by Alex Niehenke Partner at Scale Venture Partners
Small and medium-sized businesses are the lifeblood of the economy. By the latest estimates, they make up 99.9 percent of the businesses operating in the U.S. today and employ almost 48 percent of U.S. employees. So, why then do so many Silicon Valley software companies overlook small businesses?
The truth is, they don't. Selling to small businesses is just really hard.
Of the 28 million business in the U.S., 23 million are run by solo entrepreneurs. What's more, the average employee count for businesses that earn less than $1 million annually is only three. In other words, not only are the technology budgets small -- they also have few to no employees to source, implement and use software in the first place.
But, what the small business market lacks in depth, it more than makes up for in breadth and scale -- not to mention the "green field" nature of the customer base -- and cracking it can lead to huge success. Google, for instance, has over 3 million small businesses paying for its productivity tools and HubSpot, a ScaleVP portfolio company, grew to a public company with a $5.9 billion market cap by initially targeting the small business market.
How do you succeed at building a small business-focused software business? Based on my experience helping companies like Hubspot, Box and DocuSign sell to small businesses, there are two critical strategies startups must learn if they want to do it right.
Build products they can't live without.
The best way to win over small businesses is building products they can't live without.
Multibillion-dollar enterprises may have budgets for purchasing dozens of software products -- some mission-critical, some less so -- but small businesses don't. Operating on lean budgets, these businesses can often only buy a handful of products at a time, which means that each one needs to deliver significant (and immediate) impact.
The easiest way to create this "high need" is by selling products that help customers comply with government regulation. Intuit's tax preparation software and ADP's payroll solutions are great examples of this strategy. Both have built remarkably successful businesses targeting the small business market.
Another strategy is developing a product that operates as a core system. Square's payment platform is a seminal example: As consumers shift away from cash and checks, local merchants and small-business owners need better options for accepting credit card payments. Square makes it easy and affordable, while also providing access to a vast ecosystem of highly valuable add-on products and services -- turning their payments platform into a core business system. This approach is also known as a platform strategy.
Core systems (or "platforms") can also produce powerful network effects, where the product gets better as more people use it. Yelp and OpenTable provide relatively commoditized software, but both businesses successfully cornered their market by building network effects into their products.
Build products for huge addressable markets.
To build a successful small business-focused software business, you also need to build products for markets with large numbers of potential customers.
Instead of building technology that solves the needs of a specific workflow or industry, focus on horizontal use cases or build products where the customer experience can be customized across many different workflows. MindBody, for example, has seen breakout success with fitness and wellness small businesses of every kind in recent years -- from salons and spas to personal trainers and yoga studios -- because it can easily customize the same underlying code to meet the specific needs of each vertical.
Selling to customers of multiple sizes is also important. You may not think there's much difference between a business with $250,000 in receipts versus $1 million, but in reality it's huge. That fourfold increase is the relative difference between $10 million and $40 million in annual recurring revenue (ARR).
Lastly, adjust your product for customer size. McDonald's attracts even the most price-sensitive customers with its dollar menu, but then upsells more affluent customers with premium items. Small business software businesses need to do the same. Consider pricing your product for small businesses with one employee and then structuring the product to reveal premium features for larger customers, increasing the average price customers pay for the solution.
Small businesses are notorious for underinvesting in technology, which can lead entrepreneurs to believe there are scarce few opportunities to build a large small business-focused software business. This is faulty thinking. In reality, there are a large and growing number of exceptionally valuable businesses that generate the majority of their revenue -- if not all of it -- from small-business customers. To succeed, these companies develop software that solves high-need problems for a vast pool of potential customers. This combined strategy solves all of the sales, marketing, retention and market sizing problems frequently encountered when selling into small businesses.