The Coming Polarization of the SMB Software Market

Share this:

Many, if not most, B2B startups begin life selling to small-to-medium-sized businesses. This is a great first market. For one thing, it’s massive. It’s also far easier to reach than the enterprise.

Just how large is the SMB market? According to Intuit, there are 30 million small businesses in the United States alone. There are 60 million in the English-speaking countries and 600 million globally. That is a truly massive market!

Strangely, despite the size of the opportunity you don’t find too many SMB companies in most VC portfolios. You see plenty of consumer and enterprise-focused startups, but much fewer on the SMB side.

The reason for this is that it’s “hard” for companies serving SMBs to grow at the rate that can deliver “venture” returns. The most common criticism from VCs regarding this market is that customers are too small and that churn rates are too high. You just can’t build a big business in this market.

Obviously, this isn’t always the case, as there are many leading and emerging leaders in this space from Intuit to Gusto. Still, it’s worth thinking about churn and it’s impact on how software gets built for the small business customer.

Churn (the rate at which customers cancel their software subscriptions) is the single most important metric in the long term for your SaaS business. Churn equals gravity. If you’re adding 100% new customers this year, but losing half of the customers you started the year with, you’re only growing 50%. And of course the number of customers you need to replace each year just to cover your churn gets bigger and bigger as your business grows.

As I look back at the reasons why users churn, or never truly try the software they have signed up for in the first place, it’s often the same reason — time. Small business owners have huge demands on their time. They are involved in every aspect of their business, big and small. They have to balance running a business with all the other demands of modern life.

Back in my CFO days when I would look into conversion and churn rates for my companies I saw a recurring pattern: customers would sign up and just not engage. It’s not that they didn’t have a need. They just didn’t have the time to see if our product could solve their need. So, they just went away and, I assume, continued to have an unsolved need.

Perhaps better onboarding is the solution. That definitely helps. But I think something much more fundamental is needed. In fact, I believe that the SMB software market is going to split into two very different camps soon.

In the future, I believe that the best software products for small business will either be completely automated black boxes that just ‘automagically’ do things with no user intervention. Or, software will be supported by managed services so that, once again, their is no intervention required from the business owner.

Artificial Intelligence (AI) and Machine Learning (ML) are the current buzzwords du jour. While current reality in AI and ML does not match up to the hype, it’s clear that these are the next big movements in software. In fact, Google, Salesforce and other have declared this to be their priority. I guarantee you that every board of directors of any established technology company is asking management what their AI and ML strategies are.

Going back to the weak link of time for small business owners, AI and ML promise to give the gift of time, by relieving user of having to actually “do” anything.

We see examples of this in market already. From personal assistants like X.Ai and Zoom to the growing number of bots that handle niche tasks. I would say today these assistants are more error prone than what we would ever tolerate from a human being.

But there is no question that the technology will soon reach a tipping point where we trust it to handle things consistently and correctly. When that happens, we will see a huge number of business owners adopt and hand off many of their responsibilities to these automated black boxes.

Do it for me
If we think back to the Geoffrey Moore’s seminal book, Crossing the Chasm, there is a key concept there called the technology adoption lifecycle. For the foreseeable future, trusting AI to just do things will be reserved for the early adopters. As a result, the early and late majority of the market will need another solution. They will not be ready to trust full blown automation.

Enter managed services. Remember, the small business owner has no time. No matter how good your onboarding, she still won’t have time. If your product comes with an in house service arm or an ecosystem of service partners that can help, then that business owner can truly have success with your product.

There are many examples of this. The most successful SMB-focused companies all have large ecosystems of service companies.

If you want a website but don’t have the time or ability to build it yourself Squarespace has approved partners to do it for you. If you’re launching an online store Shopify has a large number of these designers and customization experts to help you out. And of course, Google and Microsoft have massive value-added reseller ecosystems that often act as the outsourced IT departments for many SMBs.

These are all examples of companies that build technology but rely on external partners to deliver the supporting services. This works when you have the scale to attract those partners. Before that, despite what VCs say, it could make sense to offer services in house. I know of many startups that do that. Their services revenue is profitable. But most importantly, it makes their software business flourish.

If you want to succeed in selling to SMB, you will need to align with one of these two camps: If you prefer automation, then be prepared to wait some time before the bulk of the market is ready. Otherwise, offer services, either directly or through trusted, curated partners so that your SMB customers can get the help they need to succeed with your product.

Mark MacLeod is the Founder of SurePath Capital Partners, the leading strategic financial advisory firm to the global SMB software market. Follow him at @startupcfo.