rate is in the 15%-20% (annual) zip code, you’re at the top of the game. If it’s north of 30%, you’re going to have a hard time building a sustainable business.
Get in the payment flow. As highlighted above with Shopify, billing and payment are often a critical part of the SMBTech solution stack. It’s a terrific mechanism for creating value for the customer (often replacing numerous manual billing and payment processes), drives share of wallet/IT spend, and has become a reliable and valuable source of revenue for the SMBTech provider. It also has a super strong hidden value for the SMBTech provider—once an SMB customer has moved core billing, payment, customer and/or accounting information over to a new platform, they become much less likely to churn. No customer will stick with you if your offering is terrible, but if it’s reasonably good, they’ll think twice about switching to another provider if the switching costs are high—and moving anything related to cash flow, the lifeblood of any small business, is hard (and dangerous).
Create network effects where possible. Network effects help support viral, compounding growth—and also help support a certain level of stickiness (= reduced churn). Network effects help your sales and marketing dollars go further if with every customer you acquire you also bring on additional ecosystem participants (in the form of your customer’s partners, customers, etc.) at relatively low cost. Network effects also drive customer retention, brand value, and can be a significant barrier to competitors at scale. We will go into this in more depth in our next post, but SMBTech leaders Shopify, Square, DocuSign, Etsy, GrubHub, Yelp and Dropbox all have strong network effects to their business model (we’ll go into this in more depth in a future article), and private companies like Houzz, Slice, TalkSpace, BigCommerce, and Toast have built network effects into the core of their business models.
As we highlighted at the start of this post, the GGV SMBTech Index of public companies today is valued at over $200 billion, up from just $15 billion eight years ago. Will it grow another 10X+ in the next eight years?
Seems crazy, but it’s worth noting we’ve focused the bulk of this article on the U.S. market, while SMBTech is decidedly a global wave. One of the most successful companies of our time, Alibaba Group, built its entire $450 billion (market cap) business by empowering 10 million+ SMBs in China. Research firm IDC estimates the U.S. market for SMBTech at approximately $39 billion, while the worldwide number is orders of magnitude larger (estimates range as high as $600 billion). Many of the companies we mentioned above already have thousands of customers outside the U.S. (it is not uncommon for us to see this at Series A in SMBTech private companies), and we expect the globalization of SMBTech to be a significant driver of growth for both U.S. and international companies.
With strong tailwinds for technology adoption among SMBs, global markets open for the first time via the app store distribution model and global e-commerce platforms, we expect the Rise of SMBTech to be a storyline worth following for the next decade+. We’re betting on it.
Tiffany Luck (@lucktm) is an investor and Jeff Richards (@jrichlive) is a Managing Director with GGV Capital, a global venture capital firm with $6.2 billion under management. GGV SMBTech portfolio companies include Alibaba, Square, Zendesk, Houzz, BigCommerce, Poshmark, Namely, Slice, Brightwheel, and Tray.io.
(2) Market cap data from Capital IQ as of December 1 for 2010-2017 and as of December 3 for 2018