In the following table, we summarize emerging database innovators that offer solutions focused on performance optimization and are capitalizing on DBMS market growth.

• Growing sophistication with cloud-based architectures: Many enterprises are becoming more sophisticated with cloud-native IT implementations and governance. Additionally, IT executives are investing in data teams to optimize productivity while handling ever-growing data sources. As data tooling standardizes further, ML projects should become more feasible and investable.
• Network effects within ML: Over the last two years, the widespread success of foundational models trained on expansive datasets has unlocked high performance across ML modalities. The emergence of foundational models creates network effects, with one model able to flow into other derived models to fine-tune performance.
• Nuanced data training capabilities: ML practitioners are employing a diverse array of strategies to increase the amount of training data available. For example, self-supervised learning, which avoids human tagging by using the data and its underlying structure as labels, has seen significant progress in the natural language and vision domains. Simulation is also enabling more businesses to train models with minimal costs.
• Range of cost savings and efficiencies: When implemented with proper strategy and resources, MLOps tools can potentially offset the upfront costs required by providing a range of benefits including:

Private markets appear robust for data software

In 2022, the market for data software continued to attract capital despite macroeconomic headwinds – five data-software companies attracted nearly $500m in funding in Q122 alone. While pace slowed throughout the year, growth investors seem to remain willing to pay premium valuations for differentiated data, infrastructure, management, and analytics solutions.

Section 3: Fintech − embedded finance

Every company may become a fintech company...

“Software is eating the world” is among the most commonly used phrases in markets given the wide-spread industry disruption which followed. Over the next decade, fintech could be poised to eat commerce, as A16Z partner Angela Strange recently stated: “Every company will be a fintech company”.

Many small and medium-sized businesses have benefitted from the democratization of technology across core business functions including accounting, payroll, HR, advertising, and logistics. Embedded finance is another: disintermediating incumbents, resetting distribution channels, and integrating banking products into non-financial companies. Recent adoption has likely benefitted from the shift in consumer spend to online, as the development of the orchestration layer creates potential new profit pools for both technology providers and merchants.

In our view, embedded finance could be central to private capital flows within the V&G markets. The market dynamics, value chain, and private-market activity are outlined below.

...driving the US embedded finance market towards $50bn+ by 2025

In 2021, embedded finance revenues exceeded $20bn in the US alone, according to McKinsey. Revenue was generated on transaction volume of $2.6trn, suggesting a take rate of around 80bps which varies by product. According to a report by Future Markets Insights, North America represents around 35% of the embedded-finance market, suggesting the global market may have reached almost $60bn in 2021.

The US market alone is expected to at least double in the next five years to $50bn – while Lightyear Capital expects the global embedded finance market to be worth up to $230bn by 2025. A large portion of this growth is expected to accrue to the top line of private fintech companies.

Tech-enabled providers have been a key area of disruption for growth companies

Simplifying the value chain is important to mapping the V&G landscape, and we would highlight a few players within embedded finance: the financial institution, technology enabler, merchant, and consumer.

• Regulated institution: A regulated license holder which sits at the top of the stack, offering services such as balance-sheet capital and license provisioning
• Tech enabler: A financial-software provider delivering an integration of financial services into the customer journey via APIs
• Merchants: These companies utilize customer insights and their distribution capabilities to provide financial products at the point of sale across industries
• Consumer: Customers are consuming financial products at the point of delivery for goods and services. Consumer education and younger digital natives are helping increase attachment rates.

In the figure below, we map the embedded-finance value chain. We differentiate from banking-as-a-service which reflects the more full-stack distribution of banking products.

Based on 2021 data within a recent Bain report, payments accounted for over 90% of embedded transaction volume and 50% of revenues but derived the lowest take rate of around 60bps. Lending and banking delivered higher take rates, likely commensurate with the higher level of risk, relative maturity, and lower competition. Embedded payments and BNPL providers have raised the largest funding rounds in recent years, reflecting the high contribution to overall volume.

Secular drivers are supporting merchant adoption at the point of sale

In our view, a number of tailwinds exist for embedded finance adoption, potentially balanced between i) demand from consumers and merchants, and ii) increased supply driven by regulation.

• E-commerce penetration: Around 50% of US card spending now occurs online (33% globally), according to industry reports. Online card penetration is likely to be higher among SMEs, with relatively higher contribution from certain industries.
• Customer preferences: The integration of finance within the customer journey could provide a natural adjacency for many merchants, as consumers become increasingly familiar with digitally embedded products. Reduced friction at the point of sale is also likely to increase attach rates.
• Improved unit economics: Against a challenging macro backdrop, merchants have often faced both revenue growth and profitability headwinds. Embedded finance could present an attractive opportunity for diversifying revenue streams as well as margin accretion. Access to customer traffic means merchants are positioned to extract a share of the economics.
• Vertical SaaS: Many software firms with industry focus have been able to increase CLV and lower churn through embedding payments into the core value proposition. Merchants benefit proportionally through simplified processes and cost savings.
• Regulatory unlock: Regulation such as the Consumer Financial Protection Bureau’s (CFPB) announcement to democratize access to consumer data in October 2022 should improve the interaction between third-party applications and could help unlock increased supply of embedded finance providers.

Venture activity is spread across embedded products

Mapping the private market ecosystem for embedded finance is challenging, given market and geographical fragmentation. However, based on our analysis and interactions with companies and investors, we have mapped out some early-stage companies below:

A number of these companies raised rounds in 2022. We highlight some interesting deals below.

Four trends expected in embedded finance

We now highlight four interesting themes which we believe may potentially play out in private markets:

• Increased supply within certain embedded verticals: Payments and BNPL have seen the greatest traction with consumers and investors to date. Looking ahead, products which have seen less relative activity and offer higher take rates may be targeted - such as lending.
• Broadening growth beyond the core product: Horizontal product expansion may help preserve technology providers’ differential advantage, and address product areas of greater resilience from take-rate erosion.
• Upstream integration: While not without risk, the backward integration of technology providers into balance-sheet lenders could help capture a larger share of the economics. This strategy may be dependent on the ability to obtain a banking license and presents exposure to credit risk.
• Embedding products within SaaS: The increasing penetration of financial products embedded within verticalized SaaS offerings could continue. This helps ensure software platforms are business critical and allows SaaS providers to leverage more diversified revenue streams to cross-subsidize core platform functions, pricing below competitors and reducing churn. Toast (which provides payment systems for the restaurant sector) is one good example of this strategy in practice.

Section 4: Digital health − value-based care enablement technology

Digital health funding eased in 2022...

Even as one of the more defensive sectors in tech, with a relatively stable, fixed spend base, US digital health investment dropped to pre-pandemic levels of $15.3bn in 2022, after having doubled to approximately $30bn in 2021. In the US, deals exceeding $100m showed a significant drop-off in the last 12 months, likely reflecting broader cross-industry trends of investors reducing check volumes for late-stage growth raises during a period of macro volatility.

As noted in Rock Health’s recent 2022 review, this trend marked a significant reversal from 2019-2021, when capital concentration was more prevalent in digital health than most other sectors and the top-five fundraises in the US totaled, on average, over 30% of total invested capital each quarter. The last three months of 2022 saw just $2.7bn invested across 146 deals (which includes a $330m raise for home care start-up Dispatch Health), less than half of 2021’s Q4 total of $7.4bn.

Much of the drop-off can likely be attributed to a waning of pandemic-inspired demand for virtual care solutions, which grew from 11% adoption of US consumers in 2019 to over 50% in 2021, according to McKinsey. Such quick growth in the market created overly saturated sub-verticals that could potentially spur consolidation in 2023 and beyond. Most investors expect a flat-to-moderate growth year in 2023 in the sector, with predicted investments totaling $15 – 25bn, according to a recent GSR Ventures survey of top digital health investors.

Market focus in healthcare transitioning to Value-Based Care (VBC)...

Looking forward, the tone of conversations at the 2023 JP Morgan Healthcare Conference among investors, corporate executives, and entrepreneurs alike was cautiously optimistic. Select key themes which have been identified from the conference include:

• Value-based primary care remains focus, while specialty is the future: Although specialty and other alternative forms of care command a large proportion of spend in the health-care industry, start-ups and V&G investors seem focused on reimagining primary care as a first target in the transition to value-based care. Broader market players, including retailers such as CVS Health and Optum, have been exploring and completing acquisitions to expand hybrid care models and enable greater VBC access for patients. Many in the industry expect JVs and partnerships between VBC-enablers and health systems to accelerate. Below is a depiction of how specialty areas currently rate in terms of VBC adoption:

• Financial and operational improvements expected: Many health-system operators expect revenues to rebound after a sluggish 2022 and believe endemic staffing shortages could begin to abate and return to a stable capacity by the end of 1H23.
• Health systems expansion: Health systems seem to be increasingly active in evaluating potential acquisitions of provider groups and expanding into specialty service offerings outside of hospitals seeking to expand access to a larger patient population, reinforcing care delivery in support of the VBC transition.
• Valuations in a new reality: Certain healthcare services companies that recently were valued at 20x ARR are now being valued at closer to 3x ARR. Chief executive of General Catalyst, Hemant Tenaja, indicated that start-ups need to be creative with figuring out how to grow their valuations because these multiples are unlikely to return to pandemic levels.

...with a possible re-calibration of the sharing of risk between payers and providers...

We believe one area for growth investors to potentially focus on in 2023 is identifying differentiated tech platforms that enable the broader industry transition to VBC payment models. Put simply, VBC models enable health-care providers to be paid on the basis of patient outcomes rather than volumes. Back in 2016, Bessemer Venture Partners highlighted the $1tn opportunity in seeing an industry-wide shift from the historical FFS to VBC payment models. Recent McKinsey analysis estimates that in a bullish scenario fueled by increased private-market funding, this goal could be attainable as early as 2027.

At the heart of the VBC model is the sharing of risk among payers and providers, leading to more collaboration and improved care quality to improve patient outcomes. The range of VBC payment models, along with associated risks, compares to FFS as described below:

...but the shift may be hard to navigate with substantial challenges to reaping the benefits...

The VBC payment model should provide clear value to each of the three major health-care stakeholder groups. However, operationalizing and implementing the transformation away from FFS operations in an often outdated, fragmented industry has proven more challenging than many VBC advocates anticipated. In theory, VBC seeks to align incentives across the payer-provider-patient ecosystem. However, many providers and payers with near-term concerns, including complex contracting requirements and impacts to patient volumes, revenue, and implementation costs, seem to remain reluctant to change. Below we indicate some of the potential benefits and challenges stakeholders are likely weighing in the VBC transition:

The transition is benefiting from multiple tailwinds...

Despite delays, recent regulatory and market indicators have become possible tailwinds toward broader VBC acceptance:

• Regulatory: The Centers for Medicare & Medicaid Services (the largest US payer) is embracing more VBC initiatives and has issued an ambitious goal to shift 100% of Medicare beneficiaries into an accountable-care (ACO) relationship by 2030. Of the 1,760 active ACO contracts in the US, private-sector arrangements continue to represent the largest payer type.
• Private markets: According to McKinsey analysis, private-capital inflows to VBC companies increased more than 4x from 2019 to 2021, while new-hospital construction—a proxy for investment in legacy-care delivery models—remained flat. Additionally, as many investors are considering sustainable profits over expedited top-line growth, FFS models will likely become less appealing.

• Patient coverage: McKinsey estimates the number of patients treated by physicians within the VBC landscape could roughly double in the next five years, growing approximately 15% per year.
• Stakeholder prioritization: Recent KLAS research and surveys of top health-care stakeholders revealed that 71% of primary-care providers believe their capabilities required to deliver on value-based care will improve over the next five years, but practices will have to be intentional in their plans to adopt VBC models.
• Payer/provider convergence: While having gained most traction in primary-care settings to date, payer and provider convergence seems to have also facilitated the emergence of enabling data tools to help stakeholders realize VBC. Payers can play an important role in helping providers make the shift to VBC by simplifying and aligning quality and process metrics so the providers can be rewarded for clinical and operational changes.

Diving deeper into some of the categories above, we have created an abbreviated market map of some emerging and later-stage growth companies which seem to be in support of the VBC transition. While many of these companies offer platforms that cut across multiple use cases, we have broadly bucketed select early- and late-stage leaders that we believe could have credentials to attract potential V&G investor interest in 2023 and beyond.

Section 5: DeepTech – sorting through the AI landscape

AI demand increases despite broader software investment slowdown…

While generative AI has generated significant buzz in the V&G space in early 2023, and there are signs of market adoption (i.e. Microsoft’s recent $10bn dollar investment in OpenAI), in our opinion there may be other deep-learning and AI applications with enterprise use cases emerging as potentially more actionable investment opportunities for cautious V&G investors. As shown below, automation of IT and business operations, along with security and threat detection capabilities, remain core areas of focus for executives looking to develop or acquire AI-driven solutions.

While it’s hard to define the market size for AI software as most general-purpose SaaS apps coming to market are powered in some fashion by AI, we estimate the global market to total between $60bn - $120bn ("core"/platform AI solutions only at the lower-end, all AI-enabled applications included at the higher-end). Additionally, industries including retail and financial services are the most active investors and producers of new AI applications. E-commerce tailwinds seem to have driven intelligent product recommendation capabilities to be differentiators for online retailers. In financial services, many institutions appear to be increasingly turning to AI to create personalized and automated banking experiences. Unsurprisingly, the education and public service sectors have been less rapid adopters, though we believe interest in AI innovation remains high in these industries and could be potential long-term growth catalysts.

• ROI by function has evolved: Across functions, service optimization, and customer analytics are key areas where enterprises are adopting AI tools, and this has remained consistent over the past four years. However, ROI by function has evolved – in 2018, AI in manufacturing and risk generated the most ROI, and today, as identified by McKinsey, marketing and sales, product development, and strategy and corporate finance are providing companies the best mix of improved revenues. Supply chain management stands out for significant cost reductions

We have identified several areas that could drive potential corporate AI investment over the next 12 – 24 months:

• Security and risk management priorities: As enterprises look to reduce vendor load across the application and infrastructure layers in a challenging economy, those platforms with AI-enabled capabilities that can automate key parts of the security lifecycle are likely to be more attractive investments.
• Data management, analysis, and governance: As budgets for data science talent may decline due to economic constraints, businesses will need to become more familiar with AI/ML solutions that enable them to extract insights from large structured and unstructured datasets, automate data-driven processes, and generate predictive analytics.
• ESG reporting: Environmental and sustainability practices are at the forefront of many enterprises’ resource allocation strategies heading into 2023. Collecting, analyzing, and reporting on ESG performance from a variety of data sources will require automated solutions at scale.
• Natural language processing (NLP) market remains robust: As noted in Silicon Republic, NLP is one of the few fields in AI which is not limited by data – deep learning systems can merge languages, images, and real-life object detection to build models without first needing to aggregate large volumes of data from customers (i.e. as is the case with self-driving car software). The global NLP market was valued at $15bn as of 2022, and is projected to grow at a CAGR of 25%+ over the next five years.
• RPA use cases continue to expand: RPA is increasingly being viewed by some as a pivotal tool for businesses to at least partially-automate a range of functions including: IT Ops processes, customer care experiences, supply chain/inventory management, and asset utilization/performance.
• Moving towards an integrated AI future: Larger corporates (i.e. Fortune 500 companies) who have previously experimented with different siloed AI and ML applications could begin to adopt a more holistic strategy in which data obtained from across business functions can be used to strengthen ML models that touch multiple applications.

With the developer-friendly foundations of this technology mentioned above, growth investor Base10 Partners argues that companies in this category will reach $100m to $1bn in revenues over the next five-plus years, following a similar trajectory to SaaS leaders at the height of the cloud transition. Bessemer Venture Partners has predicted that we will go from less than 1% of online content being generated by AI models today, to over 50% in the next ten years. While we think it is too early to see how monetization schemes and content uptake for specific use cases could materialize, we expect over the next 12-15 months that the industry could see some businesses grab early, commanding market share and investor dollars while early entrants remain in an experimentation phase.

Over time, we believe investors’ potentially growing appetite for high-growth AI markets could support a broader competitive landscape with vertical-focused AI companies carving out their own niches. As far as timing of development and adoption of generative AI technologies is concerned, in our view the platform layer (for example, OpenAI, Stability AI, and Hugging Face) may continue to be the near-term focus of large check-writers because it helps create the foundation upon which applications will be built and scaled, and in some sense, could be seen is a mission-critical element of the category’s future growth.

Meanwhile, applications could be likely to trail infrastructure tools in adoption as enterprises attempt to limit their vendor load and scrutinize implementations of new technologies with unproven economics in a challenging economic environment. We summarize the foundations of the AI/ML stack below:

The global generative AI software market is estimated to be valued between ~$6bn as of 2022, and industry experts project high-velocity compound annual growth of ~30% over the next decade. The end-customers today are largely in the creative/media and entertainment space (see market share breakdown below), however we might expect this disparity to reduce over the next 12+ months as text, audio, and visual applications come to market to address pain points for both soft- and heavy-asset industries (i.e. manufacturing, healthcare, financial services).

A critical question investors will likely be asking regarding the trajectory of generative AI adoption in 2023 is how well will model-training capture learnings from a fast-growing global user base with varying use cases to prove tangible ROI? We see this as a difficult question to answer that could take years to formalize, with certain use cases proving success quicker than others (particularly in creative domains). In the meantime, in our view experienced DeepTech investors could be likely to hedge their bets on new generative AI use cases as the major cloud leaders (Microsoft, Google, Amazon) possibly invest more heavily into generative AI infrastructure tools developed in-house and by emerging startups.

Key highlights on how to think about possible use cases from a recent Sequoia Capital overview and Bessemer Venture Partners overview of the market are summarized below:

Model layer

• Text: This is the most advanced domain. Models are still adjusting to natural language nuances; however, current versions are mostly effective for short-form content with simplistic messaging.
• Code: Using AI to write code will have significant impacts on developer productivity and efficiency; currently, GitHub has become the training ground for developers implementing this use case. It could also benefit non-developers through more democratic code-sharing.
• Images: Use of image models to edit and modify generated images is a recent trend that is gaining traction.
• Speech: Speech-to-text automation has been prevalent in enterprises via contact centers and other back-office functions. More nuanced use cases, such as for film and podcasts, will require further refinements.
• Video and 3D: This is attracting attention for its potential ability to transform large markets in the consumer space such as gaming and AR/VR, and in the enterprise space, for things like construction, architecture, and product design.
• Other domains: Use cases have been seen in alternative proteins, audio/music, and other R&D functions.

Application layer (select use cases)

• Copywriting: A good early test-case for language models for use cases such as personalized web and email content to assist sales and marketing strategies and customer support. The short-form and stylized nature of the verbiage combined with the time and cost. pressures on these teams may drive demand for automated and augmented solutions. Additionally, marketing creatives were among the first to embrace social media and ‘low-code/no-code’ design tools for enterprise use.
• Vertical specific writing assistants: Sequoia’s belief that there is a strong opportunity to build better writing assistant applications for specific end-markets/use cases, such as legal contract writing, screenwriting, and healthcare documentation. Product differentiation here will probably depend on how well models are fine-tuned and designed for specific industries.
• Code generation: Some current applications can create significant efficiencies for developers to make them more productive: GitHub Copilot is now generating nearly 40% of code in the projects where it is installed, and significant market opportunity exists to expand code generation capabilities to consumers.
• Art generation: A growing proportion of art history and pop culture is now encoded in these large models, allowing anyone to explore themes and styles freely.
• Customer support: Given the recent rise of customer-success functions in the enterprise as a revenue-generating necessity, call centers have implemented synthetic voice and messaging solutions to increase service performance, quality, and timeliness.
• Gaming: One immediate focus is on speeding up production pipelines, however, the future state encompasses a potentially vast set of use cases including enablement of concept art and other content for game engines and in-game features, creating benefits for both developers and players.
• Media/advertising: This involves automation of agency work and optimization of ad copy and creative for consumers. Opportunities exist here for multi-modal generation that pairs sales messages with complementary visuals.
• Design: Prototyping digital and physical products is a highly manual and costly process. We have already seen high-fidelity renderings from rough sketches and prompt, and as 3-D models become available in the future, the generative design process will likely extend up through manufacturing and production (i.e. text to object).
• Social-media and digital communities: Many consumers are seeking new ways of expressing themselves, and generative tools could be a next evolution of this trend. New applications like Midjourney are creating new social experiences as consumers seek new outlets for public-facing content.

Section 6: Consumer − TravelTech

Given macro headwinds the opportunity set in consumer may be weighted to earlier stage

The rotational forces within the consumer sector have meant finding durable earnings streams is often challenging for V&G investors. The delta in duration between public and private investors has converged, with near-term revenue visibility a priority for many investors when allocating capital. Based on our estimates, private funding levels across the US & European consumer sector fell by 60% in 2022, with late-stage companies seeing the greatest erosion to valuation.

A higher proportion of private capital is now being allocated to earlier-stage companies and appears to be congregated around certain thematic trends such as the circular economy and alternative proteins. We believe that another area of relative resilience has been within the experience economy, as digitally native consumers allocate the incremental dollar to personalized experiences, rather than goods.

Post pandemic TravelTech looks like an interesting growth vertical

In this section, we outline the broader theme of TravelTech and identify some pockets of potential opportunity for investors. Travel was severely impacted by Covid, but in our view the ongoing recovery, accelerated digital shift and high levels of fragmentation across the value chain suggests technological disruption in the sector could continue.

We have identified four areas of interest:

• Hotel management software
• Alternative accommodation
• Online booking platforms
• Corporate travel management

Let’s first set the scene, then travel across each of these areas below.

The global travel market was worth around $1.7trn in 2019

According to Citi, the global travel market was worth about $1.7trn in 2019. This splits down into a few buckets: hotels, airline, alternative accommodation (alts), experiences, and rail/car rental.

Post Covid, online travel agents (OTAs) have accelerated their dominance

Booking volumes have accelerated their online shift post Covid, with OTAs taking share from offline tour operators, many of which have gone out of business. The top three OTAs command a dominant market share of booking volume and have continued to grow their penetration of the overall travel market. For AirBnB, Booking and Expedia, GMV is expected to exceed 2019 levels by around 24% in 2023E based on current street estimates.

Independent hotels are reliant on OTAs for customer traffic

Independent hotels are therefore reliant on the OTAs for indirect traffic and incremental occupancy. This has seen the top three OTAs extract a healthy share of the economics.

Alternative accommodation platforms are also booming

Alternative accommodation is also running well ahead of 2019, with growth likely to remain as experiential and flexible travel continues. Hotels have returned to pre-Covid levels, with the lagged recovery in air travel suggesting domestic travelers may have led the rebound.

1 – Hotel-management software offers improved economics for independents

Around 85% of hotels are independently owned, leaving a fragmented supply side often reliant on the OTAs for booking volumes. Many independent hotels lack pricing power, scale, and the ability to generate organic traffic. Hotel-management software provides strategic tools which can drive customer traffic and help recover economic ownership. In our view, there are potentially three main benefits to software adoption:

• first, network effects through leveraging data insights across platform customers;
• second, the ability to simplify in-house operations and consolidate the cost base; and
• third, the opportunity to deliver more personalized features and upsell incremental revenue opportunities.

There are four main use cases for hotel-management software: in-house operations, customer experience, revenue management, and marketing. Increasingly, providers are expanding beyond a core use case and targeting a full stack offering.

Using illustrative economics, we see why hotels might benefit from utilizing software tools to acquire direct traffic. Incremental occupancy delivers more marginal profit per room.

A number of vertical software providers have raised private funding rounds in recent years. Moreover, despite Covid, Siteminder – based in Australia − went public in November 2021. We set out below a few notable raises in Europe and the US over the past two years. Cloudbeds, based in San Diego raised the largest round to date, with $150m in late 2021. In Europe, Mews raised $185m in December 2022 against a backdrop of challenging market conditions. Mews supplements operational property management with embedded payments, creating higher switching costs and strategic value for customers.

2 - Alternative accommodation may be a secular growth trend

AirBnB trades at a higher multiple versus peers, likely due to its higher relative growth rate and Street expectations for continued outsized growth in alternative accommodation. If this thesis is correct, demand for short-term rentals and lodging accommodation may continue, catalyzing more activity within the segment. For us, there are two interesting areas.

• Short-term rental or lodging hosts may become more sophisticated as they scale, with software adoption expected to grow as hosts aim to drive occupancy and streamline costs. A number of companies have raised rounds in relation to this model in recent periods − Guesty is the largest, raising $170m in August 2022.
• The second area of interest relates to marketplaces. While AirBnB retains a high market share in alts (around 20%), alternative platforms may emerge with a more specific focus. Outdoorsy and Holidu are two companies we have identified which have attracted capital, each raising $100m rounds in June 2021 and October 2022 respectively. Texas-based Outdoorsy provides a marketplace for recreational-vehicle adventures, while German-based Holidu offers a rental booking platform, with an integrated host-software component, Bookiply.

3 – Online tour operators simplify the frictions of complex travel

Travel spend has been more resilient following the pandemic compared to other leisure categories. However, this could change in 2023, with consumers under pressure from erosion to their purchasing power and low consumer confidence. In fact, it is estimated that consumer confidence has reached its lowest level for over 50 years.

The segmentation of the travel industry may provide some optimism. The figure below is taken from a recent OC&C report, which highlights the recovery of various sub-segments. We can make a few observations: i) traditional travel agencies ceded share to online; ii) complex, premium, multi-day tour packages look to have recovered well; iii) the OTAs have been important to the post-Covid rebound; and iv) vacation rentals (or alts) have seen strong demand.

Heading into 2023, the figure above may be helpful to identify areas of relative resilience, with competitive moats, customer demographics, travel preferences, and geographical coverage particularly important.

• Deeper competitive moats: Construction of complex, multi-day travel appears to be comparatively well positioned. Aggregation of a fragmented supply base of hotels and experiences across a broad range of locations leaves these online tour operators potentially better insulated from OTA disruption.
• Demographics: Companies who target higher income and older demographics may also see relative resilience through a period of real-wage erosion and higher unemployment.
• Consumer preferences: Personalized travel and end-to-end digitization throughout the customer journey are two structural trends which continue post Covid. Integration of meta-search engines alongside booking platforms could help create community and loyalty.
• Geographical exposure: When we plot foreign-travel expenditure as a share of core PCE, the increase in foreign-travel intensity in the US pre Covid is interesting − it is around 30bps to 40bps higher in 2019 compared with 2015 after remaining rangebound since the 1990s. Targeting US consumers could present opportunities.

In V&G markets, a number of online tour operators have raised private capital in recent periods. These are split by geography but also by channel. B2C targets travelers directly and B2B provides booking infrastructure to existing tour operators (often local players).

In Europe, Paris-based Evaneos raised capital in 2018 and 2022, with a view to offering personalized and sustainable travel options to consumers. Exoticca – based in Barcelona – raised $30m in mid-2021 offering travelers buy-and-build optionality for complex travel, with a high exposure to US consumers.

4 – Corporate Travel slow to recover but SME market continues to offer opportunities

Our last post-Covid trend has been the recovery in corporate travel. Total transaction volumes fell by over 50% in 2020, and have been comparatively slow to recover. In fact, Morgan Stanley do not expect corporate travel to exceed 2019 levels until 2026.

When we segment the $1.4 trillion business travel market, the opportunity for private companies within corporate travel software becomes clearer. According to Amex GBT, almost $950 billion is borne by SMEs, or companies who spend below $20 million on corporate air travel annually. Only around a third of SME travel spend is held under management, with market share fragmented. This is compared to enterprise travel spend of around $60 billion where Amex GBT commands 40% of annual volume.

Below we outline some of the potential benefits for SMEs adopting travel management software:

• End-to-end solution: platforms typically operate across use cases such as online booking, travel management, invoicing, and customer support;
• Efficiency gains: customers benefit from a simplified booking process, with improved workforce productivity and lower overheads;
• API integration: travel platforms are increasingly integrated across enterprise workflows through API connectivity with adjacent expense management tools such as HR and payroll.

There are also a few attractive characteristics to the SME platform business model:

• Large and growing market: the SME unmanaged segment is worth over $650 billion with an ongoing shift from unmanaged to managed corporate travel. Moreover, the overall SME business travel segment seems to be recovering ahead of enterprise in the post Covid recovery.
• Improved unit economics: the lower cost to serve SMEs can result in higher margins versus enterprise, according to Amex GBT. Amex GBT, for example, derives a share of total transaction volume of around 7-8%, suggesting take rates for the SME segment may exceed 10%.
• Two-sided monetization: both corporates and suppliers can be monetized by travel software platforms. Corporates via management and transaction fees, and suppliers through incentives and platform fees.

A number of corporate travel platforms have raised capital in recent years. Tripactions in the US, and Travelperk based in Spain have each raised large funding rounds to support their growth. Both firms have also been acquisitive to expand their global footprint and consolidate market share. For example, Tripactions acquired Comtravo in February last year to expand their reach in Scandinavia.

At an earlier-stage in the US market, Spotnana raised an $80m series B round in July 2022. Spotnana’s platform-as-a-service aims to help incumbent corporate travel firms digitize, and spend management companies integrate travel within broader enterprise spend. The company also provides core travel management software, with a more traditional end-to-end travel solution to corporates.

Corporate travel accounts on average for around 10% of company expenditure, and therefore capturing an increased share of company spend will help expand the profit pool. Looking ahead, we have identified three potential areas of expansion:

• First, growing customers through organic or inorganic entry into new geographies and sectors;
• Second, via access to ancillary revenue streams such as carbon management; and
• Third, through upward vertical integration into broader spend management.