Software horizons: Profitable growth
Over the past 15 years, the number of B2B software companies has grown exponentially. This rapid growth has been driven by a generational shift with exploding demand coming from enterprises moving on-premise software to cloud, embracing Software-as-a-Service (SaaS), composite applications, and APIs along the way.
In 2021, global SaaS and cloud end-user spend reached $410 billion1. Rapid industry expansion has been driven by easy access to capital and investor focus on sales/customer growth as the primary measurement of success. For many software companies emerging over the last decade or so, this benign environment is all they’ve ever known. Now market dynamics are shifting rapidly. Faced with shrinking valuation multiples, increasing growth uncertainty, and the possibility of a recession, software companies must adopt strategies that balance growth and profitability to position themselves for a stronger future.
The market capitalization of B2B software companies has declined dramatically, between 40% and 70% in recent times2. During the first 8 months of 2022 alone, these companies have cut their annual growth forecasts by an average, of 20%, as compared to the average YOY growth in the last five years2. More than half of software companies are now scaling back their revenue growth projections for this year; the total revenue projections shortfall 2022 (year-to-date) vs 2021 is a whopping $4.2B2.
Growth is slowing and demand destruction is applying the brakes hard to rapid expansion. And in a climate of rising interest rates and higher inflation, combined with geopolitical instability, investors are shifting their focus from pure high-growth models to more conservative alternatives. It is clear that investors are now seeking proven cash flow and profitability. In this context, the traditional B2B SaaS success measures, such as the Rule of 40*, are also evolving. Achieving or exceeding the Rule of 40 with a singular focus on hypergrowth is no longer acceptable.
Although almost half of all software companies meet or exceed the Rule of 40, we find that 84% are unbalanced in favor of revenue growth over free cash flow margin2. In today’s changing software market, B2B software companies must take a more measured approach to growth, balancing expansion goals against the need to deliver bottom-line results.
Software companies need to adopt new strategies and implement new operating tactics to achieve realistic objectives in today’s economic and market environment. With profitable growth now being the imperative, these organizations must understand the challenges and opportunities associated with their level of SaaS maturity – and the implications across all areas of their business from talent to market channels and competition.
Today’s B2B software landscape is made up of four different generations, each with unique challenges and opportunities in the emerging market context.
Hover each generation to click explore the principal challenges their leaders must deal with as they look to succeed in an era that’s shaping up to be very different from what’s come before.
No matter where a business falls on the SaaS generational spectrum, hypergrowth at a loss is no longer a viable strategy.
With classic software businesses experiencing the lowest growth rate within the industry (by a wide margin of 36%2), the transition to SaaS operating model should be priority #1. It’s the only way forward. After all, the move to SaaS has been the single biggest change in enterprise software in the last 20 years. It’s turned industry business models – and the way that the financial market has valued them – on their heads.
Gen 1 SaaS businesses need to capitalize on their cash flow and profit margins, to accelerate public cloud adoption while finding growth in new or adjacent market segments. This includes exploring a well-defined strategy that targets opportunities down-market via growth areas such as small and medium-sized businesses (SMBs).
Classic and Gen 1 SaaS businesses can harness their healthy capitalization to make transformational acquisitions that would have looked impossible just a few months ago. And to increase customer acquisition and retention rates, a Gen 1 SaaS business can adopt second and third-generation companies’ product-led growth strategies.
Meanwhile, many Gen 2 and Gen 3 SaaS businesses that responded quickly to the unprecedented increase in demand during the pandemic benefited from a significant sales boost. For some companies, however, the demand is waning. Now facing a less buoyant and less stable economic climate, these companies’ business models are being challenged: strategies, including consumption pricing and the scaling of operations to drive massive, transformational enterprise deals, must now be re-evaluated. These businesses could benefit from the tactics of classic and Gen 1 SaaS businesses in expanding channels, scaling processes, and achieving operational efficiencies.
Of course, the pressures of each business vary, particularly within the context of the software market’s new normal, but certain common guidelines apply.
We have identified four priority areas where all B2B software companies – regardless of the stage of SaaS maturity – can prioritize and approach the market landscape differently: