Beyond Hypergrowth: How SaaS Companies Can Successfully Pivot to Profitability

Key strategies to survive tech-sector turbulence and position your business for enduring growth

By Derek Kennedy, Charlotte Kiang, and Saarah Murphy

It’s been a tough couple of years for the tech sector. Collectively, businesses in the space have laid off at least 230,000 employees since 2022, and the banking crisis has taken a further toll both on tech startups and on the venture investors on which they depend for growth capital.

As we’ve written previously, these economic jitters have forced Software as a Service (SaaS) companies to reevaluate their priorities. Over the past 15 years, SaaS businesses were generally encouraged by investors to focus on growth at any cost: companies that demonstrated rapid growth were rewarded with sky-high valuations and easy access to capital. Now, the heady days of “free money” are largely over. Investors are newly focused not on hypergrowth, but on SaaS vendors’ commitment to responsible management, and on their ability to demonstrate a clear path to profitability. Growth remains important, of course, but it no longer trumps efficiency and effective strategic planning.

When the tech downturn began and SaaS valuations started to slide, many executives at early-stage companies focused their attention on reducing their burn rate and extending their runway. Increasingly, though, it’s becoming apparent that SaaS investors aren’t simply temporarily nervous. They are reexamining the foundations of their investment theses, and prioritizing profitability over hypergrowth in new — and, apparently, enduring — ways.

The good news is that despite turbulence in the broader tech sector, and widespread reductions in IT budgets, enterprise software spending remains relatively buoyant. While SaaS businesses are navigating choppy waters, real growth opportunities still exist — and there is reason to believe that the SaaS sector will rebound strongly as the economy improves.

This sea change means that in today’s marketplace, SaaS businesses face a key challenge. It isn’t enough to cut costs and hope to weather the storm. Instead, executives need a clear strategic plan for driving operational efficiency and long-term profitability — while retaining the ability to adapt to changing conditions and capitalize on emerging business opportunities. To pivot to profitability, in other words, SaaS businesses will need to show they can strategically trim fat without cutting away the muscle needed to drive future growth.

A new mandate for efficiency

The reason for investors’ new focus on efficiency is clear: after surging early in the COVID crisis, the Nasdaq fell more than 33% in 2022, and continues to underperform relative to the Dow industrial average or the S&P 500. With interest rates rising to over 5% (as of July 2023) and the banking crisis accentuating existing macroeconomic headwinds, we’ll see financial players of all kinds proceeding with extreme caution in coming months.

This hesitancy will dampen the prospects of a rapid rebound in the SaaS space. While VCs continue to hold significant undeployed capital — representing perhaps as much as $290 billion in “dry powder” — the reality is that VCs are themselves under pressure from their LPs, and many are likely to shepherd their resources carefully, with a focus on supporting companies already in their portfolio.

The upshot, industry leaders say, is likely to be a lasting shift in the ways that SaaS companies think about capital — and in the way that investors think about SaaS companies:

• “Rethinking growth targets, in light of the rising cost of capital, to focus more on efficiency in this environment is a consistent thread in board meetings these days,” says Charles Birnbaum, a partner at Bessemer Venture Partners.
• “Less money in the system means companies need to have better operational excellence,” argues Mar Hershenson, managing partner at Pear VC. “Investors are also going back to basics. Diligence is back, along with appreciation for companies that are building real value, not relying only on future value.”

The bottom line: investors are likely to remain less willing to pay a premium for hypergrowth. Instead, they will expect to see SaaS businesses operating efficiently and prioritizing long-term profitability. Growth remains a must-have, of course, but it’s no longer the only game in town; investors are willing to settle for significantly less growth if a business can demonstrate strong and sustainable profit margins.

Investors have long used the “Rule of 40,” which states that a company’s profit margin and growth rate should sum to at least 40%, to frame their view of investment opportunities. During the hypergrowth era, investors were willing to put their thumb on the scales and forgive low profitability — even if it dragged the company below the “Rule of 40” threshold — as long as it was paired with high growth. By contrast, a high-profitability but low-growth company was rarely seen as an enticing investment.

In recent months, we’ve seen an inversion of that trend. High-growth, high-profit companies remain appealing to investors, of course, though in today’s tightening economic climate they’re no longer delivering the extremely (and perhaps excessively) high valuation multiples they once did. When they’re forced to choose, though, investors are now far more likely to steer their capital towards lower-growth but highly profitable businesses than to invest in fast-growing but money-losing startups. Companies in the high-profit, low-growth quadrant have thus seen their valuations protected from the broader downswing, with only a modest valuation downswing relative to other growth-positive quadrants.

As we look back at the past couple of years, we’re seeing that investors’ recalibration of the Rule of 40 has led to more companies prioritizing profitability over growth. But we’re also seeing that this transition isn’t easy. In fact, many companies are struggling to build a viable pathway to profitability.

Between August ’22 and April ’23, we’ve seen a sharp decline in high-growth companies. We’ve seen a corresponding increase, of course, in low-growth companies — but few of the companies making that transition have successfully pivoted into the high-profit quadrant that investors favor. While some companies have successfully repositioned themselves as profitmakers, we’ve seen over twice as many companies entering the low-growth and low-profit segment — the worst of all possible worlds, and a hard position for any SaaS business to bounce back from.

How to execute your pivot to profitability

The key challenge facing SaaS businesses today, in fact, is how to execute their pivot to profitability — easing off on strategies designed to fuel hypergrowth, and stabilizing their business model for long-term success — without stalling out and spiraling into a low-growth, low-profit position.

To achieve success in this climate, SaaS executives will need to think holistically, and take a long-term view in order to reconfigure their business for steady flight without losing too much altitude. From past downturns, we know moments of adversity are also when strongest businesses pull ahead. That makes it as important, if not more important than before, for tech leaders to look beyond reactionary cost-cutting measures, and instead take the opportunity to comprehensively re-imagine their strategy to thrive in a downturn.

In doing so, SaaS executives should take a critical eye to four broad dimensions of their business:

1. Re-establish your right to win. Efficiency may be the order of the day, but ensure you have a clear thesis for how the changes you make now will ultimately allow you to emerge as a leader in your segment, or to conquer new markets. Survival is only the first step: think strategically to ensure your business is positioned for lasting growth, and that you’re ready to exploit emerging opportunities during the downturn and beyond. Often, this kind of strategic realignment requires a bold bet on a big idea. One company made the unconventional decision to de-emphasize the software platform it was most known for, and established itself as a true innovator by putting cloud infrastructure at the center of its business. By empowering a small team to take charge via a kind of “reverse merger,” the tech company unlocked double-digit growth and saw its share price surge — a reminder that even the biggest companies need to embrace disruption, and back themselves to succeed in emerging spaces.
2. Streamline your product portfolio. In a down market, SaaS businesses can’t afford to carry dead weight. Take a close look at your product lineup and your customers’ evolving priorities, and be ruthless about terminating projects that don’t have align with your evolving mission or that lack a clear pathway to near-term profitability. Pay attention to your feature roadmap, too, and ensure engineering resources are invested in areas that directly translate into sale, retention, and upsell opportunities. We’ve seen even the largest tech companies adopt this strategy successfully: One company unified its engineering function under a single strong CTO, and created a core cloud platform to power its full range of enterprise software products. The result: a more seamless customer experience, a unified data map to drive innovation and break down internal silos, and a dramatic increase in development velocity — including an increased ability to integrate AI solutions across the company’s entire product portfolio.
3. Refocus on GTM productivity. Your GTM strategy and ability to monetize your product has never been more important. To turn your business into an engine of profit, not just growth, you’ll need to think strategically about your sales and marketing operations, and ensure your entire team is laser-focused on winning profitable deals, maximizing revenue-flow, and delivering the retention and upsell opportunities that distinguish highly profitable SaaS businesses from also-rans. One leading SaaS company achieved this kind of transformation by taking a clear-eyed look at their core offering, and recognizing that their core IT customers were close to fully vended. Instead of launching new logos, the company adapted its sales and product roadmap to extend its offering into HR and procurement functions with similar user workflows. By leveraging customers’ IT divisions as an internal proof-point, the company was able to unlock new use-cases for existing customers and establish an effective cross-selling GTM motion.
4. Restructure for lean G&A. Cutting the fat will always be a part of a pivot to profitability. It’s important to remember, though, that running a lean business isn’t just about scrimping and saving. It’s about deploying capital efficiently across your operations, with streamlining and proper organizational hygiene, in order to execute on your strategic vision. The goal is to reduce waste, while still making the key investments your business needs to succeed. Going lean shouldn’t be about hitting the panic button when times are tough. One high-performing SaaS player embraced lean strategies even as it was significantly outperforming both guidance and expectations, as part of a broader strategy to drive long-term growth. By reducing spending on external resources and areas such as real estate and non-essential travel, the company was able to consolidate its operations and prioritize strategic spending in revenue-generating areas such as sales and customer support.

To stay ahead and ensure profitability, SaaS businesses need to consider all four of these dimensions rather than choosing a single axis to prioritize. Implementation will be different for each organization, based on the specific challenges and opportunities they face, but it’s worth paying attention to ways that other industry leaders have navigated similar situations to ensure efficiency and profitability.

In addition to applying specific best practices to their operations, pivoting to profitability requires a focus on identifying opportunities and capturing market share in areas where enterprise buyers are continuing to invest resources. This might mean doubling down on established technologies that are still in demand from customers, or that address perennial and recession-proof business needs. According to BCG’s IT Buyer Survey, for instance, 37% of IT leaders expect to increase their total spending on cloud solutions this year, while 31% will boost spending on security infrastructure. While buyers are indubitably more cost-conscious than usual — and are making significant cutbacks in areas such as server infrastructure and hardware — SaaS vendors that target the right areas or provide the technological solutions that buyers need can still generate a strong revenue stream.

The key takeaway: SaaS leaders need to listen to their customers, anticipate their evolving needs, and ensure their pivot to profitability is underpinned by a corresponding pivot into technologies and market segments that are poised for continuing (or, ideally, increasing) enterprise software spending. Ensuring the continuing relevance of your SaaS business and your core technologies will necessarily require a focus on the latest and most potentially disruptive tech trends. Executive interviews and earning call transcripts highlight areas for growth including cloud services, AI/analytics, and cybersecurity. Recent VC investments also show a focus on areas including AI Ops, generative AI, TinyML, IoT security, and synthetic data.

Aligning with IT buyers’ evolving needs necessarily means looking toward the future, and planning for disruptive technologies and trends that have the potential to reshape your sector of the tech ecosystem. To zoom in on just one of these tech trends, consider the surge in attention being given to generative AI tools in recent months. The technology’s ability to break through into mainstream discourse with powerful tools such as ChatGPT has perhaps obscured the degree to which the foundational technology is now emerging as a powerful solution across a wide range of business and industry use-cases.

There’s a reason why ChatGPT was able to hit 1 million users in just five days — enterprise users in many sectors can easily envision a world in which generative AI capabilities boost productivity by 5X or even 10X in coming years. Key areas where generative AI could have a plus-sized impact include:

• Data management, including the development of synthetic data to solve for privacy concerns while enabling the generation of more representative and ethical datasets;
• Software development, with generative AI capable of writing code and technical documentation far faster than human teams can manage;
• Content creation, with large language models providing editing, marketing, and sales copy creation at scale;
• Audio and video services, including editing, text-to-speech-to-text services, on-the-fly translation, and automated animation and 3D modeling solutions.
• UX enhancements, such as automatic field population as customers fill out online forms.
• Gaming and entertainment, incorporating responsive motion-capture technologies to generate human characters and immersive environments in real time.

What do such applications mean for profit-focused SaaS businesses? The possibilities are almost endless and vary widely by the specific industry and customer use-cases being addressed. Executives will need to seek ways to understand the potential for generative AI to transform both internal processes and customer-facing products and user experiences, and also the scope for new AI tools to disrupt the economics of the industry they serve.

As generative AI technologies mature, we’ll see use-cases cohere around a number of transformative capabilities, including the ability to use English to code without learning programming languages, and the ability to access “infinite memory” by drawing on the vast bodies of data used to train GenAI models. Innovators will also increasingly exploit the ability of probabilistic AI to arrive at unexpected (and thus creative) responses to prompts, to develop and executive complex plans, and to scale up rapidly using cloud infrastructure.

To leverage such emerging capabilities, companies will need to build in-house expertise while also forging partnerships with other players in the AI space, and taking a clear-eyed look at the risks inherent in emerging technologies.

Stay agile to drive your pivot to profitability

The bottom line: to successfully pivot to profitability, SaaS businesses will need to apply best practices to ensure strategic focus, manage their product pipeline, optimize their GTM posture, and drive lean operations. But they will also need to stay agile, paying close attention to emerging tech trends (including, but not limited to, generative AI) and be ready to adapt decisively but with appropriate caution to exploit new opportunities, corner emerging markets, and meet the evolving needs of enterprise IT buyers.

By running their business with focus and efficiency while keeping a finger on the pulse of emerging trends (whether technological, societal, or customer-specific), executives can construct a holistic strategy that supports their long-term growth and their appeal to investors — even during continuing turbulence in the tech space and beyond.

The authors would like to thank Stella Su and Rohan Hebbar for their help in conducting research for this article.