News - October, 2023
The global industrial software market was valued at US$92.58 billion in 2021, 16.1% of the overall global software market in that year. However, Pitchbook numbers suggest that only 8% of all software startups which were backed by investors target customers in the industrial space (industries such as manufacturing, energy, transportation, or healthcare) and probably even less of them are pure industrial tech startups in the sense that they develop software only for these industries. On the other hand, industrial software startups often have an extremely loyal customer base and face less competition due to highly specialized and proprietary technology resulting in high margins and efficient growth. Additionally, potential buyers in this space have deep pockets due to very high EBITDA margins and very high valuations in the public markets, making successful exits much likelier. So why are there less industrial software startups out there? In this article, we will explore the reasons behind this phenomenon and shed light on the distinct skill set and perseverance required by founders in this domain.
Fewer Founders: A Rare Skill Set and Long-Term Vision needed
One primary reason why there are fewer firms backed in the industrial software space is simply that there are fewer founders in this space as they need a rare skill set. Alongside general software know-how, they must possess a good understanding of the pain points in the industries they target, including knowledge about hardware products, industrial processes, workflows, regulations, and the existing software architecture at their potential customers.
Technical expertise is vital for any software startup, but in the industrial software realm, it becomes even more critical. Industrial software often deals with complex systems, data integration, and mission-critical applications. As a result, founders need a strong technical background in software engineering and manufacturing or hardware design to tackle the identified pain points effectively.
Fewer Investors: The Complex Journey to Market and Scale
Industrial software startups face unique hurdles that contribute to a slower growth in the beginning and might explain their limited backing:
1. Longer time-to-market and time to reach scale
Product management of industrial software from finding product-market-fit to scalable product-sales to continuous, up to long-term (!) product development is a challenging and specialized discipline. So your time-to-market and to reach scale takes much longer than in other startups with makes fundraising harder after an initial seed round.
2. Generally longer sales cycles
Industrial software products often require extensive testing and evaluation to ensure they meet the specific needs and requirements (“90% just isn’t good enough”). Compatibility with existing systems, customization options, scalability, and reliability are crucial factors that demand thorough examination, leading to a longer sales cycle.
As they often involve significant investments on the customers’ site or have a direct impact on critical operations or infrastructure, decision-making within industrial organizations is typically more evolved, requiring thorough evaluations, multiple stakeholders, and extensive internal discussions before committing to a purchase.
And finally, industrial software solutions often require customization to align with unique industry-specific software legacy systems, processes, workflows, and regulations. This customization process can take additional time and effort to develop, implement, and validate, extending the sales cycle.
3. Unclear addressable market
Another reason for less backing next to the long-time to market might be the fact that the definition of the addressable market and if it is big enough is challenging for investors: The industrial sector is often fragmented, with numerous niche markets and specialized needs. Similar products by different companies might have very different production setups and legacy software systems. Additionally, as many industrial sectors are subject to strict regulations and compliance requirements, it is hard to move from one sector to another, limiting the addressable market at the time of an investment. This can make it challenging for investors to specify the addressable market of the target company and convince themselves that the market is big enough for the solution the company is selling.
4. Specialized skill set
Finally, another hurdle to reach scale faster is the specialized skill set an industrial startup needs in the R&D, product management and sales departments which is still hard to find externally.
Navigating the Road to Success
Industrial software startups face a long and challenging journey before they can reach scale and see substantial growth. The time required to develop a robust product, establish market fit, and win over risk-averse customers can extend to a decade before generating significant recurring revenues.
However, once the companies are well established and successful, they have also created much deeper barriers to entry by having:
a. developed a deep understanding of industrial processes, workflows and regulatory requirements in their specific industry like manufacturing, energy, transportation, or healthcare;
b. integrated their solution into the complex systems of their customer, such as ERP software, control systems, or hardware devices, and thereby having developed a good understanding of the integration points, protocols, and standards;
c. focused on reliability and safety as they often operate in critical environments where reliability and safety are paramount (prioritizing robustness, stability, and error-free performance to prevent any potential risks or disruptions in industrial operations is something which is somehow contrary to the flexibility a startup needs to have in any other field);
d. established a longer-term product lifecycle compared to general business software as they are designed to operate for years, supporting mission-critical operations and infrastructure. Planning long-term roadmaps, maintenance, upgrades, and support often happens together with the customer and ensures the software remains relevant;
e. found a good balance in their solution between customization and configurability to cater to the unique needs of different industrial customers so that they can offer a flexible, adaptable solution while still maintaining a manageable product portfolio.
They can now embark on a long, sustained period of growth and increasing revenue per customer with little risk of being challenged by new entrants.
Finding the Right Growth Financing
As industrial software firms take more time to gain scale, early-stage investors may already be eager to exit their investment, at the time the startup is becoming a scale-up and entering a phase of sustained rapid growth. This situation creates a complex dynamic where management must balance between shareholders wishing further investments into growth and shareholders seeking to monetize the value already created.
To overcome the challenges and capitalize on the opportunities in the industrial software space, industrial software companies entering the growth stage may need a financing solution that adapts to their specific needs. They need to simultaneously secure further growth capital and provide liquidity for some early backers. We at Cipio Partners recognize the unique characteristics and the long-term vision and growth potential of industrial software scale-ups. We offer tailored financing solutions typically consisting of new growth capital for expansion, combined with a liquidity option for business angels, early venture investors and founders.