We recently polled some SaaS clients and found a somewhat challenging market. In particular, churn was up 5% year over year and the sales cycle had extended by 8%. Translated, that means that more people are bailing on existing SaaS apps than in the past and it takes longer to sell the products.
This is a reflection of two changing variables in the market: Saas fatigue among customers and increased competition.
At this writing, AngelList claimed there were about 11,000 SaaS startups in the market with an average valuation of $4.3 million. That compares to around 7,000 in 2015.
What’s driving overall growth is that SaaS has evolved beyond basic business functions like CRM, ERP and HR toward specialized industries like healthcare, energy/utilities and retail a.k.a. the “industry cloud.” At the same time, the category growth has prompted many me-too products that offer narrow functionality but drew venture capital. The result is that the SaaS market is either overcrowded or underserved, depending where you’re looking.
“What happens in venture-backed categories is that a bunch of companies compete against each other and all raise capital to do the exact same thing,” said Blake Bartlett, partner at OpenView. “And the way that they’re competing against each other is by burning venture dollars.”
That’s one factor driving churn, Bartlett said. “If you’re not satisfied with one system and there are five other systems by five other vendors coming after you, they’ll switch from one to the next.”
Compounding this competition, new venture-backed startups tend to launch in narrow slices of the market. “There start to be narrower applications that get funded and even-narrower applications get funded after that,” he said. “Then you start to see things that are barely applications that you can start calling features. You just have a lot of crowding.” At that point, customers often assess what they’re paying overall and realize that there are some expensive redundancies.
This isn’t indicative of the SaaS market as a whole though. The previously mentioned industry cloud still represents blue-sky territory as does areas like finance that have been relatively untouched by the SaaS revolution.
The good news is that there’s little evidence of “SaaS fatigue” among buyers or of an IT department that’s frustrated with shadow IT in which heads of business purchase SaaS products without their consent. As Gartner has predicted (and reiterated in late 2016), in 2017 the CMO is projected to spend more on IT than the CIO. This switch, which has been occurring for some time, fosters a mindset in which the nuts-and-bolts of the technology is less a factor than the perceived benefit.
While the demand for SaaS appears to be continuing to grow, the real reason for cooling valuations and investor wariness is likely that too many SaaS companies have flamed out because they were hell-bent on pursuing growth at all costs. For instance, shortly after LinkedIn and Tableau’s crash in early February, another SaaS firm, Zenefits, announced it was laying off 17% of its workforce. “It is no secret that Zenefits grew too fast,” Zenefits CEO David Sacks wrote in a memo to staffers, “stretching both our culture and our controls.” That memo came after Sacks also cracked down on a freewheeling culture that included on-the-job alcohol intake and sex in the hallways.
Around the same time, Optimizely, which was once “on pace to grow revenue faster than any other SaaS company in history,” announced layoffs as well.
As the overall SaaS market grew 21.7% in 2016 according to Gartner, the only explanation for this sudden contraction is that some companies were growing too fast.
Despite the perceived carnage of Feb. 5, the sector as a whole did quite well in 2016. The BVP Cloud Index showed that publicly traded SaaS firms handily outperformed the overall market during the year.
“The public markets oftentimes can be fairly volatile or seemingly fickle,” said Bartlett. “I think a lot of times there can be overcorrection. Public investors get spooked.”