We’ve all felt the squeeze these last 3 years. Higher prices at home, higher prices at work, smaller budgets. Software subscriptions haven’t been exempt from this. In fact, they’ve outpaced almost everything else you’ve been feeling the squeeze on.
This SaaS inflation has been around longer than these last 3 years though. It’s been accelerating for the past 6 years, even when times were better economically.
And this isn’t going to change. In fact, it’ll probably keep accelerating. I’ll explain why.
The Vertice Report
After looking for more data behind my anecdotal experiences around software negotiations the last few years, I stumbled across Vertice‘ SaaS Inflation Index: 2022 report.
Two key snippets from the report that we’ll dive into:
- Software is a significant expense on the P&L
2. Software pricing inflation is outpacing market inflation significantly
Why These Two Points Matter
1 in 8 dollars being spent on SaaS means that this line item should be at the forefront of executive focus. Software is eating more and more budget every year. According to SVB’s State of SaaS 2022, around 37% of companies expect a 6% increase in IT budget. But that also includes IT Services, not just software costs.
Companies will have to eliminate software or renegotiate contracts to align with those budgets.
For the second point, SaaS prices are inversely correlated to 1 year after Global VC stagnations or decreases in funding. Basically, SaaS companies start playing debt catch-up when funding opportunities start becoming scarce. Valuations have been set high but the market has become more competitive.
This means paying attention to fundamental business economics since that next funding day might not come for a while, or will be significantly reduced. To satisfy current investor interests and continue growth in valuation, fundamental business economics must outshine other SaaS companies competing for less available funding.
When this happens there are several levers that can be pulled. Oftentimes multiple are pulled at the same time.
- Increasing prices
- Reducing headcount
- Reducing marketing spend
- Eliminating discounts
Macroeconomic conditions around rising interest rates, shaky banking situations, and rapidly overcrowded marketing channels due to AI capabilities are suggesting more
One Justification For Higher SaaS Prices
There is a counterpoint that doesn’t make the future look so bleak. After all, not all SaaS companies are just raising prices because of high expectations.
Many SaaS platforms started as a niche solution. Then as they tapped that market, they expanded capabilities to continue growth. This is a great reason to increase prices. The customers save money on a simpler tech stack with less tools to maintain, and the SaaS platform solves more business problems with their solution and can charge more. Win-win.
HubSpot is a great example of this. They started as a Marketing platform, then added their CRM, Service Hub, CMS Hub, Operations Hub, and Sales Hub along the way. Their pricing evolved and increased with these evolutions. They made more money to grow into their expectations, and customers saved money by eliminating other subscriptions and the staff to maintain the tech stack.
The Future SaaS Inflation and What To Do
My hypothesis is that this won’t change in the future. SaaS will continue to become more expensive. And the risk for investing in the wrong SaaS company is rapidly increasing.
If you pick the wrong one, you could be locked in and subsequently squeezed for huge price increases year after year. You also will have significantly less ROI on tools if they increase price without providing additional value to your organization.
AND the more complex the SaaS is to set up and maintain, you’ll also suffer from wasted labor spend to get those tools set up and running. Only for the investment to flop.
SaaS inflation will continue because we’ve seen a stagnation in VC funding. Valuations were super high leading up to 2022 and companies are trying to catch up to those valuations to raise again and deliver for their current investors.
Plus, Marketing and Sales is becoming more expensive for these companies as channels become even more difficult to cut through noise at scale.
Expect pricing to outpace general inflation the next several years.
What To Do When Choosing SaaS
Software is an investment. This is not a metaphor, it needs to be treated like an actual investment where you do due diligence behind the company you’re investing in. Because your business operations literally depend on the software to run. Otherwise, why are you investing in the software in the first place?
This means that when you’re looking at software vendors, you should get as much info as possible on their financials. Obviously for private companies this is more difficult, but it doesn’t hurt to ask the people you’re talking with in the company.
Figure out what their revenue looks like, their operating expenses, revenue per employee, NRR (net revenue retention), average customer LTV, etc.
If they’ve been valued at 20 times their ARR, you know they have to grow into that somehow. They need to increase their number of customers with the same pricing, or increase their pricing with slowing/stagnating customer acquisition.
If they are focused on increasing customers, you might get less support when needed. If they’re going to increase pricing due to slower customer acquisition, make sure you get value in those increases. Ask for better SLA’s or additional functionality after those price increases.
Another major risk to consider is companies going bankrupt/shutting down because of poor business economics. What if they can’t raise again? What if they cut headcount in the wrong places and the platform stops working? Does that company have enough cash reserves to weather the storm?
What To Do During/Between Renewals
If you’ve already passed the evaluation stage and are in a contract/up for renewal, there are still opportunities.
Start with a Tech Stack Assessment/Tech Stack Audit. List every single tool, what you spend, how many users, and their feature sets. Then look at which feature sets overlap, which tools aren’t actually solving a specific business problem, which ones don’t contribute to your company strategy, etc.
Then cut redundant ones. Explore ways you can consolidate your tech stack to make it easier for employees. Talk to vendors that you’re renewing with and see if they have additional modules/features you can upgrade to so you can replace other tools.
Wrap-Up
Software is getting more expensive. Low interest rates flooded the market. This resulted in unsustainable pricing and now pricing has to catch up with tightening economic conditions.
Avoid the hurt of investing your operations in SaaS products with poorly run businesses behind them. Do your due diligence.
If this article made you think about your Tech Stack and the subscriptions you have, check out the Tech Stack Audit at MergeYourData.com.
We see and work with hundreds of different SaaS tools every month on behalf of clients. Skip the confusion of trying to evaluate software subscriptions, overlap, and usage in your organization. Reach out to our team instead.