Market Sizing in Vertical Software (Part 2)
Euclid’s Evaluation Framework + Portfolio Case Study
Last week, we shared Part 1 of our essay on market sizing in vertical software, covering how SaaS TAMs have shifted over time and the impact of venture hype cycles. In today’s Part 2, we’ll dig deeper into how we think about building conviction in a market at Euclid.
Step One: Dollars Today, Dollars Tomorrow
Our playbook for assessing markets was built by evaluating thousands of startups across our 30 combined years of vertical market investing. While we would have to write a longer blog to share every aspect of our framework, we will summarize two of the most important.
Naturally, our first-order analysis of a category focuses on sufficiency of addressable spending to support a venture-scale outcome. In this context, addressable spending refers to gross spending, not IT dollars. Software spending in most markets is a lagging indicator, especially in underdigitized sectors earlier on their technology adoption curve.
For example, at the time of our investment in BuildingConnected in 2015, bid management & estimation SaaS spending was <$50M per year. However, when we considered that commercial construction was a >$1T industry, and that each project required the interaction of thousands of estimators and bids, the potential for a large, sustainable software category in pre-construction became evident. It is not that the market for BuildingConnected didn’t exist–we aren’t interested in funding the creation of new markets wholesale. Demand was already reflected in the millions of dollars contractors would lose by picking and choosing which RFPs to respond to. BuildingConnected recognized digitizing bid management workflows could turn a weeks-long process into a few simple clicks, making the shift of budget to software a no-brainer.
Today, Euclid targets markets with gross revenue of >$15B as a baseline. We also stress test bottoms-up assumptions to hit $100M of ARR (e.g. number of customers * revenue per customer). We start with the initial core market but spend significant time evaluating horizontal or vertical expansion opportunities that emerge as penetration grows. Typically, TAM expansion occurs by selling additional products and services to the install base or leveraging existing product / technology to target adjacent markets. In some markets, segments are distinct enough to make horizontal TAM expansion more difficult than it may initially appear.
Some startups can successfully capture seemingly distant new verticals (e.g., Mindbody from yoga studios to gyms and spas); others struggle to expand into outwardly analogous segments (e.g., ServiceTitan from residential HVAC to lawn care). When underwriting TAM expansion, there is no substitute for shoe leather—the more important to the story it is, the more industry and market reference calls we bake into our process.
Step Two: Adoption Dynamics
A second critical element of our playbook is assessing the viability and urgency of a market to adopt a new tech platform. For example, we generally find attractive markets are either white space or dominated low-NPS, aging market leaders (more often correlation vs. causation but a solid indicator nonetheless). More importantly, we look for a high-value, hair-on-fire vertical-specific pain point that software is uniquely positioned to solve. We seek medium-to-high market fragmentation (on either supply or demand side), complex transactions, high-friction idiosyncratic workflows, and the presence of inefficient middlemen (e.g., brokers, distributors, agents). We also ensure sufficient gross margin dollars in the specific transaction, workflow, or process to ensure meaningful ROI for the buyer (incentivizing adoption), while still allowing for strong startup fundamentals.
Vertical markets are rife with unique complexities—from physical footprints to entrenched business practices to simple psychological resistance to digitization—and this is precisely what makes them such attractive targets. Each inefficiency represents an opportunity for technology, whose solutions ideally benefit most businesses in the industry, their workers, and of course, the startup. That said, some complexities are simply too hard or too costly to surmount (for a capital-efficient software startup looking to grow 200%+ YoY, anyway). Buffett rings true here:
When an industry with a reputation for difficult economics meets a manager with a reputation for excellence, it is usually the industry that keeps its reputation intact.
We don’t invest behind a vertical because it fits our thesis; we invest behind our thesis because the breadth of verticals in demand is unparalleled.
Our Framework in Practice
Last year, we invested in TheraDriver, a vertical software business selling into ABA treatment centers, a sub-segment focused on treating children with Autism Spectrum Disorder (ASD). Behavioral health is a large and growing market, projected to reach $100B by 2029. That’s interesting and relevant to longer-term expansion opportunities but less so for the ability to drive initial go-to-market momentum. To validate the latter, we needed to understand the ABA and closely interconnected Speech Therapy and Occupational Therapy markets, building a point of view on market size, viability, and, lastly, expansion opportunity.
There are roughly 7,500 ABA clinics in the US today, a number that has grown rapidly over the past few years. Beyond the top 10 agencies (mostly PE roll-ups and representing ~20% of the market), the landscape is highly fragmented. In aggregate, these clinics represent roughly $15B of annual revenue today; this figure meets our threshold, but becomes much more compelling once we factor in growth (more on that below). In speaking with 20+ ABA proprietors, we also confirmed the interconnectivity of the peripheral Speech and OT practices, which alone would expand our addressable clinic base by ~5x.
The competitive landscape of behavioral health software had many of the hallmarks of a favorable target. Approximately 40% of ABA clinics today use a solution called CentralReach, a 13-year-old PE-backed platform and dominant market leader. Our clinic reference calls indicated a mixed NPS for the business. Some of its most commonly criticized features aligned well with the company’s early product roadmap. Rounding out the small field of legitimate offerings is 2-3 mid-sized players (also older) and 1-2 recently funded startups (neither immediately competitive nor much older than Theradriver). Due to the fragmentation of the clinic market, the smaller operators we spoke to often felt there was no solution tailored to their needs and cited significant time spent on manual administrative tasks unique to behavioral health clinics.
Market growth was another key aspect of our underwriting. Clinics in this space have struggled desperately to meet growing demand in recent years, leading to a severe skilled labor shortage today. Two primary factors have fueled demand:
4x growth in ASD prevalence in children over the past 15 years, primarily due to improved, earlier detection
All 50 states now mandating insurance coverage for ABA therapy (up from 1 state in 2005 and 29 in 2012)
Job growth tells the story: there are >60K ABA-certified therapists in the United States, up nearly 2x over the past five years. Demand for those therapists is growing twice as fast, with open job postings doubling over the past two years.
The net result of this clinician shortage is growing costs to clients and increasingly long wait times for treatment. Technician pay rates often spike to double historical rates, and client wait times for initial appointments range from 9 months to 2 years today. Clinician burnout and turnover are high, creating significant hiring and retention issues for clinics. It is also clear that unmet demand is a multiple of the current market opportunity. Especially given the long-term nature of the trend in diagnoses and the inelasticity of parent demand, we concluded that—while perhaps only “big enough” today—sustainable growth will bring TheraDriver’s TAM into highly attractive ranges over time.
As a reminder, the crux of our market viability framework is a high-value, urgent pain point that:
Software is uniquely positioned to solve, and
Represents a high ROI for both buyer and startup
TheraDriver is targeting a set of complex transactions and workflows around how clinicians are recruited, trained, managed, and retained. By improving utilization and scheduling alone, the company’s software can increase gross profit per clinic up to 20%. With an average estimated top-line of $1.5M - 2M per clinic, that is a significant impact for a beachhead product. Increasing retention of clinicians can generate meaningful cost savings (on recruiting and training), while also meaningfully increasing revenue by increasing bookings and technician throughput. From our qualitative work in the market, ABA workforce management is a complex, hair-on-fire problem for clinics that software can solve, starting with digitizing processes that are today 95% manual in nature. Theradriver cannot fix the workforce shortage alone, but it can make it easier for its customers to find and train clinicians, make them more productive, and hopefully accelerate their goal of supporting client-children as well.
The last phase of our market analysis focused on the extensibility of TAM. We feel that a workforce management suite for ABA clinics is a strong wedge product into a larger platform of offerings and services. While we’re always skeptical of an “easy path” into peripheral verticals, we also believe TheraDriver’s horizontal growth opportunity are sensible and achievable. These additional opportunities would represent another 4-5x multiplier on TAM without underwriting expansion into more saturated behavioral health segments.
In Summary
Compelling numbers behind a TAM are a good start, but especially in vertical markets, extensibility and dynamics are just as critical. While we do our best to systematize market evaluation, none is valid without spending time talking to stakeholders. 2-3 calls confirming / casting doubt on peripheral expansion opportunities—or the priority level of the problem itself—can be a lynchpin. This is a key aspect of what makes vertical software different and the best vSaaS founders great: it is exceedingly difficult to nail vertical product-market fit without understanding users and buyers deeply. Entrenched industry-standard practices are commonplace and often unintuitive.
Hopefully this picture of how market work begins at Euclid has been helpful. We look forward to elaborating on various aspects of vertical evaluation (and perhaps a few more case studies) in future posts.