Introduction: the unbundling of mid-market ERP
ERP is one of the critical technology stacks for businesses, but there is a tension in today’s market. On the one hand, large core ERP providers enjoy massive product surface area, high barriers to entry, and deep moats in key product areas such as accounting. There seem to be strong financial incentives to purchase from the platform with a relatively high bar to buyers ‘double-paying’ for functionality, and considerable cost and complexity in maintaining integrations between multiple vendors and systems.
On the other hand, ERP is such a sprawling category that large core vendors are spread extremely thin, maintaining a very wide set of product modules. Their business customers — diverse and complex — are finding it a challenge to map workflows to generalist vendors that can’t hope to cater to company and vertical specificities. The multitude of resulting pain-points felt by business users cannot be understated with many processes still taking place offline, with significant manual intervention and associated costs and inefficiencies.
It’s a problem felt most keenly by mid-market buyers who have reached a considerable degree of scale and operational complexity, but don’t yet have the deep pockets or technical resources to invest into heavier enterprise systems and maintain a fully best-of-breed stack. They also face fewer options when selecting vendors, with the majority of platforms built primarily for smaller SMEs or larger enterprises. The deep and diverse mid-market is therefore considerably underserved.
New challengers building this space have the potential to create deep and sticky platforms — generational champions — that drive significant value for customers and users tailored for this mid-market segment; but they must navigate complex market dynamics with a fine-tuned product and go-to-market strategy.
Over the next few posts, we’ll explore some of the opportunities and key execution challenges we see for challengers building the next platforms in this space.
The ERP stack
The ERP (Enterprise Resource Planning) software stack forms a critical backbone for businesses as the fundamental system of record for finance and operations data. Whilst simple in principle, in practice ERP ‘systems’ tend to actually comprise a sprawling set of modules and business workflows that may be more or less interconnected, and that sit across diverse areas including accounting, payments, treasury, planning, procurement, operations and supply chain. At times it even extends into typically adjacent areas such as human resource management (HRM) and customer relationship management (CRM).
For smaller SMEs or companies just starting out, there’s typically no defined ERP system in place. Simpler businesses can get by with a few different, often disconnected, systems to manage things like payments, operations, and HR. We’ve increasingly seen scaled SME-focused tech vendors broadening their platforms and moving into adjacent areas; but still, smaller SMEs tend not to have a single system of record or an orchestration platform that comprehensively ties the various components of an ERP together. Much of the time they don’t need one, or at least the cost of such a luxury would be prohibitive.
But greater scale and organisational complexity of course intensifies the need for business to consolidate data and build cross-organisational visibility across finance and operations functions. And so begins the need to embark on a journey towards an ERP stack. For many, one of the first triggering points for this journey is the requirement for a finance and accounting record to consolidate multiple geographies, multiple entities, or support more complex financial processes. But from there, how quickly companies move towards a wider ERP stack — and what shape this stack ultimately takes — differs significantly from company to company and across industry verticals. A construction business operating in a single geography, for example, will have vastly different needs to a professional services organisation that works across multiple markets.
Despite this diversity in business needs, the core ERP market is dominated by a relatively small number of generalist vendors, owned by some of the biggest names in tech: SAP (S/4HANA), Oracle (Fusion Cloud and NetSuite), Microsoft (Dynamics) and Workday. There is a vast long-tail of subscale vendors selling into the mid-market, but again there remains significant concentration in the biggest platforms including NetSuite, Dynamics and Sage Intacct.
The current vendor landscape
There are a few very good reasons why the core ERP vendor landscape has taken this shape. Firstly, large vendors in this space benefit from scale efficiencies and platform moats. There is significant cost (manpower) and complexity involved in building and maintaining some areas of strategic product functionality — for example, supporting a vast number of country-specific tax codes — which is hard to replicate for new entrants. Incumbents platforms also cover an extremely wide product surface area, bundling modules at competitive price points and regularly place restrictions around data usage outside their system, putting pressure on customers to stay within the platform.
Secondly, the criticality of the ERP to buyers is so significant that new entrants face a high credibility barrier to adoption (not least given potential continuity risks). And thirdly, ERP systems are very disruptive to rip out once in place. This has been to the benefit of legacy vendors in the long-tail, sustained by customers who have built customised technology around them over time making them very difficult to rip out.
There are nonetheless obvious limitations for buyers facing this vendor market structure. Firstly, the large ERP platforms are generalists, not specialists. They can provide 80% of a solution for many companies across many use cases, but they simply aren’t flexible enough to provide that last 20% to deliver what’s really needed by customer and industry sub-segments. It’s impossible for them to provide a full solution in every module — just look at NetSuite’s breadth of modules.
Fig. 01
And secondly, these platforms are heavy systems. They’re difficult to implement and install, and they come at a high price point for smaller businesses who are just joining the graduate class and investing into an ERP stack.
Shifting to a more composable mid-market stack
So there’s a tension in today’s ERP market. On the one hand, the north star for an ERP system is to be an organised and entirely consolidated system of record across finance and operations; and it would appear to make sense for buyers to consolidate as far as possible in one system with a trusted vendor. Platform offerings and pricing benefits add to these incentives to work with large incumbents, particularly for functionality where customers don’t necessarily require bells and whistles and can simply make do with ‘good enough’.
On the other hand, we almost never hear from companies who are happy with their ERP vendor or set-up. Despite hugely painful implementation processes, outcomes are rarely optimal and users are still left working on disconnected tools and systems, or needing to make manual interventions. So there are clearly benefits to be had for buyers looking further afield and augmenting their core ERP system by investing into additional tools that better align with their business processes. We’re seeing a huge number of vendors playing into this trend, accelerated by cloud-adoption and API-led architectures, as well as the drive towards greater automation. The core ERP vendors are therefore seemingly being “attacked from all sides.”
Fig. 02
The tension between these two dynamics is most keenly felt by buyers in the mid-market where the cost and complexity barriers of piecing together a ‘best-of-breed’ stack are most acute. The apparent middle-ground of ‘double-paying’ for the most strategically important functionality can even at times be offset by the high cost of maintaining integrations and strong financial incentives to purchase from the core platform. We see this in our own portfolio — for example, one of our fintech portfolio companies who had been using Anaplan in parallel to Netsuite for financial planning (given the importance to their business), but recently made the decision to revert back to NetSuite’s more basic offering given both the expense and arduous nature of setting up and maintaining the connection between the two platforms.
This is just one example to demonstrate the dynamics that must be navigated by new entrants building in this space, particularly those targeting mid-market buyers, as they develop their product and go-to-market strategies.
But the pain-points felt by business users are so real, deep and widely felt that there are huge value-creation opportunities for the companies that get their approach right. Already we are seeing winning companies starting to create a different kind of market structure, by hollowing out the core ERP and moving critical business logic, orchestration, and user interfaces to separated best-of-breed vendors in a more composable ERP stack.
The next generational platforms
We believe the generational winners will show differentiation in three important areas:
- Firstly, they will deliver products that are best-in-class at mapping technology to their customers’ unique business logic and workflows. This will be about more than providing fantastic UIs; successful platforms will need to have not just a deep understanding of functional customers use cases and industry specificities, but also how their platform fits within the customers’ surrounding technology stack to successfully deliver effective and scalable automation. We expect to see an increasing number of vertically-focused platforms emerging in the mid-market to achieve this.
- Secondly, successful challengers will need to drive clear ROI for customers by offering a full solution without significantly increasing their total cost of technology ownership. This will require both a fine-tuned pricing strategy and delivery model (where an open source platform like Odoo’s provides an interesting example). Ease of integration and deep ecosystem technology partnerships, and low-touch configurability to enable fast time-to-value and limited ongoing maintenance costs will be absolutely critical to mid-market customer purchasing decisions.
- Thirdly, successful new entrants will need to think intelligently about their platform strategy, building sufficient product surface area to warrant spend from buyers (and sustaining any ongoing integration complexity). This is particularly important for building stickiness and monetisation potential in the mid-market where there are more incentives for consolidating technology stacks than there are for enterprises with many choosing best-of-suite over best-of-breed.
Of course, ERP is a massive area, but the next couple of posts will go deeper on some of the opportunities and vendors we see emerging on the finance side of the ERP stack. We’ll cover operations separately in the future. We’re starting with finance as it forms the heart of so many ERP set-ups sitting on top of the general accounting ledger, it’s often the area where companies first feel the need to invest into a core system, and it remains a key part of the moat for the largest platform vendors.
Please find links to parts two and three below: