Thriving in a Downturn: For SaaS Companies, It Takes More Than Cutting Costs
Authored by Derek Kennedy, JB Reed, and Efrem Huang
It’s safe to say that software as a service (SaaS) companies have enjoyed a heyday for the past fifteen years. But this golden period is over. And with its passing comes a huge challenge for SaaS executives. Perhaps for the first time, they must pivot away from growth-at-all-costs to a new approach that puts a premium on efficient and profitable growth. In this transformation, SaaS management teams will have to look well beyond reactionary cost-cutting measures — and instead adopt a comprehensive strategy that more imaginatively revamps their business to thrive in a downturn.
First, a look at how we got here. In the wake of the 2008 financial crisis, the Fed responded by expanding its balance sheet, principally through quantitative easing. That had the desired effect of slashing interest rates to near zero, creating an environment of inexpensive money. From a software company’s perspective, especially for the booming SaaS sector, this whetted investor appetite for nascent, sometimes risky ventures that promised rapid growth, even without meaningful earnings — or even a clear path to them. By the mid 2010s, the Fed had begun to change course and slowly tighten the money supply. But when the COVID-19 pandemic hit and global economies began to shut down, the cash flowed again, this time in the form of broad stimulus packages.
Now another seismic shift has begun. In part because of the Fed’s earlier actions, inflation is up sharply, and the Fed is raising interest rates and tightening the money supply. As of the end of September, the Fed has raised rates 5 times in 2022. And Fed Chairman Jerome Powell was recently quoted as saying, “We must keep at it until the job is done.” In turn, economies are wobbling, and investor attitudes have shifted from targeting growth and taking chances on unprofitable SaaS companies to favoring EBITDA improvements and positive margins. One statistic makes this point convincingly: between December 2021 and June 2022, the enterprise value (EV) to next twelve months (NTM) revenue ratio of relatively high growth, low profit SaaS firms fell from 19.7 to 5.5, a 72% decline. By contrast, lower growth, higher profit SaaS companies fared (relatively) better, declining 47% from 15 to 8 (see Exhibit 1).
The consequences of failing to successfully navigate uncertain economic periods like the current one are significant. A BCG Henderson Institute analysis of US companies across all industries with over $50 million in annual revenue found that only 15 percent were able to increase both sales and margins during the last four US downturns, while nearly three times that many experienced both falling sales growth and shrinking EBIT margin. A separate BCG study on the impact of COVID on companies’ Total Shareholder Returns (TSR) shows that businesses that emerged as leaders in their industries generated shareholder returns up to four times higher than the industry average (see Exhibit 2).
Although the tailwinds of low interest rates and free-flowing capital have abated, there is nonetheless tremendous advantage to be gained during this new period of adversity. But many companies will miss the opportunity because they will fail to think holistically and take a long-term view about the current imperative to change. At many SaaS companies, headcounts have been slashed this summer. But without improving efficiency and productivity and reconsidering whether the business model is suitably poised for profitability, this type of response tends to leave companies smaller, but not better.
To come out ahead, SaaS executives instead need to take a fresh look at their businesses through the lens of four broad dimensions: strategy to win, product efficiency, go-to-market productivity and lean G&A (see Exhibit 3). Here’s a closer look at each of these categories — the status quo and the new management imperatives.
Strategy to Win: When capital was freely available, many SaaS companies aggressively invested in new features and products to grow revenue across a broad customer base. Moreover, growth from existing products mitigated the need to evolve business models. But in this new environment, companies face significant shifts in core markets while resources are more constrained because of the need to reduce costs. An efficient growth strategy today starts with a well-founded understanding of market potential and customer needs to form an Ideal Customer Profile (ICP). From this, investments in product design, sales and pricing decisions, go to market expenditures, portfolio adjustments and marketing campaigns are prioritized based on their value to these target customers. Simultaneously, efforts that are a drag on resources and earnings are eliminated.
In one of our engagements, a client went so far as to create a separate strategy office to tie company activities, including goal setting and tracking and portfolio expansions, to business outcomes. These strategy leaders steered the development agenda and oversaw revenue management, which including resetting packaging, prices and discounts for key customers. These activities added about 15% to the bottom line, reduced customer churn by 1,000 basis points during a downturn and precipitated a highly successful exit for the founders.
Product Efficiency: In prior low interest rate regimes, the cost to companies of stretching beyond the core portfolio was low. Capital was inexpensive and growth superseded margins, so extending the product line to capture a greater share of wallet or attract new customers was a reasonable tactic. In some contexts, SaaS companies found themselves building customized products for their larger clients, chasing revenue at the cost of efficiency. The downsides are now evident, from high development expenses to pricing inefficiencies to heavy support overhead. The incoherent product line-ups and inconsistent customer data resulting from a patchwork portfolio limit the ability to glean customer insights, further confusing focus and priorities.
One client we worked with tackled this situation by first strategically defining their ICP and subsequently focusing all product development on market suitability. They were able to consolidate 25,000 SKUs down to 450, adopt agile development principles, and create a more coherent pricing structure, ultimately eliminating $500 million in costs across all functions with no meaningful negative impact to topline growth.
Go-to-Market Productivity: Under a growth-at-all-costs philosophy, SaaS company go-to-market priorities have frequently favored acquisition, functionally aiming to “purchase new customers” even if efficiency and potential profitability suffer. Similarly, management teams have thrown bodies at the sales funnel in an effort to maximize growth, sometimes without strong pricing guidelines or an approach for linking sales to overall company strategic goals (i.e., good growth). In these contexts, pricing is often used as a top-line lever only to be pulled in the event of missed growth forecasts. A disciplined approach to customer expansion often is put on hold until the company achieves scale.
Seeking sustainable profitability, SaaS companies will have to sharpen their sales operations models, relying on their ICP to right-size market share targets, reorient incentives, set appropriate quotas, and retain and promote the best talent, especially those that have proven to be capable during periods when new logos were more difficult to come by. In addition, pricing must be viewed as a margin enhancer that is applied consistently to increase profitability over time. Finally, given the relative difficulty of acquiring companies when IT expenditures are slowing, the importance of increasing customer renewals and upsells has never been more critical, highlighting the imperative to adopt a highly efficient net revenue retention (NRR) program and collecting the critical data to support it.
One company we worked with used machine learning to improve their daily sales forecasts and optimized its sales and production priorities based on these projections. The company was able to alter its sales staffing recruitment and incentive policies and enhance efficiency in product design and development, increasing sales productivity by 12% and reducing labor costs by 10%.
Lean G&A: For many years, the technology sector has hired new workers at a steady clip — often beyond what was truly necessary to maintain operations — under the belief that smaller teams would bottleneck growth. As the current downturn began to take shape, cutting seemingly extraneous headcount or freezing hiring became the go-to response for many SaaS companies.
This is generally a rational reaction to a slowing economic environment, but it is far from enough. While there are frequently opportunities for organizational thinning through headcount reductions, by simply making blanket cuts companies run the very real risk of destabilizing the broader business without necessarily providing the desired impact. Often, indiscriminate cuts make existing problems worse as departments get smaller, struggle to complete tasks and silos emerge. This is potentially a “high risk, low reward” move when you consider G&A spending typically represents only a small part of expenses (10–15% of revenue) compared to R&D and sales and marketing. Indeed, achieving truly sustained efficiency in G&A requires a deliberate, longer-range approach to process improvements, including focused investments in process excellence, automation, and strategic outsourcing.
Find your own path: But where to begin with a SaaS company transformation? After all, challenges may be rooted in strategy, product, or go-to-market (or any combination of them). Given the many possibilities, the best way to handle this is to first determine which category the primary problem falls into.
For instance, do you have a strategy problem? Perhaps revenue growth has weakened due to market shifts, and you are trying to make up for it with price concessions. In that case, realigning product strategy with changing market needs is an obvious priority. In the meantime, retaining and upselling the customers you already have is essential while you take the time to redirect the ship.
Or if your main issue involves product and engineering velocity or productivity — maybe your R&D spend is not providing the revenue lift you were hoping for — sunsetting underproductive efforts and right-sizing the portfolio to focus on the greatest market opportunities could help put you on a more lucrative track. And better aligning your product and engineering organizations against core market objectives — providing mission clarity — can improve the yield of inputs to outcomes. In the manic environment of rapid growth, engineering and product leaders often lack the time and space to thoughtfully design and align teams to optimize velocity. The current environment creates the opportunity to take those steps — or perhaps even demands it.
And if your go-to-market effectiveness is suffering — for instance, it’s taking longer and longer to recoup the cost of acquisition — you might need to realign your GTM against a tightened definition of your ideal customer profile, and perhaps recalibrate marketing budgets, take a hard look at sales effectiveness, and consider shifting towards more digital selling. And to help offset the potential, and hopefully temporary, slow-down in new logo sales, it may be important to take a hard look at customer success productivity, which could mean introducing new data-driven methods to identify churn risk and cross-sell opportunities.
Those are just a few ideas to not only survive, but thrive, through downturns — to put you in a market-leading position to emerge a winner. By keeping the aperture open to problems SaaS companies face across four discreet — but often intertwined — areas, management teams can define more robust paths forward.
In today’s SaaS environment, management needs to focus on these sorts of solutions to improve and maintain profitability. For many SaaS companies, this is unfamiliar territory, but the transition from growth to earnings should be welcomed. After all, management teams need strategies and tactics to ultimately make money rather than just seek capital. Knowing how to do that is a capability that many SaaS companies were able to defer in the last couple of decades. But not anymore.
