Scale's John Gianakopoulos: Vertical Payment Networks Will Stitch Together Value Chains

ABSTRACT

KEY POINTS FROM JOHN GIANAKOPOULO’S POV

Why are vertical payment networks emerging as an important category today?

• Payment networks have hit on a hard-to-resist wedge: free automation and back-office software. While “deskless” industries like construction and freight might not have the most intense competition for software, it still helps to beat any available alternatives on price: “If something has worked in an industry for 20 years, like an old ERP tool, they aren’t going to change unless you offer a really compelling reason,” says Gianakopoulos. “That means eroding the price of adopting the new software to the point where it's impossible to not switch. This makes it much easier for these platforms to be adopted at critical mass.”

What are the business models that might be attached to this category?

• The monetization prize comes with the roll-out of payments and lending. Factor-financing and interest-bearing business loans are proven business models. But before either can happen, the underlying networks need to reach some scale. “The first act is to reach critical mass within a vertical, likely with a SaaS-like offering that makes back-office workflows easier,” says Gianakopoulos. “The more automation you offer, the more valuable your product, and the higher its potential to gain adoption. And then the second act — the prize — is to build payments and financing products on top of the network.”

• Connecting parties across industry value chains allows for low-friction embedded financing and powerful network effects. Companies in many industries are paid 30 or 60 days after sending an invoice. These payment terms, referred to in business shorthand as “net 30” or “net 60,” mean companies are constantly facing cash-flow gaps. These gaps are traditionally bridged by advance payments — known as factoring or factor financing — as well as traditional loans.
  • If they gain broad adoption in an industry, payment networks can use their improved data to boost the performance factoring and lending activities. “It is becoming a lot easier to embed financing when providers of capital are able to analyze data throughout a connected network,” says Gianakopoulos.
  • Network effects kick in: the more companies there are on the network, the better the data, the better the underwriting becomes, and the more attractively priced the financing can be, which will tend to attract more companies to the network, and so on.

What are some of the potential roadblocks?

• Selling into ‘deskless’ industries is inherently challenging. “Convincing customers to replace old ERP infrastructure that is already there or to integrate something new can be a very hard sell no matter what you offer,” he says. “These companies are hardly actively searching Tech Crunch for software solutions in their verticals. So they don’t really procure new software often.”
• Another challenge is building trust as a transaction entity in lieu of longstanding relationships, he adds. “These professionals’ businesses and livelihoods are built on their reputations with their counterparts. Building out a network in place of what's already there requires taking the time to build trust. On the flip-side, once that trust is there these networks can grow very quickly.”

IN THE INVESTOR’S OWN WORDS

A simplified example can illustrate how factoring works as a business model.

Let’s look at a shipper that buys mangos year-round from farmers across South and Central America. The mango growers need to be paid in cash for the product, but the shipper sells to distributors on net-45 terms.

So you can already see how there’s this cash flow problem that is likely to extend across this vertical. Typically, this shipper would have to go to a bank or another so-called factor, and that party will give them around 80% of the invoice value on the spot. The factor might pay out an additional 15% once the invoice is finally cleared, and then keep 5% as their fee.

The core monetization opportunity is in replacing the incumbent factoring providers. With a payment network that has stitched the entire vertical together and gathered payment data from the parties, you can offer improved loan terms. You can aspire to take 2% to 5% of all contract value transacted in the network through factoring.

Everybody wins. That same mango shipper might get 95% of the invoice value immediately, increasing cash flow significantly, while as the payment network you monetize off the 2% to 5% charge that the shipper would have had to pay anyway. Keep in mind, the annual value of contracts in these categories can be massive. So factoring revenue will represent many multiples of what standard SaaS subscriptions could drive, for an equivalent level of industry penetration. In fact, factoring revenue could be 5x to 10x higher than SaaS revenue.

What’s more, this strategy opens opportunities for software in markets that wouldn’t be large enough for traditional SaaS models otherwise. If you’re investing in verticals, you need a big outcome. You can’t just sell software subscriptions to farmers in specific verticals like perishable food, it's not big enough. You have to layer on additional monetization opportunities for it to be interesting from a venture perspective.

MORE Q&A

Q: How do you assess the market opportunity for vertical payment networks within different industries?

A: "To start, there's transactional market size. You’re constrained to the vertical you serve, so the more GMV that flows through the vertical, the more valuable the network for that vertical. Second, network fragmentation is important. Platforms that connect fragmented value chains are creating more value than networks that are situated between consolidated entities. Stitching fragmented networks is harder to do, but there's a more defensible business to be had there.

Ideally, the vertical network has to solve issues that horizontal products haven’t already addressed, to up the chances for attracting a critical mass of businesses to the network. SAP is already used in agriculture and freight and so on, but if you create a verticalized and specific ERP and AR/AP platform, then you can reach a level of adoption that past players haven’t been able to accomplish.

Finally, there’s a need to look at the relative demand for financing, given that your advantage is as a capital provider with a free or low-cost SaaS product in the industry, which gives you advantaged distribution and a dataset on the repayment and transaction history between parties."

Q: What are a few industries that offer particularly attractive opportunities for vertical network integration?

A: "There’s opportunity in trucking logistics, maritime logistics, rail, construction, even procurement within steel and forestry and other commodity goods. There’s a lot of opportunity in food.

For example, there’s a network for perishable food, Silo, that connects growers and distributors and is trying to be the vertical payment network in this space. They’ve built out a whole vertical-specific ERP and they’re automating the back office. Think of it like Quickbooks for this specific vertical. They’re doing everything from purchasing to sales, order management, accounting, and insurance. The whole back office can potentially live on this network. They’re trying to do a lot, but there’s a lot that can be done if they reach a critical mass of adoption from growers to shippers to even the end grocers."

Q: How do these emerging payment networks compete with incumbent software providers in their respective industries?

A: "In many cases the incumbent companies are 20 years old and they’re nickel-and-diming for every single feature and upgrade in the same way you would buy Windows 95 and then have to buy Windows 96, but the new version is no different and maybe even clunkier. They aren’t trying to solve how to monetize in ancillary ways, they’re just maximizing revenue from software subscriptions. In some verticals there just isn’t a vertical-specific software incumbent with a large share of the market."

WHAT ELSE TO WATCH FOR

Look for players in this space to experiment with downstream monetization opportunities, some of which might be sector specific. Once a payment network has deep penetration in an industry, it can enable procurement, logistics, and more. “In pure commodity markets, such as steel, buyers will source from any source so long as their quality criteria are met,” according to Gianakopoulos. “If buyers and sellers anywhere can be connected, not only can you provide financing and procurement, but software-enabled services related to the logistics and delivery of the end product as well.”

There will be jockeying around specific tools to drive the adoption of vertical-specific software. While not as crucial to this category as the go-to-market innovation of offering zero or low-priced software, this aspect of competition will certainly play a role. “There are interesting automations possible today that add to the value of adopting new software,” says Gianakopoulos. An example is “using Natural-Language Processing (NLP) and other tech to identify transactions and monitor inventory in ways that weren’t possible before AI improved.”

STARTUPS MENTIONED IN THIS BRIEF

• Silo