Software companies operating in the latter part of the business cycle must consider the implications of a potential recession on their business. It’s worth noting that during the Great Recession, some software companies endured and even thrived. A decade later, the industry can learn from these businesses how to prepare for another economic downturn.
SaaS growth slowed, but didn’t stop
Software as a service companies saw a decrease in average annual growth rates during 2008 and into 2009 (Figure 1). Growth plunged from more than 40% before the Great Recession to approximately 10% during that period. SaaS Capital, an industry growth fund, reports there were only 16 publicly traded SaaS companies prior to the Great Recession; over 80% of these companies continued to grow despite the economic contraction.
Growth of traditional software licenses slowed more than SaaS
During the recession, there were more software companies providing on-premise products than SaaS offerings. One of the benefits of a SaaS offering is that revenue is generally spread evenly over a period, rather than recognized at a point in time. Because recognition of revenue at a point in time can translate to uneven earnings, revenue growth rates for SaaS (Figure 1) outperformed those of software companies selling licenses. When the economy slowed, there was an abrupt decline in software license revenue (Figure 2).
A shift to SaaS offerings
Over the past decade, many software providers have changed their offerings to a SaaS model, which is why the decline in sales growth for licenses seen after 2010 was offset by an increased growth rate for SaaS companies. In addition to the cost and security advantages of a SaaS offering, investors prefer earnings consistency from quarter to quarter.
The software industry has thick (but not impenetrable) skin
The business model of many SaaS companies allows them to burn cash in order to scale their business under the so-called Rule of 40 performance metric for software companies: they can spend capital as long as revenue growth is significant. As top line growth slows, so the rule goes, investors generally look for improvement in the bottom line.
Many growing SaaS companies experiencing significant growth are also burning cash and require capital from the investment community to sustain their operations, which is acceptable to investors under the Rule of 40. If the U.S. economy were to enter a recession and software companies continued to have access to capital, it’s very possible that history would repeat itself: The SaaS industry could have an insulated soft landing.