(2024-01-23) Brown Dark Software

Matt Brown: Dark software. TLDR: The last decade’s playbook for building startups is breaking down, particularly in SaaS and fintech. Founders need a new playbook to create winning startups. But what will the playbook (and the winners) look like? “Dark kitchens” (ghost kitchen) in food delivery might offer a hint: they’re able to win in highly commoditized, low-friction markets with hyper-specialization, a full-stack product offering, and everything outsourced except the brand and integration.

The new model for startups will be that of “dark software”: combining fintech and SaaS products from different vendors into a seamless, full-stack offering for hyper-specialized segments. (headless)

the last decade’s model1 for building SaaS and fintech products just doesn’t work anymore. Stagnant or declining growth, high and rising CAC, declining LTV… all are symptoms of this breakdown.

These problems are adjacent to but independent of the recent pull back in venture funding

What’s causing this breakdown? There’s too great a supply of undifferentiated software chasing increasingly picky demand that’s also locked behind a small number of monopolistic platforms extracting ever greater margin to access that demand. (monopoly, overproduction)

AI will cause these dynamics to spiral even faster, making software even cheaper and distribution more expensive. (red queen race)

are plenty of fascinating examples of AI acting as an increasingly competent replacement for engineering

On the other hand, AI will accelerate the competition and increase the cost to acquire users. Everything from producing SEO content to personalizing outbound sales will be cheaper and easier with AI.

Dark kitchens (aka virtual, ghost kitchens, or cloud kitchens) exist because of super successful food delivery platforms, including DoorDash and UberEats. These are kitchens that don’t offer any dine-in service, and probably don’t even have a sign on the building

what’s the most efficient way to build a delivery-only restaurant?”

why limit yourself to a single brand and menu? You can run different brands out of the same, lower cost, more efficient kitchen

You can run a high-end bistro, maybe upselling truffles and a wine pairing, while also running a low-cost pizza brand that upsells beer and wings (It's not easy to manage multiple cuisines, though you might be able to achieve mediocrity.)

This can lead to almost comical over-optimizations of the model, like the SF pizza restaurant that was running 70 different virtual storefronts...

This is all thanks to the delivery platforms, which (1) aggregate demand, (2) handle delivery and payment, and (3) encourage suppliers to outsource everything that’s not core to the business and specialize to win niches

This makes it easy to test new menus and brands, specialize, and move quickly towards the highest-profit options.

also increasingly describes the software market.

The cost of code is dropping (commoditized inputs). Software buyers are increasingly picky and expect products that suit their exact needs (differentiated demand).

a new model, which I call dark software. It has three key points:

a hyper-specialized ICP to maximize conversion and minimize CAC.

Compensating for this narrower focus requires…

a full stack product offering to maximize LTV

can sell more products to a narrower customer set (LTV)

Because these products span many areas and range in complexity, it’ll be difficult to build all in house, requiring dark startups to…

outsource the maximum amount of product to minimize fixed costs.

A classic SaaS business would offer a point solution, say invoicing, to a broad set of companies and use cases, like SMBs. Nearly all of the product would be built in house, with a focus on making the core invoicing use case 10x better.

On the other hand, a dark software company would start with a hyper-specialized use case, say small law firms in the US. Rather than start with a wedge product like invoicing, a dark software company would launch with multiple products on day one, like marketing tools, project management, time tracking, invoicing, payment acceptance, payroll, etc.

Nearly all those products would be integrations offered by third party vendors rather than built in house (API, headless)

the focus of product development would be on seamless integration and a smooth, consistent experience across these various products

The chart below shows this evolution visually

What are the implications of the dark software model?

Variations on this model already exist, from vertical ERPs to compound startups.

There need to be more embedded fintech players, and they need to bundle more products. (see 2023-07-31-BrownTheIronTriangleOfEmbeddedFintech)

There need to be more embedded software options (CRM, customer communications, etc)

These will each need to be offered as a service to dark software companies looking to build full stack bundles quickly. Some current examples here include Layer (accounting), Twenty (CRM), Tailor (ERP).

Because every dark software company will use multiple products, they’ll need orchestration and a common data model. Some companies are already offering this as a solution to the bundling of fintech products, in the form of ledgers-as-a-service, like Fragment.

One winner will probably take all (or most) in each sub-vertical.