I’ve spent ~4 yrs observing and working on Software sales, marketing motions and the operating side too. Naturally, I’ve developed some strong opinions based on these experiences.
It seems like that the narrative that surrounds VC-backed SaaS businesses trying to grow 100% year-over-year even at $100M revenue scale often glosses over the harsh realities—sky-high customer acquisition costs, the arduous journey towards profitability, and the cutthroat competition that lurks around every corner.
Acquisition costs, difficulty in achieving profitability, and competition are facets of every business. EVERY. So, why talk about only Software / SaaS?
Well, I think these problems have become exponentially harder and some trends are here to stay for the next ~8 to 10 years that make it SO hard to build a $3B-$4B company that’s financed assuming sky-rocketing revenue growth and best in class profit margins. Is it possible to build the next Open AI, Salesforce, or any supremely amazing solution? YES, and if you want to rely on hopium / luck / your hustle – go for it.
So, what’s changed?
Increased Market Saturation:
The software landscape has become incredibly crowded. India has ~800 SaaS companies and maybe a ton more after we discovered the paradigm shift called Generative AI. Same story goes for the world — too many SaaS companies (30K+). Are they creating value? Yes! Do they have good people? Yes! Do most have good business fundamentals – I don’t think so
I do think software ate the world from from up until now. Insane levels of basic digitization so everyone got a flavor of what software can do. Building became easier if not easy. Selling, Growth, Profitability became bonkers hard!
Unbelievably High Customer Acquisition Costs (CAC):
There is enough data to support this out there but right now I will focus on what OpenView is saying – this is not a secret that needs to be debated to death. Software businesses are spending 40% of their revenues ($40M on a $100M basis – damn, that’s tough to digest) on trying to sell product. I have nothing against this percentage but it does squeeze profit margins and lengthens the time it takes to break even on each customer investment. This does not sit very well with some people who have given you money assuming you will recoup your customer acquisition costs in 12 months – 15 months or land such customers that in 3-5 years they will pay you million of dollars making it all worth it.
If the next ambitious person is going to be able to build the same product you developed 1 year later and sell it for 25% cheaper, don’t you think that’s a big problem? If you spent $200K on sales, marketing in a year, acquiring customers worth $500K with the hope of keeping them for 3-5 years and they leave you next year, that stings right? And, to be clear I am not talking about technologies that push the human race forward by leaps and bounds. Those are extremely rare and if the insane number of software companies are indeed pushing the human race forward by leaps and bounds, only time will tell.
A lot of time re-earn what you spent on acquiring a customer:
It is taking ~2 years to recoup the dollars you spent on acquiring a customer. On top of that guess what, prices are going down because of competition and they should because technology is only getting better, more easily available right? I don’t know the sentiment but it seems like venture capital is not the right kind of capital for many software companies anymore.
Challenges in Sustaining High Growth Rates:
Do you know what’s hard? Going from $10M in revenue to $20M in revenue in one year. Do you know what’s very hard? Going from $20M to $40M in the next year. Do you know what’s very very hard? A few years down the line, going from $100M to $200M in a short period of time (1-2 years). Can be done but a rare few who are lucky enough will get there 😉
Thinking about this differently, you have to really think if you want to use VC dollars beyond a Series-A or a Series-B to finance your growth or R&D shortfall. Using your own cashflow after a Series-B to fully finance your growth is not an unfair expectation.
Growth assumptions are the bedrock of many Venture Capitalists out there and if they have to return a fund and give you their money, they will ask you for growth at some point in time, right?
The climate of the era has changed OR Software Markets have evolved:
Valuations / multiples plummetted from ~50X revenue to 10x in the last ~2 years and while it is a bad metric to focus on, I think it will repeatedly compel founders, VCs, and employees to focus on the question “What’s the return I will get from this effort”.
I think timing is very important here and to use an analogy, these market shifts are not weather fluctuations – This is the climate changing. And, my hypotheis is that the software markets for next 7 to 10 years will need more of a business model innovation along with product innovation. What does it mean? The businesses to which you are endlessly selling software seats / licenses are really tired now. They are not in the business of helping you grow, they are in the business of making money, reducing costs, and mitigating risks. Selling some seats is ok and necessary but don’t pin your hopes on easily expanding – some software business in India or Eastern Europe or some other place is vying for those seats and will underprice you, sell you a decent experience too.
Software ate the world, almost every business digitised to an extent. Good or bad digitisation you can judge but many got a flavor of software. Now, the businesses want software that does magic in order for them to pay you hundreds of thousands of dollars.
Lower Cost for same Quality of Innovation:
I do want to say that I struggle with this one just because I live in Silicon Valley but I also have a deep India connect. There is no doubt that staying competitive necessitates ongoing investment in product development. But, if companies are spending $30M on R&D at a $100M scale with the assumption that that R&D is going to allow us win for ~10 years, you have to move mountains to make that assumption come true. Some founders DO do that and make it happen and I see them sometimes. Otherwise, I have just been amazed by the quality of the software innovation and the cost of the innovation being delivered by folks sitting in India.
This is perhaps an uncool thing to say but businesses who buy software ultimately are looking to solve their problem (make money, reduce costs, reduce business risk) at the best cost possible. Today many software solutions are not the cheapest and neither the best way to solve the customer’s problem.
Profits on the Income Statement are cool again:
I have immense respect for every founder, innovator who can think of ideas, build something from scratch that provides value. But, if you don’t treat a business like a business and specially if you don’t treat a VC-funded business like a VC-funded business, you will be very disappointed. Enough data, Twitter Anecdotes, and closed door conversations will tell you that we are creating good products but we are not building good businesses.
I am certainly not that genius right now who can build cool products that transform companies so it is easy for me to say that but I do consider myself to be a sharp and competent business operator to comment on the above. Humbly speaking, which I’m admittedly not great at :).
Complexity in Scaling Operations:
If software businesses do get to this scale, which is no joke, managing a VC-funded software business with 50M or 100M revenues with high growth expectations does require you to think how will I support customers, how will I scale internanationally, how will I sustainably manage 85% gross margins, etc. And given the growth expectations, I am quite certain that businesses will want to look at non North American markets to sell their software to much sooner than companies did 10 years back.
Difficulty in Achieving ‘Perceived’ Differentiation:
In such a noisy, seemingly saturated software market, differentiating is obviously challenging. The most amazing revenue leaders, marketing geniuses, who can literally sell anything still require a massive marketing and sales machinery, which can account to 40% or 45% of revenues. It is not easy to bring those costs down by a lot when you are 5 to 7 years in your journey.
Customer Churn is here to stay because of rapid innovation:
Simply put, if your technology does get outdated or the solution is 2x expensive, your customers will leave you for competitors in 1 year. You know who hates that? Everyone – your investors, you, your employees, the customer!
If your 20X or 40X valuation depends on you not losing these customers come what may, what will you do to make these customers stay? Fix product issues and build more stuff? Service them with love, care along with reducing your margins? Reduce your price? Sign 5 year contracts? Partner with your competitors for a win-win deal and reduce the amount of product you sell to them?
Am I overthking all of this and have gotten this completely wrong. Maybe. What do you think?
PS: If you want to discuss software, more nuanced thoughts on this topic, I would love to chat with you — I am on rohan.manchanda28@gmail.com and would love to hear from you.
Rohan Manchanda 