Processing the Vertical Software & Payments Landscape in Europe
Executive Summary
Here at VGB Insights, we often spend time analyzing business model formation in vertical software markets (our recent pieces on hotel management and shipping are linked here). Many characteristics appear consistent, such as establishing an operating model around a key control point – other areas are more varied, including the inter-section of vertical software with financial services, notably payment processing.
In this report, we outline how independent software vendors (ISVs) have integrated payments within their product offering, and analyze how merchant acquirers and payment service providers (PSPs) have re-focused their strategic initiatives. Our key takeaways are included below.
Since the advent of the iPhone and cloud computing, three growth vectors have driven the evolution of payment processing in vertical software markets over the last decade, in our view: (i) increasing digitization, (ii) growth in ecommerce penetration, and (iii) the democratization of software to SMBs.
Many incumbent merchant acquirers who historically held and benefited from direct merchant relationships have experienced increasing competitive pressures and risk of disintermediation. There have been two main disruptors. First, from payment service providers, like Stripe. Second, from independent software vendors who supplement their vertically-focused platforms with payment processing capabilities, like Toast.
Our bottom-up analysis suggests there is a wide dispersion of payment enablement among ISVs and across verticals. For example, hospitality (inc. hotels, restaurants, and wellness) has been the most payment-enabled to-date, compared to vendors within more complex industries which focus on software, such as energy and construction. Moreover, Europe, seems earlier in the growth cycle compared to the US, where some venture-backed ISVs have listed on the public markets.
In the final section, we screen ten verticals and highlight some interesting ISVs we have come across in Europe.
Please reach out if you would like to discuss in more detail.
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Introduction: Evolution of Integrated Payments
The growth in cloud computing and emergence of the mobile internet has catalysed significant growth in card payments over the past 15 years. According to a recent Nilson report, global card volume exceeded US$40 trillion last year, up from only US$5 trillion in 2006. Against this backdrop, traditionally offline and fragmented vertical markets have progressively digitized their core software and payment infrastructures. We can breakdown this evolution into four phases.
- Emergence of payment service providers (PSPs): commerce globalized and shifted towards digital channels, with PSPs becoming increasingly central to processing online and offline transactions. Venture-backed PSPs include firms such as Stripe and Square.
- Growth of platforms & marketplaces: digitally native merchants scaled, with customers demanding a frictionless online check-out experience.
- Vertical software: fragmented vertical markets begun to digitize as independent software vendors (ISV) developed industry-specific applications.
- Payment facilitation: ISVs built payment capabilities, typically in offline verticals where merchants are mostly SMBs. Other vertical payments companies also scaled, like Flywire.
Figure 1: Evolution of Integrated Payments
Source: Lazard VGB Insights
The direct relationships between merchant acquirers (and more latterly PSPs) and merchants have been threatened by disintermediation risk. European and US venture & growth markets have been at the forefront of this disruption, with early-stage investors backing the growth of consumer internet platforms (i.e. Netflix, Spotify), payment service providers (i.e. Stripe, Square), and ISVs (i.e. Toast, Procore). This report unpacks these dynamics and consists of three main sections:
- First, we disaggregate the payments value chain
- Second, we outline how ISVs have added payment processing to their core software offering
- Last, we screen 10 European vertical software markets to identify interesting ISVs
Section One: Payments in Focus
Disintermediation across the Payments Value Chain
The payments value chain is complex. In the figure below, we outline a simplified framework underpinning two key sub-processes: payment authorization and settlement. The figure also demonstrates two ongoing trends we have identified: first, PSPs positioning between merchants and acquirers; and second, ISVs utilizing their vertical product offering to compete directly with PSPs.
Figure 2: Disintermediation across the Payments Value Chain
Source: Lazard VGB Insights
Zooming in on ISV Disruption
ISVs appear most disruptive within the offline SMB segment, with notable growth in software adoption among SMBs. For example, up to 50% of small businesses now use ISVs as payment providers, according to a recent McKinsey report.
In the figure below, we outline the competitive positioning of some different payment processing firms. ISVs have taken share largely in the SMB segment, PSPs have targeted digitally native merchants, while merchant acquirers are focused on legacy offline enterprise. ISVs are increasingly looking to target mid-market and multi-channel merchants.
Figure 3: Competitive Positioning of Independent Software Vendors (ISVs)
Source: BCG, Lazard VGB Insights
Strategic Response from Merchant Acquirers and PSPs
Merchant acquirers and PSPs have made strategic choices to protect their competitive positioning and mid-term growth prospects. Merchant acquirers have utilized M&A to help preserve card volumes and merchant relationships, with many players acquiring vertically focused assets or point-of-sale solutions. PSPs on the other hand have built in-house capabilities to work directly with ISVs via direct API connectivity – Stripe Connect is a notable example.
ISVs have looked to add payment processing as a core product feature - in some cases becoming payment facilitators in their own right (we explore the different shades of payment enablement later). A payment facilitator (Payfac) provides payment services through aggregating merchant funds into a master, pooled account. ISVs who establish Payfac capabilities look well-placed to build defensible competitive positions, with lower levels of disintermediation risk in our view.
Figure 4: Strategic Responses by Stakeholders
Source: Company Reports, Lazard VGB Insights
European Payments + Software M&A
ISVs' growing relevance has been noted across the payments ecosystem. For example, some vertical payment companies have looked to add volume and expand their profit pool using M&A.
This has been most notable in the hospitality vertical. SumUp – a mobile point of sale solution – has made two recent acquisitions in Tiller and Fivestars which added complementary software capabilities and provided cross-selling opportunities to their existing merchants. While private-equity owned Planet Payment – specializing in acquiring and processing services – has focused its own M&A strategy on acquiring retail and travel software tools, adding relevant products in both hotel PMS and retail SaaS. Other notable examples include Saltpay, Xplor, Unzer and Concardis.
Figure 5: Examples of European Payments + Software M&A
Source: Company Reports, Lazard VGB Insights
Section Two: ISVs in Focus
Now we’ve mapped some of the competitive landscape, we can dive into the core of the report - independent software vendors. As a reminder, an ISV sells enterprise software applications to serve the specific workflow needs of stakeholders.
ISV Payment Models
Integrating payments can be beneficial both operationally (to merchants) and financially (to vendors) - ISVs therefore need to consider whether to integrate payments within their software offering. This requires assessing benefits to the customer experience, and the varying levels of risk and return. The decision tree below illustrates how we categorise the decision process.
Figure 6: ISV Payments – Decision Tree
Source: Bain & Company, Lazard VGB Insights
Should the ISV conclude payment processing may be additive, the company would then likely target one of three economic payment models: referral, agent or principal.
- Referral: includes commission-based agreements with a PSP or merchant acquirer. This option is the lowest low-cost approach but quickest to market. Recently PSPs have built APIs to provide simple integration for vendors seeking this option.
- Agent: ISVs sell payment services as an agent, with the vendor earning commission on the spread between wholesale and retail processing rates.
- Principal: payment facilitators operate in principal position, maintaining sub-merchant accounts, and making it easier for SMBs to accept payments. This option involves the highest upfront cost – to build out the required payments infrastructure - but can delivers the most attractive long-run economics.
Using a recent Bain report, the figure below summarizes the relationship between upfront cost, time-to-market and unit economics.
Figure 7: ISV Payment Models
Source: Bain & Company, Lazard VGB Insights
Software & Payments – The Growth Curve
Our assessment of ISV business models has led us to establish the five-step ‘vertical software growth curve.’ This encompasses the journey from early vertical penetration, to embedding financial services, through to leveraging volumes to establish a marketplace. ISVs may take these steps in different sequences, but in our opinion the core principles remain consistent.
Step 1: Identify the core control point in a given vertical market and build targeted workflow applications to acquire initial merchants.
Step 2: Build (or acquire) additional product capabilities, helping embed organic growth from existing customers and support new customer acquisition.
Step 3: Integrate payment processing through selecting one of the three operating models described above. Firms often look to capture incremental economics as they scale.
Step 4: Add further financial products to benefit merchants or other vertical participants, such as short-term lending or insurance.
Step 5: Utilize scale and data insights to establish a two-sided marketplace. Marketplaces built by ISVs can derive attractive take rates given demand fragmentation of SMB merchants.
Figure 8: Vertical Software & Payments – The Growth Curve
Source: Lazard VGB Insights
Case Studies: Toast and Procore
Now we explore two examples of mature venture-backed ISVs: Toast and Procore, examining their progress around our ‘growth curve’ framework above.
First, we look at Toast’s journey to become a scalable, cloud-based restaurant management platform
Figure 9: Toast – Growth in Restaurant Locations
Source: Lazard VGB Insights
- Core features around specific control point: Toast begun as a payments processing platform aiming to streamline in-restaurant point of sale systems.
- Broaden platform offering: Across time the company added ordering and core restaurant management functionalities, including inventory and menu management.
- Additional payments capabilities: Despite being payment-led, the company added additional features such as ToastGo to enable handheld POS to increase staff productivity.
- Adjacent financial products: Toast added spend management capabilities as well as monetizing its data moat to add insurance and lending products (i.e. Toast Capital).
- Establish two-sided marketplace? Integration of third-party software increases Toast’s malleability within the restaurant tech stack. Toast has yet to establish a wholesale ingredient ordering platform, such as firms like Choco and Rekki.
Second, we analyse Procore’s ability to streamline management of construction projects through a single integrated platform.
Figure 10: Procore – Growth in Organic Customers
Source: Company Reports, Lazard VGB Insights
- Core features around specific control point: The company established its core product simplifying workflows for general contractors, positioned as the industry’s system of record.
- Broaden platform offering: Procore expanded to a multi-product offering, adding product features such as quality & safety, and tailoring new products such as specialty contractors and owners - also entering new geographies.
- Additional payments capabilities: Initial financial management tools were focused on capital planning and cost management. In 2022, Procore Pay was launched to drive efficiencies through the construction payment cycle.
- Adjacent financial products: The company offered materials financing through partners, such as Bild, and recently launched an insurance brokerage – Procore Risk Advisors – aiming to apply vertical expertise to improve underwriting quality.
- Establish two-sided marketplace? Procore is yet to launch an integrated materials purchasing platform – but the firm does utilize a third-party app marketplace to help customers build a customized tech stack around their core workflows.
Section Three: Vertical Software & Payments in Europe
Assessing Payments Integration by Vertical
When we look across the vertical market opportunity set, the individual dynamics are important to consider:
- Software verticals are often deeper in the US compared to Europe, in our view. For example, each market often has higher volume of participants, typically with a listed or late-stage player such as Toast, Procore, or Veeva.
- The size and complexity of verticals is quite varied. That is, in terms of: addressable market, cyclicality, fragmentation, number of end customers, online penetration, payment frequency, average order value, etc. Identifying the core control points can be more difficult in complex verticals.
- A continuum exists between ISVs being software-led or payments-led by vertical. High volume, offline and fragmented verticals are more akin to payments, versus more complex markets such as construction or energy where software tools derive comparatively greater value. In our view, we consider the level of payment penetration in the terminal year as an important feature.
To illustrate this final point in more detail, we have taken 10 vertical markets in Europe and plotted merchant fragmentation against the average level of payment integration. Currently, restaurants, wellness and hotels are more payment-led verticals compared to ClimateTech, Supply Chain and Government which are more software-enabled. Looking ahead, we might expect the level of payment penetration to continue to evolve.
Figure 11: Integration of Software & Payments – by European Vertical
Source: Lazard VGB Insights
In short, we believe a number of variables are important when assessing a vertical market:
- addressable market size (split by software & payments)
- type of business model
- industry cyclicality
- breadth of end customers
- merchant fragmentation
- industry online penetration
- potential for marketplace adjacencies
- evidence of existing players of scale
We summarize each of these in the figure below across our ten selected European markets.
Figure 12: Vertical Market Screen - Europe
Source: Lazard VGB Insights
From our analysis, we can infer a few key takeaways.
- Larger markets are positively correlated to vertical complexity. Payments’ economics often play a more central role in less complex, smaller verticals for ISVs.
- Vendors operating within more limited TAMs may have comparatively less business model differentiation versus peers, with the end customer also more homogenous. Vendors in narrower markets may utilize payment processing to: i) build better economics, ii) cross-subsidize software pricing, and iii) allow merchants to build an improved customer experience.
- Some verticals have a wider dispersion of ISV business models – energy for example, has multiple different types of operating models.
- Cyclical industries may provide a more attractive setup for vertical software, with ISVs able to drive workflow efficiencies and bundle fixed costs for merchants.
- Verticals with high merchant fragmentation and with low online penetration appear to have been the most penetrated to-date.
Vertical Software Vendors – Europe
While our top-down analysis is important for differentiating between markets, we generally identify companies on a bottom-up basis. Our bottom-up screen included a two-step approach: i) we identified the different types of ISV operating models within a given market, and ii) used desktop research to identify related venture-backed companies. As a result, we have identified two lists: first, 100 ISVs which we find interesting, and second, around 20 companies we have come across, which we believe may be well positioned within their given vertical in Europe.
Figure 13: Selected European ISVs
Source: Lazard VGB Insights
Our list of around 20 sit across a range of verticals, with different payment capabilities. Companies such as Vita Mojo, Flipdish and Phorest have closely aligned payment processing with their software suite – each of these companies interestingly operate within hospitality. Mews is another good example – utilizing its core position as a hotel PMS to integrate payments across the guest experience.
More software-focused companies can be broken down into two segments: i) solutions which target data analytics such as OTA Insight in hotel management or PriceHubble in real estate, or ii) vendors who operate in more diverse, complex verticals such as construction or logistics.
Firms which sit in-between are building a diverse range of payment use cases, from Brightflag which incorporates e-billing software within its legal product offering, to ZeroNorth which is enabling end-to-end bunkering solutions within shipping.
Figure 14: Selected ISVs - by Level of Payment Enablement
Source: Lazard VGB Insights
Investor Participation in European Vertical Software funding rounds
Analyzing historic funding rounds across the 100 interesting ISVs we have identified in Europe, we have assessed investor participation to-date. We illustrate our findings below. For reference, red denotes high concentration of investments, with white where no investment has been made.
Figure 15: Top 100 ISV - Investor Heatmap
Source: Lazard VGB Insights; Pitchbook
Later stage VC has been the most prolific investor type across our verticals, closely followed by early-stage VC and Growth PE. US and UK-based investors are key participants – and together with France & Germany contributes around 95% of investors. Interestingly, SWF, CVCs & FOs have been relatively less active, with crossovers also subdued likely due to the lower maturity of companies in Europe.
Conclusion
In our view, there have been two core stages of disintermediation around merchant payments. First, PSPs positioning ahead of merchant acquirers as industry verticals begun to digitize payments. Second, independent software vendors utilizing their vertical software tools and direct merchant relationships to embed their own payment processing capabilities. We believe that ISVs should be able to build long-term competitive moats, with lower level of disintermediation risk in payments.
Based on our market analysis, the US seems to have established a deep pool of vertical software companies across industry verticals – with some of the more mature reaching the public markets. Europe appears much earlier in the growth cycle, but our bottom-up vertical analysis suggests to us that there is a deep pool of ISVs in Europe. The level of payment enablement and digitization is varied by vertical, but payments may become an increasing driver of growth, and terminal value for ISVs.
Based upon our analysis, our selected list of ISVs in Europe includes some companies which we believe may be well positioned within their given vertical, including: ContractPodAI, Goodlord, VitaMojo, Plentific, Phorest, Flipdish, Brightflag, Planradar, Cosuno, Capmo, Bryter, ZeroNorth, Tibber, Mews, OTA Insight, Amenitiz, Lodgify, Itineris, Sendcloud, Price Hubble, Shippeo, Kayrros, and Deliverect.
Looking ahead, we believe ISVs may provide a rich pool of opportunities for investors as many of the identified companies continue to scale.
Appendix
Figure 16: European ISVs – Selected Company Profiles
Source: Lazard VGB Insights; Pitchbook Data Inc.
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