Why SaaS businesses should keep a foot on the gas pedal during a recession.

Up and Downs

The three recessions the "dot.com" bubble in 2001, the financial crisis in 2008 and the current one, none have been the same. At least not on the surface. While the financial crisis was caused by a great degree of risk-taking the current recession came out of nowhere, a black swan. Still recessions have some similarities to the preceding business cycles. Factors such as consumer and business confidence (spending) as well as investment spending have been important variations in all three cycles.

Refreshing our memory

An Econ 101 textbook will define investment spending (I) as investments made in land, machinery, equipment as well as construction of new houses and investments in building an inventory of goods. An increase in investments (I) would follow an increase in Aggregate Demand (AD) or Consumption. When AD rises so does the output (GDP) of a business, region or in our case, a country.

In contrast to traditional business models, Software-as-a-Service (SaaS) does not require any serious investments in land or equipment. And instead of producing a bicycle or power generator, SaaS companies offer intangible goods such as streaming music or another internet-delivered application service. These services are offered through a subscription plan.

Learning from SaaS leaders... and clients

The subscription-based model requires even greater attention to customer service since most customers pay on a month-to-month basis. This requires SaaS companies to work harder than most other businesses on customer retention. After all, switching from Netflix to Hulu or Disney+ is a piece of cake.

Covid-19 tested the business model. A few leaders in the space were quick to display sympathy with their clients. Salesforce, for instance, offered temporary financial flexibility to clients, directed its workforce to work from home, shifted customer events to virtual without any compromise in service. The efforts seem to have paid off.

On May 28, the company reported its Q1 earnings topping estimates and showing stellar top-line growth of 30% yr/yr. Another SaaS player, Workday, also reported strong subscription-based revenues of 34% yr/yr.

So what's the secret ingredient(s)?

• Advertising, brand strengthening and more of the same

While Salesforce has always been customer-centric (think 4-day customer celebration Dreamforce), the company also spent generously on sales and marketing. Keeping its blades sharp in good times and bad times, Salesforce would regularly spend over 40% of its revenue on advertising.

During economic downturns, businesses set stricter budgets and look to cut costs often by reducing sales and marketing budgets. Or even worse cut their R&D budgets for that next product. It’s the wrong approach. Although it’s prudent to manage costs in a downturn, failing to properly support customers and most importantly your brand could have some negative implications down the road.

• Don't ignore the competition and offer new innovative products/services

Organizations that miss the opportunity to realign their offerings and increase customer success in a contracting economy will have a difficult time re-emerging from it. Some may never come out. And if you are still unsure, just have a look at the skidding energy sector.

One of the worst-performing sectors of the S&P 500 in the last 10 years, the energy sector accounts for only 2.5% from the S&P 500. Down from 13% in 2008! According to the Institute of Energy Economics and Finacial Analysis (IEEFA), GE, backed by Blackrock lost over $190 billion in share value over three years due to "series of gambles in natural gas and fossil fuel investments." And it's not only the price of oil that dragged the sector down, but the ignorance and lack of innovation of oil majors such as Exxon, BP and the rest.

S&P 500 Sectors (2020)

S&P 500 Sectors (2008)

In contrast, the leaders in the SaaS seem to listen to their customers and competition. Salesforce has allocated $844 million from its purse to R&D so far this year. That is roughly 17% of its Q1 revenue. Cultivating customer relationships and continuous innovation is at the epicentre of a business, particularly in the new digital economy.

...And what about the consumers (clients)

During slowdowns, consumers also reduce their spending and set stricter budgets, e.g. delay that T.V. set purchase or that new 5G iPhone (or not?). As a result, companies see their sales drop. At that point, businesses take a decision to cut expenditures, investments and yes sales and marketing.

Everyone can sell during frothy times when consumer sentiment is positive. It’s not rocket science. But companies who take time to understand the psychology of their clients during a recession will come out as clear winners. After all, sales is not all about advertising but doing the right thing for the client, solving their problems and sticking together during good and bad times.

Booms and busts are inevitable. It's part of the game. Austrian economist Joseph Schumpeter called the process of a new business replacing an old one the “Creative Destruction.” Software is still eating the world and it's not likely to be replaced soon.