SaaS firms brace for rough ride as macroeconomic conditions worsen

The software-as-a-service (SaaS) ecosystem in India and globally is starting to feel the heat of slowing demand growth ahead of a likely global recession and are beginning to implement cost-cutting measures including layoffs.

While many investors still favour the sector, calling it “just another cycle of correction,” there are fears that valuations of SaaS companies will decline further with more layoffs and cost rationalisation on the cards.

“Enterprises globally are seeing inflationary pressures, high-interest rates and growth is dampening… due to this, many companies will eventually want their software for cheap and SaaS companies will also look to reduce costs,” said Mohandas Pai, who has invested in SaaS unicorn DarwinBox.

Pai, a former Infosys CFO, said many business-to-business (B2B) SaaS companies will always anticipate that their business will go through this cycle.

The Russia-Ukraine war and its impact on supply chains, runaway inflation, and the US Federal Reserve’s aggressive interest rate hikes are causing fears of a recession in the US. Experts are concerned that this may lead to lower spending on software, a dampener for SaaS companies.

“In the US, there is a massive selloff and inflationary pressures and its impact will trickle down. Definitely, valuations were too high last year and it will touch the lowest now – it is bound to happen,” said Prasanna Krishnamoorthy of Upekkha, a SaaS accelerator and early-stage venture capital fund.

Increased layoffs

Many SaaS companies added more than two to three times their employees in a span of one to two years. Chargebee reported about 400 employees in 2019 which grew to more than 1,000 in 2022. Freshworks had about 1,000 employees in 2019, which grew by 4,000 in 2022.

Enterprise SaaS company Salesforce reportedly laid off more than 2,000 employees recently, citing low demand as the reason. According to a report by Protocol, Salesforce had 73,541 people on its payroll earlier this year.

This comes after SaaS firm Zendesk, a US company with operations in India, let go 84 employees, or about 5 percent of its staff.

Chargebee, an Indian SaaS company, said last week it was laying off more than 100 employees.

“This difficult decision was driven by external market forces as well as our need to address the operational debt we have accumulated in the last few years,” Chargebee’s cofounder Krish Subramanian wrote in a LinkedIn post.

Apart from the layoffs, companies have changed their hiring strategies and frozen recruitment.

“We’re slowing the pace of hiring as we align our resources with the current market,” Girish Mathrubootham, founder of Freshworks, said on an earnings call last week.

Zoho, Kovai.Co, Exotel, and other SaaS companies have anticipated macroeconomic pressure and have changed their hiring strategies.

Kovai.Co, which has about 300 employees, told Moneycontrol it has frozen hiring.

Exotel cofounder Shivakumar Ganesan said the company is taking cost-cutting measures. New recruits are offered 10 percent lower salaries than before.

“While there will be impacts of the recession, the maximum layoff will be just 3-5 percent for most SaaS companies,” said Krishnamoorthy. “Layoffs will happen only in those companies that undertook massive hiring in the past and will look to correct.”

High marketing expenses

B2B SaaS companies have spent heavily on marketing over the past two years. A B2B SaaS company used to spend 15 to 25 percent of its revenue on marketing. However, after the pandemic, many SaaS companies spent 35 to 40 percent of their revenue on marketing.

“Marketing is necessary for growth. Spending on marketing is absolutely important. However, several SaaS firms went overboard,” said an investor in one of the top SaaS firms, requesting anonymity.

Pai added that a correction in spending and cost strategy is significant.

“Many SaaS companies raised big capital with huge valuations, signed big deals, and spent big on marketing and branding. However, they will have to relook their entire strategy,” Pai said.

“Many large companies have been spending a lot on marketing, estimating there will be growth. However, for big companies, unless they do this, sales will not pick up…but for smaller SaaS companies, going overboard on marketing may not be a good idea,” Upekkha’s Krishnamoorthy said.

Freshworks had to drive efficiency and bring down costs in the fourth quarter of FY22 to keep up with the environment, chief financial officer Tyler Sloat said on the earnings call.

“We slowed down some hiring and we looked at areas around our sales and marketing spend in other areas. And we're able to just try to drive some efficiencies,” he said.

Interestingly a VC on LinkedIn said in November that Freshworks is a cautionary tale of why Indian founders should incorporate in India and look to list in India.

"Freshworks is down from its listing price of $43 to $12, having lost nearly 75% of its market cap. Further, it's now facing a lawsuit for having misled IPO investors," wrote Rehan Yar Khan, managing partner at Orios Ventures.

Taken in by the "glamour" of overseas incorporation whereby founders believe, those are easier operating environments, that customers (for SaaS) will be more attracted to them, they will be able to raise more capital and they will IPO there to do much better than in India. The reality is difficult, he wrote.

While B2B SaaS companies will face the impact of the macroeconomic pressure, they still stay at a better place due to a recurring revenue model. However, Indian SaaS companies are mostly in the B2B space.

B2B SaaS companies include Freshworks and Zoho, which offer software services to enterprises and small businesses.

Business-to-customer (B2C) SaaS companies are those that offer e-commerce, testing platforms, or subscription and billing management software directly to customers or developers. They include PetPooja and Browserstack.

“We have a constant stream of income. Most of our subscriptions are already renewed. The present recession will definitely result in trimming the companies' cost approach. However, it will not have a massive impact on revenue,” said a B2B SaaS cofounder on condition of anonymity.

Exciting, stable bet

“B2B SaaS firms will use this opportunity to work on cost efficiencies and building their research and development teams to brace for the future,” the cofounder said.

Ashwini Asokan of AI-based SaaS company Mad Street Den said the recession is helping the startup in a way.

“We are investing millions of dollars and building local teams across the globe, especially in the US and in the Middle East. While the recession is having an impact, AI is on top of the mind of many investors and they continue to be bullish,” she added.

Even amid macroeconomic pressures, SaaS remains an exciting and stable bet for many investors. VC firms invested over $4.2 billion in SaaS businesses last year and the figure is likely to be higher this year, according to a report by Zinnov.

VC firm Avataar has started new funds that will focus on the SaaS sector. Avataar Venture Partners said a new fund with a target corpus of $350 million will invest in 12-15 growth-stage startups that operate on B2B and SaaS models.Chiratae Ventures marked the first close of its maiden growth fund at $100 million on November 8 and said in a report that cloud security, cloud-native enablers, hyper intelligent automation, Web3, and verticalised solutions would be key areas of interest for investors.

“I continue to be bullish on the segment. Overall, the fundamentals of many startups are still very strong from a revenue and cashflow perspective,” said Krishnamoorthy.