How Small Business Software Could Produce The Next Hundred Billion Dollar Company

This is the third article  in a three-part series on “The Democratization of Local Commerce.” 

In the tech industry, the business logic behind platforms nears gospel. We know that platforms — everything from YouTube and WordPress to Facebook and Twitter — enable smaller companies to grow and compete against better-capitalized incumbents by providing a critical business assets at a fraction of the cost.  The effect is a kind of efficient fragmentation — or democratization — in the information industries.

We also know that the tech industry has started to export these platforms to traditionally offline industries. A resurgent business software sector has started to use cloud computing to bring cheaper, simpler accounting, point-of-sale, and even marketing software to brick-and-mortar businesses. With their advances, the era of entrepreneurship has come to the real world.

But behind these Davids, there’s a Goliath in the making. A handful of companies now have the potential to create an alternative to the brand model that dominated the physical marketplace for the past century, opting instead for a distributed network of smaller sellers that pool resources and share data through software. Think of a franchise — except instead of licensing a brand name and products, these companies offer small businesses access to something even more valuable: each other.

The Business Software Market Is Growing
For two decades, the business software industry remained relatively quiet. Companies such as Micros and NCR sold point-of-sale terminals and digital cash registers to restaurants, hospitality and retail merchants. In the back-office, Intuit and others peddled tax and accounting software to small businesses.

Over the course of the last half decade, that quiet industry has become kinetic. We’ve already seen two startups  — Square and Revel Systems — build point-of-sale businesses valued at over $400 million dollars and a handful of others raise high double-digit funding rounds.

Driving the transformation is a revolution in cloud computing. The qualities of the cloud — the ability to run software remotely — have altered the industry in a way that not only affects the price at which a product can be sold, but also the very qualities of the product itself.  Increasingly, business software is becoming ubiquitous in its reach, integrated across the stack, and networked between businesses.

The point-of-sale market traditionally eschewed smaller businesses — and for good reason. The on-premise systems, which still dominate today, are expensive both to install and maintain. With data stored in servers on site, a customer needed to a hire professional need to set up a network and return to fix problems when the server ran into problems. All of that added up, and if you were a small coffee shop, the investment simply didn’t make sense.

The mobile point-of-sale concept, originally developed by Square, solved many of these problems. The software is run remotely, eliminating the need for costly installations and onsite maintenance. That meant that the company could give away the hardware for free, and simply charge merchants based on standard transaction pricing.  The ability to run the software anywhere — particularly on a smartphone — also meant that millions of service providers could now use software to run their business as well.

Meanwhile, the market also continues to grow horizontally. Companies are consolidating the front-office and back-office — once two highly silo-ed categories — into a single product suite. For instance, Intuit, a long-time staple in accounting software, moved into the front-office with a half billion acquisition of dentist retention management software Demandforce. Meanwhile, Square and other point-of-sale providers continue to acquire, build or partner into marketing, scheduling, payroll, and even banking systems.

What’s left is a unified stack of business software that impacts decision-making from capitalization to point-of-sale to marketing. What’s more, there’s an intense pressure to consolidate the front and back-office into a single product, creating a land grab to capture not only a growing customer base but a bigger part of that customer base’s spend as well.

A Nascent Network in the Cloud
The takeaway here is that the cloud has done wonders to grow the total addressable market as well as the revenue generated per user (ARPU) for a business software company. The questions for these firms now is whether they can find the network effects necessary to the build business that could compare to of retail giants of the 20th century.

For the most part, the business software market has suffered from fragmentation. And in the early days, the cloud model has effectively opened the market to thousands of upstarts. Outside of product development, there was no clear reason why one software could provide a better product with 10,000 customers than with 100,000 customers.

But the cloud may also offer a way to reverse the fragmentation. By its nature, the structure of the cloud is collaborative. Each business shares space on a server and runs the same piece software — just under different accounts. That means that two businesses using the cloud-based point-of-sale provider will likely already run on the same network.  They are, in a sense, already networked.

I believe that this nascent connectivity — the ability to network a disperse client base — will provide the foundation on which a handful of companies  (Square, Shopkeep, Intuit, etc) can build the next hundred-billion-dollar business. With access to the operational data of thousands of businesses, these companies can use software to replicate the economies of scale that have given large local sellers a competitive advantage for decades and create a platform whose value grows exponentially with each additional user.

Purchasing power: Maybe the most elemental advantage of being big is buying big. The largest companies can buy in bulk, netting big discounts from manufacturers. It’s why Wal-Mart can sell a television far below market value and still make a profit.

Co-ops have been around for a while, but today, business systems could bring them back better than ever before. Shopkeep, for instance, could hypothetically offer a group buying program for coffee shops on its platform, algorithmically identifying when participants in a general vicinity are running low on a given product.

Capital: Despite a steady recovery in the financial markets, it’s still harder than ever for small businesses to secure capital. According to data from the Wall Street Journal, the number of loans for $1 million or less held by banks is down about 14% to 23.5 million since 2008. On the whole, business loans are up 14% over the same period. In addition to risk, lending to a smaller provider also requires banks to incur the cost of auditing a firm with a fraction of the return.

That’s why Square came out with Square Capital recently, in which the company looks over the operational data of its network of business and identify growing companies that could use a $10,000 loan. Then, it sends them a note offering the cash. With access to the sales data of thousands of merchants, the company can identify strong targets and eliminate some of the costs implicit in small business lending.

Benchmarking: The bigger the business, the more data it has on a market for a given product. A large retailer, for instance, will be able to more intelligently understand the ebbs and flows of the apparel market, and set prices accordingly. Think of each sale as a bit of free market intelligence, to which most small merchants naturally do not have access.

Fragmentation at scale
The local marketplace has always been a so-called “platform economy.” For years, business such as McDonald’s licensed the assets which grew with scale — the brand name, marketing efforts and distribution networks — to franchisees who help grow the company into one of the most influential firms in the world.

But the physical marketplace is quickly moving away from the mass market models that defined the brand era. What’s left is a constellation of smaller companies, tied together by software, producing products and services tailored to the markets with which they serve.

(Below: Thousands of business can share resources through software allowing smaller,more tailored brands to flourish.)

Steven Jacobs is Street Fight’s deputy editor.