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Interest rates are rising in the US, a cost of living crisis is taking hold in Europe, and investor appetites are cooling worldwide. In short, a global recession is likely on the way. In the coming months, we can expect to see anxieties rise and spending fall and should be prepared for a knock-on effect across all sectors, but particularly in software.
There is no shortage of generic advice for businesses facing a recession, but generic advice is about as helpful to founders as a handbrake on a canoe. My expertise is in software, a market globally expected to grow to $692 billion by 2025, so I ran an analysis of more than 23,000 subscriptions and software-as-a-service (SaaS) companies to find out what the data tells us about the state of the market. I also wanted to provide specific advice that software businesses can follow to prepare for the upcoming downturn.
Overall, there are two concerning trends that suggest the trouble ahead for SaaS companies, with the growth of subscription ecommerce and B2B SaaS companies faltering for the first time since their unprecedented growth during COVID-19.
SaaS companies should see these trends as an early warning sign. If they take action now to shore up their fundamentals, they can ensure they are in the best possible position to weather the storm and emerge stronger than the competition.
What’s the data saying?
Let’s start with the consumer software market.
Consumer-driven software businesses — such as subscription e-commerce companies — tend to be more market sensitive since consumer behavior changes faster than business behavior. This makes them a good early indicator of upcoming market trends. This graph breaks down the growth of ecommerce companies, with their monthly recurring revenue tracked since January 1st, 2019.
As you can see, the market accelerated massively throughout the pandemic and with the help of economic stimulus payments (or ‘stimmies’). This led to a market increase equivalent to 10 years of standard growth.
But now, that’s all changing. As COVID subsides, consumers are moving away from nice-to-have, though not essential, subscription products. Moreover, as people try to maintain a ‘stimmy’ lifestyle, despite economic stimulus packages drying up, a consumer debt bubble is looming.
So, what does that all mean for software companies?
At best, growth rates for consumer software companies are going to stay flat, and monthly revenue will begin to ‘pancake’:
At worst, contraction will occur as sales are offset by increased rates of churn (the rate at which customers are lost). With sales consistent and churn already up 22% in subscription boxes, 16% in subscribe and save and 11% in consumer SaaS, it’s clear that consumer companies just aren’t replacing their lost customers fast enough.
To be or B2B?
That is the question, and B2B SaaS is where things start to get really interesting. B2B SaaS experienced unprecedented levels of growth during the pandemic, with revenue more than tripling over the last two years. It’s like Christmas came early and — stayed.
However, B2B SaaS has a lurking problem similar to that of subscription ecommerce: churn and downgrades. Although growth is occurring — indicating that new sales are consistent — customer churn is accelerating and is beginning to flood the market. Also, those customers that stay are looking to save unnecessary business costs wherever they can, downgrading their subscriptions or canceling them altogether.
The line on the graph below shows the rate of churn, and as you can see, it’s getting lower.
To recap: churn is up, sales are stagnating, and month-over-month growth rates are beginning to slow down. Recession typically hits the consumer world first and then trickles down to B2B. So, if we’re already seeing the subscription e-commerce market pancake, it’s only going to get worse for B2B SaaS. With new sales struggling to keep up with accelerating churn rates, companies will start to lose revenue along with customers and, exacerbated by a recession, may find themselves in serious trouble.
What do I do about it?
The good news is we’re not there yet, so organizations still have time to prepare.
You can increase your SaaS company’s chances of making it through the recession if you focus on two things: survival and lifetime value.
Step 1: Survival
In times of economic crisis, you begin by focusing on survival. And when it comes to survival, efficient spend is key.
- Start by auditing all of your expenses. Check your customer invoices, standing payments, employee documentation, and make sure that your actual paid expenses align with your internal policy guidelines and planned expenditure. Boring, but essential.
- Next, check your profitability. When entering an economic shock, you must be default alive: On track to reach profitability based on current expenses, growth rate and cash in hand. If your company is bootstrapped, make sure you have at least a 10% buffer. If you’re venture-backed, you’ll need an 18-24 month runway.
- Finally, reevaluate all non-core projects. This can be tricky. Scrutinize every strategy, project and ongoing proposal and ask yourself, is this essential to our business model? Of course, that’s not always an easy question to answer, and you’ll need to make some long-term bets. Nevertheless, it’s crucial that you park any surplus tasks and move forward with only the most essential projects if you want to make it out the other side.
Step 2: Lifetime value
Customers make a business and, in times of recession, they can break it too. With new sales petering out, maximizing the value and longevity of existing customer relationships is key.
How? Let’s go back to basics.
To start, subscription growth is basic: Acquire a customer that’s optimally monetized and sticks around for a long time. You’re likely focusing on the word “acquire,” but the rest of that sentence is pretty important too.
At its core, lifetime value is about two things: monetization and retention.
Congratulations, you’ve got a customer! But how are you going to convince your existing ones to spend more?
Segmentation and expansion revenue are crucial, so you have to make sure you’ve got a solid strategy in place.
- First, focus on cross-sells. Existing happy customers consistently buy more in recessions, so think about what other projects you could market to them, alongside what they’re currently buying. If you don’t have cross-sells, think about creating an add-on. Priority support is easy money!
- Next, raise prices. If your net promoter score (NPS) is greater than 20, raise prices starting in September (after the balance sheet audits are done).
- Evaluate segments as soon as possible. As Mark Roberge, former Chief Revenue Officer at HubSpot recommends, pull your spend and/or sales off of segments hit hard by the recession and build your pipeline in others.
- Similarly, localize to stronger economies: Make sure pricing is region specific and reflect how each market is being affected by the recession.
- Finally, cut discounts by half, as most are probably too high already.
Most people focus on acquisition, but success is ultimately about how many of your customers you can keep onboard. After all, there’s no sense trying to pour water into a bathtub if you never bothered to put in a plug.
From experience, here are four tips for reducing churn:
- Shore up credit card failures: Your recovery rate is likely half what it should be, so focus on recovering money and interest from defaulted debt
- Implement cancellation flows: Offer salvage offers and maintenance plans — anything to make the customer think twice before clicking ‘cancel’
- Term optimization: Offer a promotion to get monthly customers on quarterly or annual plans, thereby reducing ‘decision points’ where they might think about leaving
- Reactivation campaigns: Ensure you have them going 60, 120, and 180 days after a customer cancels, and use small offers to entice them back
How can you prepare your SaaS company for recession?
Start with survival and then focus on creating lifetime value. Shore up the fundamentals to reduce churn, increase or stabilize revenue and keep your head above the water during the forecasted recession.
Diamonds are made under pressure
There’s a reason people say great companies are made during a recession. If you follow the steps above to optimize your business, you’ll not only give yourself the best chance of survival, you’ll emerge in the strongest possible position to become a market leader in the years to come.
Disney was founded in the middle of the great depression: The greatest recession America has ever seen. More recently, HubSpot and Salesforce are great examples to follow. During the pandemic, they focused on community, customer experience and adding more value without raising cost.
The guiding principle for those companies? “Whoever ends this with the most users will win.” That should be the mantra for all SaaS companies preparing for the upcoming recession.
Patrick Campbell is Chief Strategy Officer at Paddle and the founder and former CEO of ProfitWell, which was acquired by Paddle for $200m. The data in this article is based on an analysis of over 23,000 subscription and software-as-a-service (SaaS) companies on the ProfitWell platform.