16 December 2022
Regardless of the temporary economic weakness, the market of Software as a Service seems to be thriving: by 2025, spending for cloud services – the quintessence of SaaS – will increase by 17% per year. This business is rising because it allows companies to optimise and automate several functions related to archiving and data processing. Hence, it helps them save on fixed expenses. Start-ups can benefit from this long-term trend if they will innovate and balance growth and profitability.
By Giuseppe Donvito, partner of P101
SaaS (software as a service) is a key field for the future development of our economy, even if it is currently experiencing a downfall, like every other industry. Thanks to SaaS, enterprises in the commodity industry can use necessary IT tools (i.e. cloud storage) without buying them. Companies can pay according to how much they use the technology. Hence, there are structural reasons that will force start-ups with the necessary capabilities to innovate in this field.
SaaS: what do numbers tell us?
The data concerning the SaaS industry are a clear indicator of its relevance. The spending for clouds (the quintessence of Saas) will exceed 1,3 trillion dollars by 2025 (with a yearly growth of 16,9%). And, as stated by an IDC study, private clouds –infrastructures of cloud computing whose hardware resources are dedicated to a single organisation or user – will grow at an even higher rate, +31% per year.
Furthermore, IDC reports that in 2021 the spending for private clouds increased by 8,8% (reaching 73,9 billion dollars). By the end of 2022, it is expected to increase by 21,7% and reach 90 billion dollars. Additionally, the companies’ implementations concerning the cloud are divided between on-prem and hosted pretty equally. On the other hand, the expenses for non-cloud infrastructures are likely to decrease by 0,3%, dropping to 59,4 billion dollars.
Status quo: SaaS has not escaped from the crisis, but venture capital looks ahead
The first data we can observe is that evaluations, especially of listed companies, are dropping because of the macroeconomic scenery. Nevertheless, we believe this recession will be transitory. Moreover, we think that the 290-billion-dollar revenue which VCs are employing to finance start-ups can constitutes a cash reserve – or dry powder, in technical terms – that will give new energy to the market in 2023.
The activity of venture capital is, by definition, patient, and VCs have long-term plans. They take into account the potential of the business in which they decide to invest more than its current value. Clearly, for start-ups operating in the private cloud business, this is a weak period of time. However, we still deem their business model represents the most innovative paradigm shift since the invention of the internet. Their potential persists and will keep growing.
Goodbye unicorns! Now it is time for centaurs (smaller but profitable)
A further element that strengthens our conviction is that the interest in the concept of "unicorn” has faded. This term is sometimes associated with inflated evaluations that do not match corporate fundamentals. According to the latest Pitchbook’s Unicorn tracker, more than 580 unicorns were born in 2021 (+120% in one year). On November 1st, 2022, there were 1.230 unicorns around the world. Therefore, this classification does not seem to be so relevant anymore.
Pitchbook bases its mapping on a very restrictive definition of "unicorn". It only considers venture-backed companies with a valuation of at least 1 billion dollars. Nonetheless, this classification still includes too many companies.
Anyway, every day 1,5 unicorns are born. They ceased to be rare animals long ago, shortly after Aileen Lee (venture capitalist and founder of Cowboy Ventures) coined the word in 2013 to describe 39 billionaire hi-tech companies (among them Facebook, LinkedIn, Workday and Twitter).
This term has been replaced by “centaur”. A word which describes businesses with an annual recurring revenue (ARR) of at least 100 million dollars. Something rare for the cloud industry. Therefore, these companies constitute an élite category in the growing crowd of unicorns. A new mythological animal which will inevitably replace the first one.
How can start-ups succeed in the current market?
We can now elaborate a vademecum to help start-ups navigate the current market scenery. Nowadays, it is essential to:
- Balance growth and efficiency. If a company lacks funds – because of its investors' withdrawal or the systemic crisis – It needs to monitor the trade-off between growth and profitability. This will guarantee its survival. Obviously, it should also carry on a precise plan that considers the need for development and profitability.
- Keep investments under control. During challenging times, it is necessary to evaluate and rationalise expenses. Hiring only if strictly necessary and concentrating on core projects are helpful rules for a business with limited assets.
- Focus on everything that works out and make it grow exponentially. The key is to focus on a few strategic elements. This is a fundamental point for start-ups operating in the SaaS industry since they only develop if on vertical markets. Additionally, it has been proven that these companies can add value to the entire supply chain if they specialise vertically.