Small and medium-sized businesses are the foundation of the American economy. There are over 28M businesses in the U.S. of which 21M earn less than $100K annually and 27M earn less than $1M annually. To put it simply, almost all businesses in America are small businesses. Yet software companies have largely avoided this part of the economy.
Why? Likely the perception that it is difficult reaching a large number of these customers cost-effectively. Of the 28M businesses in the U.S., 23M are solely the business owner and added employee ramp is slow. The average employee count for businesses that earn less than $1M annually is only three. So not only do they not have a lot of revenue to spend on software, they also have few employees to source, implement, and use software.
Sounds discouraging right? But what the SMB market does have to offer is extreme scale and size, as well as the greenfield nature of the customer base. Cracking the SMB market can offer significant success if tackled accurately. For example, Google has over 3M SMBs paying for its productivity tools and HubSpot grew to a public company with a $5.9B market cap by initially targeting the SMB market. Therefore, it’s worth understanding how to successfully build an SMB-focused software business.
There are two items that stand out for successful SMB-focused software businesses: a product that has a very high need for a large number of customers. These two attributes may not seem noteworthy at first glance, but with further explanation it will become apparent how distinctly important these attributes become when selling into SMBs.
What is high need?
Imagine a multi-billion-dollar enterprise that purchases dozens of pieces of software across its organization. Some of the software is mission critical, some creates operational efficiency, and all makes sense for the enterprise to purchase.
Take Cornerstone OnDemand as an example. It’s a very successful company selling employee training into enterprises. A very nice-to-have product if you are an enterprise, but it optimizes the business and is not a requirement for operation. You can run a business at scale without this product and be successful.
SMBs don’t have this luxury. They only buy a handful of products and each one needs to be mission critical. For software vendors selling into SMBs, if the need isn’t immediately obvious, it will raise the customer acquisition cost to educate customers. However, selling to an SMB is traditionally a low price point and it will be impossible to recuperate that cost. Therefore, only products with exceptionally high need work, those where the customer is already seeking out the product.
Why a large number of customers?
Just as the low price point per customer impacts the customer need and ability to spend to acquire a customer, it also means that an SMB-focused software business needs to address a segment with a large number of potential customers. Simple multiplication highlights that if you charge your customer $1K, you need 100K customers to generate $100M. If you increase your price five-fold on average to $5K you still need to reach 20K customers to generate the same amount. This means that the segments that are sold into need to have at least hundreds of thousands of potential customers, if not millions of businesses.
How do you create high customer need?
Regulation. The easiest way to create high need is to sell a product that customers cannot operate without due to government regulation. Broad horizontal categories have produced good examples like what Intuit has done for taxes or what ADP has done for payroll. Both have built incredible businesses targeting the SMB market. The government is pushing regulations into industries as well. For example, KeepTruckin capitalizes on regulatory changes in long-haul trucking.
Core system. While lower in need than regulation, the most common way to create high customer need is to be a core system. Payments and communications are frequent examples. You could manage a business via cash, check, or other payment methods but credit cards are preferred by end customers and so businesses like Square have capitalized on this. Likewise, some businesses can be managed off your cell phone but graduating to a solution like RingCentral quickly becomes necessary.
Network effects. You can create high need if you create network effects that make your software solution significantly more compelling than other spend for a small business. Both Yelp and OpenTable provide relatively commoditized software that many other vendors also provide, but both businesses have a successful network of consumers that make them a must-spend line item for many SMBs.
Platform. It is hard to scale an SMB-focused business as a platform, but it is one way to maintain market share, create differentiation, and turn your software into a high need. Shopify is the obvious example of this. They started as a core system for selling online and grew to significant market share through selling that solution. However, today they are able to maintain more market share than anyone else because of the ecosystem that has developed around their platform strategy.
How do you target a lot of potential customers?
Sell into many industries. A simple and obvious statement, but difficult in execution. The needs of a five-person plumbing business are distinct from a five-person design firm or a five-person restaurant. A large failure point for many SMB-focused businesses is a software application that solves the needs of a very specific industry vertical without understanding how that eventually limits the opportunity. To solve this problem, great companies have identified horizontal use cases or have product architectures that make the experience unique for many different workflows. For example, MindBody has had success with fitness, yoga, salon, spa, wellness, massage, personal training, and other health professionals because the company can customize the same underlying code for each segment’s needs.
Sell into customers of different sizes. Understand the relative sophistication when analyzing your target customer base. You may not think that there are drastic differences between businesses with one and four employees, or $250K and $1M in receipts. It’s only three more employees or $750K more in receipts. However, that 4x increase is the relative difference between a $10M ARR business and a $40M ARR business, the difference between 100 employees and 400 employees. If your product addresses a broader swathe of those customers, the larger your potential market. For example, signing documents is important to businesses of every size and has allowed DocuSign to build a very large SMB business that ranges from companies with no employees to those with dozens.
Adjust your size and product for customer size. A talented SMB entrepreneur once highlighted the brilliance of McDonald’s pricing as a case study for SMB. McDonald’s is able to attract even the most price-sensitive customers with their dollar menu, but then upsells more discerning or affluent customers with premium burgers, drinks, and sides. One way to address a lot of SMB customers is to have your pricing such that a SMB with one employee can afford the product. However, the product architecture is such that premium features can be revealed for larger customers who are then also willing to pay more for such features, increasing the average price customers pay for the solution.
Take another look at the SMB opportunity
SMBs are notorious for underspending and underinvesting in technology. This has led many software companies to believe that you cannot build a large business selling into SMBs. However, this is a faulty conclusion as a number of exceptionally large and valuable businesses derive all or the majority of their revenue from SMBs. What these businesses have done is develop software that solves high-need problems for a large number of potential customers. This combined strategy solves all of the sales, marketing, retention, and market-sizing problems frequently encountered when selling into SMBs.