2023 was an extremely challenging time for tech, with the software sector hit particularly hard as funding dried up and billions were wiped off the valuations of cloud companies.
Due to these market conditions, CIOs and IT buyers were given smaller budgets and forced to reckon with their software spend to reduce SaaS expenditure across the board. The result for SaaS businesses has been devastating, with many facing historic levels of customer churn and having to replace the revenue in a smaller market.
Despite a modest clawback as we head into 2024, the market is still nowhere near a full recovery. Instead, we’ve entered a new normal for the software industry, with annual growth rates for SaaS companies in September 2023 dramatically lower than they were 18 months earlier.
However, amidst this market turmoil some companies have thrived and grown faster in 2023 than in 2022. These companies have taken advantage of market trends and adopted certain key principles - monetizing AI; managing cash burn; prioritizing efficient operations; and embracing product-led growth - that set them out as “Outliers” in the SaaS sector. By learning from these businesses and adopting some of these traits, other SaaS businesses struggling from the past year can shape themselves into Outliers for 2024.
Monetizing AI
If 2022 was the year of the tech slowdown, then 2023 has been the year of AI. Investors are backing the technology heavily, with some of the year’s biggest funding rounds belonging to those businesses producing cutting-edge AI products. AI-native businesses are gaining serious backing, accounting for most new cloud-based unicorn companies in 2023.
This rapid rise has mostly been down to how easy-to-use AI is. Almost any business can start to implement AI into its operations without needing to completely overhaul its IT architecture, creating a vast opportunity for SaaS businesses trying to make their customers’ lives easier. And, as this technology improves, usage in companies of all sizes will surely accelerate.
But just plugging AI into existing processes is not enough for a software company to remain resilient for the long-term. To be competitive and sustainable, these companies also need to effectively monetise AI functionality. This means that AI should not be added for the sake of it - it needs to generate revenue and add value for customers. Otherwise, instead of helping SaaS businesses maintain growth during a downturn, it could become a source of unnecessary cash burn.
For a company to become an Outlier that grows during a downturn, both adding and monetizing AI is now key.
Managing burn
As funding sources have dried up, controlling cash flow and reducing burn have become top concerns for tech founders.
In recent years, many startups have responded to the booming SaaS landscape by adopting a growth at all costs mindset that encourages high spending and rapid expansion. But when a funding landscape changes - as it has in the past two years - then startups need to find a way to reign in spending and stabilize their costs, both for their own financial health and to maximize investment hopes. For SaaS founders facing smaller opportunities for growth and investment in 2023, managing burn has become a major concern. 32% of software founders named burning too much cash as a top concern in 2023, compared to just 13% in 2021.
A key metric of sustainable growth that many companies aim for is an ARR-per-employee of $250,000, indicating high levels of productivity and scalability. Reducing headcount is a difficult step SaaS businesses can take to reach this milestone, and a majority of the largest cloud-based companies have made this decision in the past year. In fact, the median number of employees at software companies with over $50m ARR or more fell by just over 50% between 2022 and 2023 - but many of those that made cuts maintained an ARR-per-employee of $250k.
Managing burn and reducing expenditure is crucial for a modern software company’s success. Cutting costs is a tough decision, but doing so sensibly can help maintain growth and see a company remain resilient and stable in a tough market.
Prioritizing efficiency
As well as reducing burn, many software companies have been attempting to improve their operational efficiency as the market has tightened. By learning to do more with less, companies give themselves the best chance to flourish in tough macroeconomic conditions.
There are lots of ways to improve efficiency. Observing the “Rule of 40+” (which claims that software companies need a combined revenue growth rate and profit margin of 40% or higher to be sustainable) is one way for startups to boost their value and gird themselves against the effects of the downturn. Monitoring back-office costs, which a large number of startups do not do effectively, is another.
Reviewing pricing and payment infrastructure is one of the most important methods for software businesses looking to improve efficiency. This does not just mean raising prices in line with inflation - though this is necessary - but implementing flexible pricing and payment strategies to reduce costs associated with taking payments and attracting new customers.
Offering localized pricing based on factors like tax, FX rates and operating costs helps businesses appeal to a wide range of customers, while offering a combination of payment options for customers will also help reduce churn and increase efficiency.
Focusing on product-led growth
Adopting product-led growth (PLG) is one of the most influential strategies used by Outlier companies in 2023 to grow faster and more efficiently.
By letting the product itself drive acquisition, companies using PLG are able to reach their market more directly and affordably than salesperson-driven outreach. Free trials, self-serve capabilities, and freemium models all drive retention and expansion - vital in a time of economic insecurity.
Firms deploying PLG have of course not been immune from the sector-wide fall in growth. However data suggests that, on average, PLG software companies have seen their profitability increase by 10 percentage points over the past year. Adoption of PLG has only grown as the impact of the downturn sets in, indicating that many in the industry are taking notice of the potential the strategy offers. As PLG strategies get the product in customers’ hands faster and cheaper than traditional sales approaches can, the benefits they offer to both SaaS businesses and their users during a downturn are clear - hence their growing popularity.
Emerging stronger
The turmoil in the software industry has impacted countless software companies and employees, but there may now be light at the end of the tunnel as innovation across the sector is leading to tentative signs of recovery, and at an encouraging pace - while it took 14 years for the NASDAQ to return to just 80% of the peak it had previously reached in 2000, it took only 18 months for the index to reach 80% of its 2021 peak earlier this year.
Growth may have been harder to find in this most recent downturn, but by properly monetizing new innovations like AI, reducing cash burn, prioritizing efficiency, and focusing on PLG, several companies marked themselves out as outliers and grew faster than before.
There are lessons we can learn from these companies’ experiences, and by heeding the key principles adopted by these outliers, many software businesses will give themselves the best chance to grow sustainably and successfully in the future.
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