ISVs need to reinvent themselves with Vertical AI or risk being swallowed up by native, agile, and more specialized solutions.
*By Lauro de Lauro
The Rise of Vertical AI
The enterprise software landscape is undergoing a profound transformation.
Driven by Vertical Artificial Intelligence (Vertical AI). Unlike horizontal software, which offers broad functionalities for various business needs, Vertical AI specializes in specific markets and workflows, using AI to automate tasks that previously required intensive human intervention.
This evolution can be described in three waves:
- First wave: Basic online services, such as scheduling appointments.
- Second wave: Financial services, focused on increasing revenue.
- Third wave: The most impactful change, driven by AI, is expanding the scope of software and transforming "Management into Software." Software is no longer a simple support tool, but a direct replacement for, or even an enhancement of, the human workforce.
Vertical AI redefines the boundaries of what's possible in terms of value and market reach. By delving into specific niches and automating complex tasks, it revolutionizes the service economy, unlocking markets that were previously considered too small or with insufficient ROI. Vertical AI's market capitalization is projected to grow exponentially as its ability to convert labor costs into software value expands the addressable market.
Challenges and opportunities for ISVs
The rise of Vertical AI is overcoming historical barriers, making large companies more receptive to the technology, driven by the concern that competitors will overtake them by adopting these tools first. The radical value proposition of Vertical AI alters the ROI calculation, making the cost of not adopting these tools significantly greater than the cost of adopting them. This dynamic creates an active search for AI-enabled tools to maintain or gain a competitive advantage, which puts pressure on Independent Software Vendors (ISVs) to demonstrate truly transformative value with labor savings. Otherwise, they risk being overtaken by agile, AI-native startups.
The most attractive markets for building Vertical AI companies are those where AI facilitates or completes tasks that were previously impossible or excessively expensive to perform with human labor alone. Vertical AI goes beyond efficiency, creating new capabilities by enabling tasks that were previously unfeasible due to scale, complexity, or cost. AI's ability to take on complex tasks allows for a drastic reduction in client labor costs. By capturing these savings, ISVs can increase their revenue per customer (ACV) by 2 to 10 times.
As Vertical AI solutions mature, they may absorb or displace functionalities from horizontal tools, forcing ISVs to make a difficult strategic choice: specialize or reposition themselves as infrastructure providers. The Vertical AI market is growing exponentially, with LLM (Large Language Model) native startups achieving approximately 400% year-over-year growth. Significant acquisitions by established companies, such as Thomson Reuters and DocuSign, signal a rapidly maturing market and put pressure on incumbents to innovate or acquire.
While initial analysis suggests that Vertical AI startups often complement ISVs, the core value proposition of Vertical AI lies in solving the most critical and highest-value pain points that traditional software couldn't address. This can lead to a "silent erosion" of the strategic relevance of legacy software, which risks being relegated to a mere system of record or a less strategic component. Customer budgets and strategic focus will naturally shift toward AI-driven solutions that deliver tangible labor savings, operational efficiency, and previously unavailable capabilities. Therefore, traditional ISVs must proactively integrate AI into their core offerings to avoid becoming a commoditized backend.
Response strategies for ISVs
To ensure relevance, ISVs need proactive strategies:
- Deepening vertical specialization: ISVs should go beyond generic solutions, focusing on specific niches and workflows that AI can transform.
- Integrating AI into existing offerings: AI should be fundamentally integrated, enhancing products to take on complex and expensive tasks, generating labor savings and increasing Annual Contract Value (ACV).
- Strategic partnerships and acquisitions: ISVs should consider partnering with or acquiring AI Vertical startups to accelerate innovation and gain access to specialized technologies and talent.
- Reassessment of business models: It is necessary to adopt revenue models based on value delivered, where the price is justified by the operational cost savings generated for the customer, rather than user licenses.
Vertical AI is not just a new software category, but a disruptive force that redefines value and expands Total Addressable Markets (TAMs). Inaction is no longer an option, and agility in innovation is crucial for survival. The future of software is verticalized and driven by AI, where the core value is derived from the ability to automate complex and expensive human tasks.
Notice: The opinion presented in this article is the responsibility of its author and not of ABES - Brazilian Association of Software Companies
Article originally published on the IT Forum website: https://itforum.com.br/?s=LAURO+DE+LAURO&x=10&y=15
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