Beyond Horizontal Markets: The Israeli Vertical Software Landscape

Capitalizing on their horizontal expertise, Israeli software companies are making significant progress into the vertical software arena. While horizontal software can be useful for a wide array of industries and more general use cases and represents the bread and butter of the Israeli industries (cyber, storage etc’), Vertical SaaS is a relatively new and emerging segment in software in Israel. Vertical software is more custom tailored to cater to the needs and problems of a specific industry, and as a testament to its popularity, we saw a significant increase in the number of Vertical SaaS companies in Israel.

I’ve outlined some of the factors that make vertical software attractive for investors:

1. Greenfield opportunity — most legacy industries are still well behind in their adoption of digitization solutions and are seeking software solutions to address domain specific pain points, digitize their assets, and automate business processes in order to create a competitive advantage in the marketplace. This process of digitization of industries can cause the emergence of new intermediaries, break apart old value chains, blur industry boundaries, and create a “winner takes it all” dynamic which is important for VC investors.

2. Lower competition intensity — vertical focused software markets tend to be smaller than horizontal markets. This causes them to often be “overlooked” by large investors who are seeking opportunities that can absorb large quantities of capital. The lack of competition enables sales teams to be more efficient as they do not need to “stand out of the crowd”, and consequently, they are able to achieve higher profit margins and higher returns on invested capital.

3. Higher switching costs — vertical software solutions tend to have a higher degree of customization, with companies continuously building additional features to better serve their target market. This can require specific training that creates additional costs and friction for customers should they consider replacing vendors.

4. Reluctance to change — an entry barrier to the vertical software market is the customers’ ambivalence towards change. These customers are typically not technology-advanced and therefore, they are more hesitant to change how they frequently operate. This type of reluctance is generally referred to in business books as “sourcing costs”. Vertical software vendors tend to have a more stable market share because they do not face intense competition, and therefore are not incentivized by the next “new thing”.

5. Fintech revenues — vertical software companies can accumulate a significant amount of information as their solution is embedded in the customer workflow. This creates a variety of potential upsells including payments, lending and more. Because the vendors have a deep understanding of the business and business processes, they are well positioned to offer complimentary fintech solutions.

6. AI models — large language models can be trained on customer specific data sets to extract vertical specific insights and solve vertical specific problems. With the implementation of vertically specific AI models, the user experience becomes better and simpler, facilitating easy adoption for the nontechnical personnel. With a potential productivity boost, many companies will likely choose to “leapfrog” to the newest vertical vendors that are best suited for their use cases and skip pre-LLM native vendors. Because of this, the AI infrastructure shift could serve as a catalyst to a new wave of digitization, generating attractive opportunities for VCs.

Seeking the Next Opportunities

Identifying the next opportunities in vertical SaaS requires having a grasp on potential market size, growth rate, deal flow volume level, and competition intensity. However, to truly recognize white spaces, one needs to dive further and investigate the fundamentals of the vertical and its level of domain specific pain points that can be digitized.

Understanding the level of digitization in a specific vertical is complex and involves heavy research. The McKinsey Global Institute (MGI) assesses three overall factors:

1. Level of investment — understanding the magnitude of investments that companies channel into hardware, software, data, and IT services. This involves a thorough understanding of how extensively companies are incorporating digital elements into their physical assets, such as smart buildings, connected vehicle fleets, and big data or IoT systems for equipment, systems, and supply chain optimization.

2. Digital engagement — understanding how deeply companies interact with both customers and suppliers in the digital realm. Leading companies in various sectors employ digital payments, digital marketing, and design-driven product development extensively. They also leverage software for managing back-office operations and customer relationships which includes utilizing e-commerce platforms and sometimes their own platforms. These companies integrate social technologies into their core business processes to engage with customers and partners.

3. Employee productivity and ease of use — what truly distinguishes the leaders in this category is their ability to provide employees with an easy-to-use tool that directly improves their productivity, convincing them it is worth the hassle to learn how to use and implement the product. Employee commitment to the implementation and usage of digital tools can overall enhance productivity.

Vertical Software: Leading Players & Notable Israeli Challengers

Opportunities and Challenges for Vertical Software in Israel

Vertical software startups offer a unique advantage as they do not necessarily have to be headquartered in the Bay area but closer to the industry’s hub. Often, the founders of these companies have extensive domain knowledge in their chosen industry. This profound knowledge allows them to pinpoint industry shortcomings and create tailored vertical solutions. Their comprehensive market insight and strong understanding of both local and nonlocal industry dynamics aids in crafting robust business strategies for swift market entry.

To that end, I believe Israel has proven that it can build strong, competitive global industries that could serve as a breeding ground for quality vertical software companies in many sectors, such as:

§ Agriculture — Israeli irrigation product producers, such as Netafim, Rivulis and others are capturing the largest market share in the world in their respective categories. Israeli producers have honed their knowledge of the different types of arable lands and hold direct and indirect ties with almost all the big farmers globally. This high level of understanding customer behavior and their pain points as well as a strong familiarity with the target market, will breed great vertical software solutions.

§ Defense — Israeli companies such as Elbit, Rafael, and Israel Aerospace Industries are well positioned to provide local and global companies with defense electronics (ex: helmets for fighter pilots) and military grade equipment (ex: drones). It would seem logical to have an Israeli established vertical software market in this realm that capitalizes on this specific industry experience. However, a potential challenge for the Israeli defense sector may be that countries might prefer to develop in-house solutions in certain areas rather than sourcing solutions from other countries.

§ Real Estate — While I don’t consider the traditional industries in Israel related to construction, architecture, or property management to be inherently distinctive, I do recognize unique circumstances that position this vertical for success. This is primarily attributed to the extraordinary convergence of (a) cutting-edge technologies developed for military applications, particularly in the fields of imaging and drones, which are poised to revolutionize the construction industry, combined with (b) exclusive access to potential customers. Many real estate business owners in the USA have Israeli affiliations or prior business experience in Israel, making them more inclined to embrace technologies and services offered by Israeli startups.

Venturing Israel’s Cybersecurity Landscape

Cybersecurity is one of the most attractive sectors in Israel, attracting roughly 35% of total global investments in the cyber space. However, with over 450 cybersecurity companies in Israel, investors can become overwhelmed as they attempt to navigate the landscape and understand differences between each company’s value proposition. Additionally, cybersecurity CEOs generally tend to keep their marketing messaging unclear in an effort to veer away from disclosing their proprietary technologies. This crowded and competitive landscape may leave many investors with the concern of “over investment” where startups increasingly compete with one another for clients. Despite this, I believe that this concern is not merited as the market for cybersecurity products is large (circa $150bn) and is expanding at a rapid pace of ~14% per annum.

Cybersecurity Market Dynamics

The cybersecurity market in general remains attractive for most VC investors. Here are a few of the reasons why:

a. Market resilience — even during economic downturns, the demand for cybersecurity products remains relatively unaffected as companies wish to keep high security standards and due to increased regulatory pressures.

b. Shorter sales cycle — the sales cycle for cybersecurity products is shorter compared to other enterprise sales due to the inherent pressures CISOs face to constantly address the dynamic evolution of emerging cyber threats.

c. Bigger clients with higher ACV — larger organizations have more data and assets to protect and tend to be more vulnerable towards cyberattacks. Because of this, it is not uncommon for many Fortune 500 companies to spend $10M+ for each vendor as it is being regarded as “mission critical”.

d. Room for multiple products and low concentration — given the level of importance for cyber products and its impact, CISOs in enterprise organizations tend to have multiple products covering many aspects as they opt for “best of breed” products rather than “best of suite”. This helps with the proliferation of many subcategories of companies that are in their early stages serving diverse customer needs when “scale” is not perceived as a clear advantage. This results in a fairly unconcentrated market where there is yet to be a dominant player that “sets the tone” for overall standards.

e. Security strategy — security is about defense and depth. This way of thinking creates a strategy that takes a layered approach, whereby no layer is perfect and requires mitigations along the way. This allows for the slowing down of threat actors as they break through the layers and provides for the appropriate alerting and monitoring across the security value chain.

While certain cybersecurity markets have undergone commoditization processes, such as areas like antivirus, VPN, email security, and two-factor authentication, this commoditization does not necessarily imply a decrease in their importance. Instead, it signifies the standardization and integration of these features into broader platforms or systems. As cybersecurity companies are among the most profitable and valuable technology firms globally (total spend often accounting for as much as 10% of all IT budgets for mid-sized organizations and 15% for large enterprises), the industry is highly susceptible to acquisitions and mergers.

To step above the crowd, Israeli tech companies are utilizing three generic strategies[1] in their competitive positioning:

1. A new product to a well-established market — these companies offer enhanced products through a product that boasts superior efficiency, accelerated performance, superior integrations, and an overall value proposition that exceeds competitors by >10x. This competitive battleground revolves primarily around the product and its distinctive features.

2. A new product to an emerging market — such companies attempt to address a rapidly trending pain point. Though budget allocations for these sectors may currently be sparse, they are nonetheless gradually increasing year by year. Businesses following this strategy acknowledge that achieving substantial revenue will take longer than those targeting established markets. The critical risk associated with this strategy is the rate at which the market adopts the product. Torq, for instance, is a company that is shaking up the security orchestration, automation, and response (SOAR) market by introducing a new concept of “Hyper Automation”.

3. A new product to an existing market via re-segmentation –

a. Niche creation — the first approach essentially involves creating a niche and meeting the needs of a particular customer group. A company that concentrates on a subsection of more complex organizations in need of “integration and consolidation”, generating a “system of systems” to cohesively manage vulnerability risk across all attack surfaces in a single location.

b. Low cost — the second approach involves offering a “good enough” product at a significantly lower cost, particularly as leading vendors increasingly move upmarket, leaving behind lower-margin market segments. However, this strategy is counterbalanced by the need for these businesses to eventually turn profitable and achieve higher average contract values (ACVs), necessitating a move upmarket for scalability.

I predict that during a market downturn and when equity is constrained, most customers will gravitate towards bundled products that offer cost-effectiveness while still delivering substantial value for their investment. Conversely, in an upswing market characterized by abundant cash flow, companies will tend to prefer unbundled specialized products. They may choose to subscribe to multiple vendors simultaneously, aiming to acquire maximum protection through a “best of breed” approach.

[1] The three strategies are portrayed in the book Four Steps to the Epiphany by Steve Blank (2013).

Crack the Code: Tailor Your Offering To The Scale of Your Customers

It’s common to hear that a market is “saturated” when there are 10-20 vendors all competing for the same customers. But upon closer inspection, many B2B markets actually consist of three distinct segments: small businesses, mid-sized enterprises, and large corporations. Each of these groups has unique priorities and needs, and understanding this can help companies carve out their space in the market. Let's look at some real-world examples to illustrate this.

For smaller businesses, the focus is often on cost-effective, user-friendly solutions that offer scalability with minimal effort. Take Shopify as an example. Shopify’s simple, plug-and-play e-commerce platform is perfect for small businesses and entrepreneurs who need to quickly launch an online store without high upfront costs or technical expertise. Shopify’s low-touch model allows users to get started with minimal friction while offering flexibility to grow their stores over time.

Mid-sized enterprises tend to look for tools that balance ease of use with a fast return on investment (ROI). HubSpot is a great example of a product tailored to this market. While the platform offers a user-friendly CRM and marketing tools, its value lies in delivering measurable ROI through enhanced sales and marketing workflows. Mid-sized companies benefit from the platform’s ability to improve efficiency without a steep learning curve, making HubSpot a top choice for fast-growing businesses that need results quickly.

In contrast, large organizations often require more complex, customizable solutions. Salesforce, for instance, caters to this segment with its highly customizable CRM platform. Large enterprises with intricate workflows rely on Salesforce’s deep integration capabilities, bespoke features, and high-touch support. These companies can afford to wait longer for ROI in exchange for a solution that meets their highly specific needs, such as handling complex customer data across global teams.

By focusing on one customer group and tailoring offerings to their distinct needs, companies can often avoid direct competition with others in the same space. For example, Slack initially focused on small and mid-sized businesses looking for an easy-to-use communication tool. However, by continuously expanding its feature set to meet the needs of larger enterprises, Slack later started to compete with heavyweight tools like Microsoft Teams, which already catered to large corporations.

This strategy of targeting a specific customer segment allows businesses to differentiate themselves in what might otherwise seem like a saturated market. By zooming in on the unique demands of different groups, companies can discover new opportunities without getting caught in battles over crowded markets.