The verticalization alternative to B2B2C
Why verticalization is often a better decision than B2B2C
There is a category of businesses where the ultimate vision of the company is B2B2C. Often, it is a complex service that involves significant expertise but a lot of data from the consumer, or where the offering is so complex that it is usually done through an intermediary. Many educational tools, for example, have a B2B2C flavor, since they often involve selling product to a family through a teacher.
The issue with these businesses is a coordination problem. To get the businesses involved, you need to show them that customers want it, and to get customers to demand it you need to have businesses already onboard. To make things worse, the buyer is often an administrator whose incentives aren’t aligned with either side of the product. Often, B2B2C is an attempt to get the market size of consumer with the predictability of enterprise, but agency problems mean that these businesses often fail to achieve either. The core solution to this problem is to ignore the B2B2C aspect of it and pick a side. Then, you dominate that side and become what Ben Thompson calls an “aggregator” because you own a set of customers.1 The B2B2C part of the business then comes easily. You can just build whatever additional functionality you want since, hey, you already have one side of the market, and owning that side of the market gives you distribution. Chicken, meet egg.
In order for this to work, your solution has to have some value prop other than the integration. What’s that mean? Instead of one B2B2C product with two features for each side of the market, you’re actually selling two products to two markets, a B2C and B2B product, that happen to include one interaction feature that connects them. For that to work, your early engineering and product vision has to be around something that provides independent value for one side only. One of my favorites is Withings. They started as a pure B2C company, making products like smart scales that customers wanted independent of any integration with their healthcare providers. Now, they offer robust features to share your clinical-grade data with your healthcare provider and are well on their way to being a true wellness B2B2C play.
There’s an alternative: verticalization. Instead of selling your better solution to a business, just build your own. In the education market, that would mean building a school instead of selling something, like presentation software, to educators at an existing school and trickling it down to students.
My poster child for verticalization is OneMedical.2 Much ink has been spilled on how painful it is to create a new EHR system.
But what if you really did build an awesome EHR system? If you were incredibly confident that this would help you compete, perhaps you wouldn’t want to sell your EHR to other providers but would just start your own clinic using your software, outcompeting the simple doctors who don’t want to use your product. Interestingly, this is how OneMedical’s parent company, 1Life, describes itself:
1Life’s heart is an EHR and charting system designed and built alongside clinicians to be the easiest way to record and read patient care information. But that’s just the beginning. The foundation of our EHR is a modern tech stack, built on Rails, implemented with technologies like GraphQL and ElasticSearch, all deployed on top of AWS infrastructure. In addition to the EHR, 1Life includes our scheduling, administrative, tasking, and messaging platforms, as well as our our patient web portal and native iOS and Android apps.
In other words, OneMedical’s killer piece isn’t just its awesome doctors, its partnerships, or any of the normal things medical care companies (including OneMedical) talk about. It’s the backend software that enables those things — the kind of tech that most founders would try to sell to clinics, but which OneMedical instead uses to directly compete with those same would-be customers.
Another verticalization success is actually Uber. The original pitch mostly describes the technological failings of an industry. Here is how Garrett Camp originally described it:
There is no notion in the pitch deck that then-UberCab was ever considering being a vendor for the aging cab monopolies,3 even though the problem slide easily could have been for a software vendor pitch. Lots of companies, in fact, would have gone on to discuss how many cab companies there were in the US with a GTM slide about a pilot with a cab company, say Yellow Cab Corporation. Instead, UberCab recognized these as weaknesses with the existing regime and was so confident that its solutions would be definitive that they created their own competitor and won.
With verticalization, there is no confusion as to who the actual customer is. With B2B2C there often is. The B2B and B2C products will have competing product choices that depend on which side of the market is more elastic and, often, inertia. Verticalization sidesteps these issues by eliminating the inherent tension of multi-sided customers: there are only users and vendors instead of two sets of customers.4
Why are founders seemingly averse to this approach?
Historically, SaaS was viewed as the low-risk, low-return alley of the tech industry with the big dollars coming from consumer Internet. Today, enterprise is having its moment, which makes the risk-adjusted opportunity more appealing.
Verticalization means giving up software margins of 80%+ for the margins of whatever business you’re verticalizing. On a multiples basis, this may make the business less attractive. But since your gross increases the total business value may actually go up.
Since so many founders are software engineers, this means building fundamentally different skills. If you’re building a verticalized salad restaurant like Sweetgreen instead of just selling supply chain software, most of what you need to do isn’t what you already know.
As David Sacks has noted, tech-enabled businesses are somewhat new, but investors are getting more discerning. Founders are probably pushed in this direction at least partially due to investor preferences.
On the downside, there are many improvements that are significant enough that existing businesses will pay for them but not dramatic enough to get customers to shift their behavior. Ex-ante, it can be difficult to know which one you have.
Ideally, the tech generates new supply. This might not always be true, and is difficult to gauge ex-ante. For software this is almost never a problem, since figuring out whether the problem can be solved is just an engineering challenge.
Of course, there is one other important problem: verticalization can be more expensive and risky. Companies like Atrium and Altschool tried to verticalize and failed. Why? Verticalization turns your company into a services business, and you need to be good at the actual service. That sometimes requires significant money to get to an MVP and service your early customers (Atrium and Altschool both raised around $100m before failing). Even if your software creates a better experience or a better cost structure, the value still needs to be there. By not being a good enough law firm, or having the wrong school model, verticalization meant failure.
This is a particularly promising time for virtual verticalization. There are a number of businesses that would normally be interesting to verticalize, but the current crisis has opened opportunities to do so without an upfront brick-and-mortar investment, lowering the upfront development cost.
Two interesting examples, though there are others. One is telemedicine-enabled verticals, like psychiatrists. American telemedicine is primarily a prescription tool. Sure, there’s Teladoc, but this has been pretty limited. One of the biggest reasons is that telehealth is billed differently than in-person care, but now this is changing — the government issued an emergency order for COVID-19 and now the government says this may be here to stay. Another is schooling. People like Austen Allred have mused that there’s a market for homeschooling. The rub is a three-way wedge: most parents are ill-equipped to be good teachers, tutors are too expensive for most families, and MOOCs aren’t personalized enough for kids. Well, guess what kids have gotten quite used to over the past few months? Online schooling. Teachers are notoriously underpaid relative to the value they provide, but they would be downright cheap by the standards of most service suppliers. On top of that, education is the ultimate B2B2C failure since the administrator-buyers are some of the least-aligned purchasers in existence.
Essentially, founder reticence comes down to the pithy phrase about picks and shovels during the gold rush. The meme is right, but if you’re the inventor of the pick you are sometimes better off being the first good prospector.
Aggregation is normally thought of as a demand-side effect. However, in B2B2C there are two sides of customers, and by aggregating the less elastic side you get a lever of control to sell to the other.
There are other verticalization successes. Lawyers, for example, are notoriously tech-averse, so any software is a hard sell. Axiom started its own on-demand online legal service instead with revenues that would place it in the AmLaw 200. Interestingly, Axiom was started in 2000 but offers many of the perks that modern sharing economy firms have only adopted two decades later (more flexible work for the labor and a cheaper, flexible offering for clients).
This is a core reason that B2B2C businesses in education fail. Education is one place where it is abundantly unclear whose opinion to optimize for, resulting in uncontrolled failures like Google Classroom. There is a reason that Jeff Bezos’s education nonprofit’s focus is making the child the customer: that focuses efforts, allowing for clearer KPIs and all the benefits that come from that.