Jonathan Bush and Todd Park didn’t mean to start a software revolution. They just wanted to get paid.

In 1997, the duo founded a birthing clinic in San Diego, with plans to franchise the model. Before long, things started to go wrong. Their company lacked a system to keep track of insurance claims. Jonathan and Todd quickly faced a cash flow crisis.

They turned to Park’s younger brother, who created a cloud-based administrative system that made dealing with insurers less painful. The software let the founders focus on patients, rather than paperwork. It wasn’t long before Bush and Park realized the problems they were solving were widespread — and the solution they built had broad applications.

Their focus quickly shifted from babies to claims processing. These days, athenahealth has a valuation of nearly $5.5 billion.

Software’s unsung heroes

Industry cloud software companies have largely been ignored by the investment world because of the assumption that the markets they serve are too small to support billion-dollar outcomes. We think that’s misguided — and a quick look at some of the numbers shows why.

Take, for instance, the automotive industry: There are some 78,000 car dealerships in North America. By working solely within that vertical, DealerTrack grew to a value of $2.3 billion. Our portfolio company, Xtime, focused solely on the sub-vertical of 260,000 aftermarket service, repair, and body shops, and sold for $325 million earlier this year.

Guidewire, meanwhile, quietly amassed a value of $3.4 billion over the past 10 years by catering exclusively to the insurance industry, which collected half a trillion dollars in property and casualty premiums last year.

Companies like athenahealth, DealerTrack, and Guidewire don’t get much fanfare in the press, but they’re solving real, industry-specific problems. And they’re poised for substantial growth in the years to come.

The industry software revolution

That’s due, in part, to a changing philosophy among industry buyers. Those who were getting into the e-commerce game in the late 1990s had to rely on the first-generation of packaged software from the likes of BroadVision, ATG and WebSphere. Then in 2004, Demandware entered the picture.

Demandware offered a multi-tenant cloud delivery model that was far more usable and feature-rich. It was regularly updated and improved. It was accessible through the web and mobile. And it didn’t require an army of consultants and IT folks to keep the software running. The company has since grown into a $2 billion business.

In addition to replacing installed software, the cloud has also made it possible for industry-specific startups to attack new markets. Software used to be limited to knowledge workers at their desks. Today’s mobile-first capabilities appeal to industries like real estate, health care and construction, which have adopted mobile devices into their day-to-day routines.

Take our portfolio company Procore for example. When construction software was sitting on a desktop in the back of an office building, it wasn’t terribly useful. Procore has made it possible for a construction team to work off a single set of blueprints and instructions — all through their tablets and smartphones in the field. By increasing the utility of cloud software, Procore is successfully selling to construction companies who never bought software before.

Fueling an industry arms race

An industry cloud software startup offering a solution that drives a meaningful competitive advantage can become both the instigator and the beneficiary of an industry arms race. Its software quickly evolves from a “nice to have” to an essential survival tool.

Veeva Systems, a $3.5 billion leader in software for the life-sciences industry, has done just that. Its clients increase the productivity of their field sales reps, while also meeting all of the regulatory standards placed on pharmaceutical companies, resulting in a virtuous cycle of competitive advantage.

Similarly, community banks using Q2 are delivering a better online banking experience and taking market share from other financial institutions. In both cases, competitors are quick to adopt software in an effort to prevent loss in market share.

Industry cloud software is not an easy nut to crack, though. Breaking in requires a deep understanding of the pain points of the industry and a common language with customers. Bush and Park, for instance, both had medical backgrounds — and had experienced the frustration of dealing with insurance companies.

‘Winner takes most’ dynamics

That steep learning curve both lowers the competitive threat and creates a unique opportunity for the companies that do succeed. Industry insiders talk to each other. They attend the same conferences and run in the same circles. When it comes to software, they typically buy what their friends are using, eschewing the formal RFQ/RFP processes favored by some chief information officers. These dynamics allow industry software companies to benefit from lower sales and marketing costs than their horizontal software peers.

And because the customer universe in a vertical industry is limited, getting an early lead can drive a virtuous cycle of adoption — resulting in a “winner takes most” dynamic. For example, RealPage, the cloud leader in residential real estate management software, services about 40 percent of its focus industry. By contrast, Salesforce.com, the undisputed leader in horizontal customer relationship management, has just an estimated 15 percent overall market share.

Moreover, industry cloud companies that solve a business user’s problems can establish themselves as the “gold standard” — opening the door to cross-selling additional applications and services. And that can lead to even higher market share. RealPage started with just a single real estate accounting module. Today, the company cross-sells 11 different applications to its customer base and boasts a $1.7 billion valuation.

These opportunities are unique to industry cloud companies — and can ultimately drive a lot of value for the winners. Building a mission-critical solution for an industry may not get much fanfare, but it’s certainly a goal we think is loaded with potential. And we’re pretty sure Steven Winn, the founder of RealPage, would agree — his stake in the company was worth more than $500 million when the company went public.

Brian Feinstein is a partner in Bessemer Venture Partners‘ Larchmont office. Brian focuses on consumer Internet and enterprise software investments and leads the firm’s efforts in Brazil and Russia.

Trevor Oelschig is a partner in Bessemer’s Menlo Park office, focused primarily on cloud software and infrastructure.

This is the first installment in a three-part series; the remaining parts will be published on VentureBeat tomorrow and on Saturday. In the meantime, scroll down for an infographic on industry clouds from Bessemer Venture Partners.
 

BVP Industry Cloud Infographic[1]

Get more stories like this on TwitterFacebook

Bessemer Venture Partners is a global venture capital firm with offices in Silicon Valley, Cambridge, Mass., New York, Mumbai and Herzliya, Israel. One of the oldest venture capital practice... All Bessemer Venture Partners news »

Track Bessemer Venture Partners's Landscape to stay on top of the industry. Access the entire ecosystem, track innovation & deals. Learn more.