Niche Software Segment Dominates 2016 Q1 Industry Transactions

June 2, 2016

The first quarter of 2016 saw a total of 523 company acquisitions in the software market, amounting to a total transactional volume of $21.6 billion. Eight of the top-ten highest value acquisitions occurred in the Niche Software segment, which regroups companies that target specific vertical markets. Three of these transactions were in the Healthcare vertical industry, the largest of which was the announced GI Partners’ acquisition of Netsmart Technologies, a provider of electronic health records, patient management, billing and other solutions, for $950 million.

“A vertical market software is one that is specifically designed to fill the needs of one industry or business segment,” explains Steph Manos, vice-president of Valsoft, a leading Montreal firm specialized in the acquisition and development of vertical software solutions. “Horizontal, on the other hand, is a software that any business or industry can use. For example, car dealerships need very specific software to run their day-to-day business. And for anyone wishing to enter this segment, the market is limited to the total amount of existing car dealerships, as opposed to a horizontal software, such as accounting software, which could be used anywhere: gyms, medical clinics, restaurants, etc.”

At first glance, the growth potential of vertical software companies is limited from the start to much smaller markets than horizontal software, but the level of transactions registered in the first quarter of 2016 shows a marked preference of buyers for these niche developers. “The wisdom of investing in vertical software does not lie in the size of the market, but in the opportunity to become a top-three player in a given industry,” explains Manos. “For example, the market for scrap yard software is minuscule compared to that of human resources, but it is much easier to become a leader in the former than in the latter.”

Large multinationals tend to stay away from vertical markets, which opens the doors for focused investors to carve significant market shares in specialized industries. In the case of Valsoft, Manos has made it a core strategy to not invest in businesses that aim to compete with the likes of Google, Facebook, or Amazon, and that try to become major players in markets dominated by such giants. “The odds of success in horizontal markets are just stacked against new comers,” remarked Manos. “We feel that it is much easier to win in smaller vertical markets, and to win more often.”

“Vertical markets have a finite client list. We know who the clients are and we know which software they are using,” added Manos. “This allows us to focus on designing better solutions, while targeting with precision our sales efforts.” Another competitive edge for niche software players is the fact that, once they switch, clients become significantly more invested in their software. They rely upon it to run their entire operation and commit their staff to using it. “Training staff to use new software is a lengthy and disruptive process, and switching costs are high.” Additionally, the available alternatives for industry-specific software are often very limited, as there are fewer players competing in vertical markets. “We prefer to excel at servicing existing clients. For us, customer success is measured by how well they are able to accomplish their work by using our software as their main tool.”

When explained with such simplicity, Manos’ approach seems to be born out of common sense more than out of the complex calculations of investment analysts. And seeing the companies who have dominated the software transactional market in 2016, as well as Valsoft’s own success in vertical market software, it is hard to argue with the wisdom of his strategy. “Operating is niche markets does not mean short-term vision,” concluded Manos. “We abide by what we call our 40-year business plan, a thinking that forces us to look at investments by visualizing their success decades into the future. We want to know that even a specific vertical market is here to stay.”

Article Via: Market Wired