Is the recession already upon us? A SaaSy take on it

It’s a foregone conclusion that we are in the midst of a downcycle. Every SaaS (Software-as-a-Service) startup’s board is therefore asking the question - how will software spending be affected by the downcycle? Like all crystal gazing exercises, it is hard, and, to an extent, dangerous. Nonetheless, we would like to share our perspective on how we think about it.

One viewpoint is that enterprise software spending must drop. After all, companies are tightening belts across the board—delaying expansion plans, instituting hiring freezes and prioritizing profitability over growth, why should corporate IT and SaaS spending be left behind? IT and SaaS spends make up more than 8% of enterprise spending, so it makes sense to look to save there in times of uncertainty.

However, there is also an alternative view which says that in leaner times, corporations look to increase their productivity without necessarily reducing their costs. And SaaS software promises to enable this very transition—away from clunky tools with poor UIs to modern, AI-enabled software that enables employees to become more productive and efficient. Transitioning away from on-premise software to cloud-hosted infrastructure also helps reduce infrastructure and maintenance costs for corporate IT departments.

So, which of these is likely to happen over the next few months? To answer this trillion-dollar question, we looked at guidance figures from earnings announcements of some public SaaS companies. Since guidance numbers are usually conservative, we believe this is a good indicator of senior management’s—and, by extension, the industry’s—outlook.

Our initial hypothesis was that we would see a mix of positive and negative guidances, with a possible cautious skew. Surprisingly, across a basket of companies (including SAP, Adobe, Accenture, Salesforce, Cisco, Workday etc.), nearly all predicted good to great growth over the next quarter and year. Workday, for example, expects both quarterly and annual subscription revenues to grow 22% year-over-year (YoY).

Intrigued, we dug in further to see how this compared to previous periods. Analysing the time series of quarterly revenue guidance growth from Q1 2019 onwards, we see that, of the 7 companies with available data, 5 had guidance growth similar or higher than the average same-quarter guidance growth in the last three years i.e. despite the broader market slowdown expectations, enterprise SaaS companies continue to predict growth! Cisco is the only notable exception, predicting a revenue decrease of -1%.

We also chose a basket of mid-cap SaaS stocks: New Relic, Altair, PagerDuty, Paylocity, Mimecast and Workiva, sampling across PaaS, cloud security, monitoring, compliance, payroll and HR verticals. The same analysis yielded very similar results: 5 of the 6 companies predicted YoY quarterly revenue growth in line with or better than their past results.

We also see a similar trend in annual revenue guidance. For large-cap SaaS companies, the latest annual guidances project growth figures that either exceed or are in line with historical numbers in three out of five cases where data is available. A similar trend exists in mid-cap stocks as well.

One possible explanation could be favourable macroeconomic factors and supply-side factors for the SaaS industry. The industry is flush with cash, with large firms having seen massive revenue growth during the pandemic and startups having raised large equity rounds until Q1 2022, leading to continued expectations of software/IT spending. Also, unlike other brick-and-mortar industries, the software industry is not as affected by supply-side constraints like shipping delays, global conflicts or energy prices.

So, what is the outlook for the next few months for SaaS founders? Our analysis indicates that, in the short-term, enterprises are not reducing SaaS spends. Companies, regardless of size, understand that SaaS products help improve productivity, create new revenue streams and drive overall value. They see SaaS as a way to reduce cost, a means to avoid paying large upfront licence costs or invest in builds. Hence, pure software spends might actually increase.

However, some founders urge caution, especially with a longer-term horizon in mind. They believe that it is still too early to tell the full impact. To prepare for this, they’re focused on reducing spends and maintaining revenues by closing annual renewals and also pushing for multi-year renewals.

There may also be a negative impact that is sector-specific as the pipeline to sell to smaller, venture-backed entities might dry up as their funding is reduced.

Alok Goyal is part of the investment team at Stellaris Venture Partners, where he primarily invests in SaaS companies.