What are the key strategies that SaaS companies are using to fine-tune growth efficiency and cost management in a challenging market? This is a topic that we’ve written about in our blog recently, and it’s certainly top-of-mind for many SaaS vendors.
In a new episode of SaaS Conversations, we dive into the strategies that SaaS companies are using to improve EBITDA Margin in 2024. Lauren Kelley – CEO and Founder of OPEXEngine by Bain & Company – breaks down how companies are navigating a slower-growth environment by tightening cost management, refining the balance between new customer acquisition and account management by using benchmarks to identify the greatest opportunities for improvement.
As the market remains uncertain and sales cycles have lengthened for many, top SaaS players are still finding ways to optimize resources while maintaining growth, profitability, and strong valuations.
Lauren shares actionable insights on how successful SaaS companies are staying competitive – from enhancing sales productivity to aligning R&D efforts with your GTM strategy and shifting customer demands.
Click here to listen to the episode on Spotify.
Transcript: More on SaaS EBITDA Margin With Lauren Kelley
Introduction: Welcome to SaaS Conversations, a podcast from OPEXEngine by Bain & Company. In today’s conversation, we’ll cover strategies SaaS companies are using to improve EBITDA margins in 2024. This is a topic that we’ve written about in our blog recently, and it’s certainly top-of-mind for many SaaS vendors.
Today, in a conversation with OPEXEngine CEO Lauren Kelley, we delve deeper into the strategies, touching on current dynamics in the SaaS sector and ways for SaaS companies to effectively fine-tune growth efficiency and cost management.
Let’s listen in!
Host: I’m Avery Ponce and I’m hosting this episode of SaaS Conversations with Lauren Kelley, CEO and founder of OPEXEngine by Bain & Company.
Lauren, my first question is: what factors do you think are driving the current slowdown in SaaS growth and how do you see this evolving over the next year?
Lauren Kelley: The slowdown in software and SaaS growth rates, I think, has a lot of different causes – not all apply to every company, but there are some general trends. If we go back and look at the history of the last couple of years, everyone thought the pandemic of 2020 and 2021 would reduce sales, which it did for many sectors. But while in person activity slowed to a halt, with some exceptions like restaurant software, hotel software, etc., SaaS got a tremendous boost as the world went virtual and online.
Loads of investment came into the market for SaaS. In fact, 2021 set a new record for VC investing – something like $345B was invested in 2021 alone. And PE invested something like $284B – not even including buyout deals. I think those numbers are roughly correct. But in 2022, the party slowed and interest rates went up. Investors told companies that more investment would be slow coming so build out cash runways and to double down on spend management. CFOs across the board tightened up controls – not just in SaaS.
For SaaS vendors, the sales process got tougher. We've seen sales cycles extend by 20-30% (and sometimes even by 50%) for many companies if you compare back to 2021. We are also seeing less new customer acquisition this year, with a smaller % of new ARR coming in.
SaaS purchases by customers are being examined with greater scrutiny as corporate buyers look at redundant purchases, usage, etc. SaaS “land and expand” sales strategies have gotten harder. Larger, more established companies have a size advantage here over newer vendors.
And then add into that all this crazy uncertainty over the past year and a half to two years of: is there a recession looming? Is the market slowing? Are interest rates going up? Are they going to come down at some point? Who's going to be the next US president?
It is natural that SaaS companies, and their investors, want to reign in resources and investments and make sure that their spend shows results in the current market. And frankly that has been really good for us as a benchmarking company because companies want to see how other companies are accomplishing better productivity. In terms of how the SaaS vendors are managing this year going into next, I see companies evolving their sales strategies and focusing on sales productivity with greater rigor today. We also see companies doubling down on pricing strategies and looking at usage or consumption based pricing in new ways or contracts and a whole variety of interesting innovations there.
Host: So, with all this uncertainty, higher cost of capital, and maybe some overspending by customers in 2021, are there any SaaS companies that are maintaining growth in this market? And can you speak to that?
Lauren Kelley: Yes, definitely there's a number of companies that are maintaining growth and competitiveness. Particularly larger companies and companies with strong momentum over $100M and beyond – there are plenty that are doing well with 25-40% growth.
In the public markets, there are vendors like Braze with 33% growth or Confluent with 36% growth or monday.com with 41% growth through last year. There are also some start-ups that are doing well, especially with AI-based products that provide incredible efficiency and ease of use. AI is a wild card right now, but there are companies that are showing productive use of AI.
It's amazing how resilient SaaS companies are and how quickly they have been able to pull back on spend and improve EBITDA. We described in our recent blog post “Three Strategies That Improve SaaS EBITDA Margins” how quickly SaaS companies have reacted to the market by tightening cost management and improving EBITDA. Few sectors are as responsive because SaaS has so many levers to pull to improve operating metrics as SaaS.
Host: Can you describe any patterns to which companies are managing successfully in this market?
Lauren Kelley: First off, it depends on market needs I think. Not all cyber security companies are doing well, but right now, if you have the right product for current cyber security needs, it's a growing investment the customers continue to make. You just don't need 100 vendors selling cybersecurity products, but if you are the leading cybersecurity product for a particular use case, then the market is not dead. Or data is definitely a growing market – look at how well Palantir is doing.
Secondly, beyond the market, which is a little bit out of your control, internally, there's a lot you can do in terms of managing efficient go-to-market strategies, which require constant data-driven analysis. A lot of companies are finding they need to go to a deeper level in terms of understanding their own data. There’s such an important balancing of new customer acquisition on the one hand and account retention on the other hand for enterprise subscription companies. We're seeing companies that we are benchmarking where that gets a little bit out of whack because the balance of previous years doesn’t match this year’s requirements. These are companies that don’t have enough new customer acquisition to fill the leaky bucket syndrome of churning customers. And the costs associated with new customer acquisition might be too high given current productivity because the structures and the motions are still oriented towards those heady, 2021 opportunities.
Generally, as a rule of thumb, if your new ARR is below 10%, it's going to drag on growth over time because that new ARR that you're putting in today is contributing to your snowball of revenue this year and next year and the year after that. But if you're just adding a tiny bit each year, but some portion is melting off through churn (again, the leaky bucket syndrome), you're just not going to be able to grow even if today you're still growing. So it's really critical to keep balancing your resources around what’s working in new customer acquisition in the current market vs. your account retention and upselling.
Host: And so what are some of the most effective strategies that you've observed SaaS companies using to improve EBITDA?
Lauren Kelley: In order to improve EBITDA, while preserving growth as best as possible for your market, it is important to use a scalpel rather than across the board cost reductions. And I think benchmarking is a really great way to get a baseline idea across the board. If you benchmark your whole company and your operations, you get a sense of where the greatest opportunities for improvement are, and that’s really the point. It’s important to take a holistic view of the company.
If you think about focusing on GTM and R&D/Product together, which typically makes up about 80%+ of a company’s spend – and it is critical to a company’s competitiveness and success. You have to remember that EBITDA is calculated as a ratio of revenue to expense and costs, so it’s not just expense and costs. So if you reduce spend but reduce revenue at the same time, then you won’t improve EBITDA.
Starting with focusing on GTM we are seeing companies manage Sales spend without reducing growth by looking at the productivity of all account executives in the current market and looking at average compensation for the whole Sales org. If your average sales comp is higher, on average, than a peer company with similar revenue growth and types of contracts, then you can work to lower those average costs.
It doesn’t mean that your high producer AEs shouldn’t be making good money, but maybe not all of them are productive. And maybe you have too many highly paid people in sales and not enough balance between high earners and more junior, lower earners who could lower the overall costs, without changing sales productivity. Companies often focus on individual position comp plans and miss the forest for the trees – that’s why I really like to encourage companies to think: how does it all add up?
Another area to look at as an indicator of productivity and efficiency of your sales team is sales cycles. It is often the case that when we see lower sales productivity overall, we see longer sales cycles than peer benchmarks. You need good benchmarks to compare against, as sales compensations and expenses overall have been changing quite a bit since 2021, and sales cycles have been changing.
Host: How does benchmarking R&D expenses and return on investment come into cost and EBITDA management?
Lauren Kelley: I’m so glad you asked that. One of the trends that I’ve been seeing lately is that while SaaS companies tend to focus first on GoToMarket for both growth and cost management, aligning R&D with changes that you are making on the GTM side can lag, which can reduce the effectiveness of your R&D resource allocations.
Let’s say that your strategy is to really shore up account management and retention, maintaining existing ARR and working hard to maintain NRR over 100%. If R&D isn’t adjusting its focus from investing a large percentage of resources into new features and products aimed at new markets and new customer acquisitions in a growth market – and at the same time making sure that bug fixing and maintenance are supporting high customer satisfaction – then the non-alignment of the two strategies will mean inefficient use of resources. And usually it’s just a time lag because the focus goes to GTM and then afterwards the focus goes to product.
And digging into costs in the R&D function is as important as digging into GTM costs, especially given the constant change inherent in our sector. Again, sometimes something as simple as comparing average R&D compensation against peer companies with similar products gives you a sense of whether your Tech organization is spread appropriately across high and low earners, and using outsourced resources in the most effective ways compared to similar companies building similar products.These R&D resource allocations have to be closely aligned with your current GTM strategy and within the alignment, you need to make sure that the costs are equivalent with what other companies are paying because there’s a lot changing here.
Host: Are there other margin improvement areas outside of GTM and Product that SaaS vendors can look at?
Lauren Kelley: Yes, definitely. Obviously GTM and Product, as I mentioned, are the biggest areas, but for example, some of our clients have been digging into cost of revenue because they have decent go-to-market and their performance KPIs look good but they can find margin improvements on some of the spend associated with hosting costs. For most SaaS companies, average hosting expense, all told (including comp for the headcount managing hosting), is usually within a point, give or take a point or two, around 5-6% of revenue. And obviously that’s dependent on your business model, but it is easier to dig into hosting or telecomm invoices than to plan, execute, and pay severance on headcount reductions.
Host: And why is benchmarking such an important practice here?
Lauren Kelley: Again, love that question. Benchmarking is incredibly helpful in cost management and identifying areas that are not as productive as others. It's really hard – when you're inside a company – to know what “good” looks like and to know what “good” looks like for every area of your company. No one’s an expert at everything. We're in the tech industry – “good” is changing all the time. So when you do “good” benchmarking, it helps provide credibility to your analysis – especially if the benchmarks are credible, it helps get the whole executive team on the same page. Look, I don’t think the head of sales is always being defensive about their headcount or comp plans for no reason – they’re just scared that they’re not going to make their numbers. They want the company to be just as successful as you do or the finance team does, and sales management gets paid directly on those results, but often they don't have access to outside data or a good comparison for how things could be done better.
Look at close rates or conversion rates or sales cycles – if you’re in sales management dealing with the day-to-day, they may think that there's no problem with the sales motion and the process because sales cycles are just what they are. But if you have credible data that shows that companies selling in a similar market with a similar contract length, size of contract, and has a 40% shorter sales cycle – that is something very concrete that people can work with and that points to [some questions] :
Is there a problem in execution? Is there a problem in resource? Maybe there’s a problem that you hadn’t even thought about at the top of the chain. There's a lot more digging into it that needs to happen.
Benchmarking provides a motivation to say, hey – let me see what I can do and work backwards to try and improve things. We all have to be clear that reducing costs and increasing productivity is really tough stuff – and that’s what management’s about, but it's easier when it's about the numbers and not pointing fingers at anybody.
Another real benefit of benchmarking is that to do benchmarking, you have to know your own numbers, which a good benchmarking process helps you pull together. So [benchmarking] is just a good regular management practice – you don’t do it as a one time effort and then move on. You need to do it on a regular basis. It gives the management team a sense of security that other companies have managed this when you're asking them to do more with less or to do something new, which again is a hard thing. But it's more compelling when it's validated than what you suspect is the issue or what you and the executive team might anecdotally think or feel from different pieces of information. Or when you’re dealing with different benchmarks from different sources and you don’t know how it relates to your business.
When you see it all laid out in black and white against peer companies and particularly a very targeted cohort [of companies] that are achieving what you want to achieve, it just helps motivate everybody. When all oars are pulling in the same direction, you go faster.
My favorite, wrongly-attributed to Peter Drucker quote is: “you have to measure something in order to manage it.” And just a side note for those management and measurement geeks out there – the Peter Drucker Institute says he never said that even though you'll often see it attributed to him. Regardless, it’s true – you can't manage what you can’t measure.
Host: That's great. Thank you, Lauren, for taking the time to go through this today.
Lauren Kelley: Oh, thank you, Avery. That was so great. Thank you for all the great questions, Avery.
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