Mental Exercise – SaaS in a mini-recession
What would happen to classic SaaS companies in an economic slowdown. Warning! This is just a mental exercise and may, or may not, have anything to do with the real world.
As a representative company, let’s go back to company ABC from our economic model at post # 40454.
An economic slowdown hits in 2019. What happens to ABC? Remember, this isn’t a real company and this is only a mental exercise. And it’s all approximations, built on the assumptions of the model in 40454, so read that first.
Let’s remember they finished 2018 with $160 million in revenue and were growing at 60% per year.
What happens to ABC’s existing customers who paid that $160 million in 2018? Do any of them pull ABC’s great money-saving software out of their own core, and totally disrupt their own company at great cost, because there is a recession? Well, here’s a clue. Would you see any of Nutanix’s, Okta’s, or Alteryx’s doing that? Maybe zero percent, to pick a round number. Let’s figure ABC loses ½ of 1% of that existing revenue, figuring that 1% of their customers go bankrupt in about the middle of the year, so they go through 2019 with $159 million of that $160 million carry-over revenue.
Then, from 2018 they had $80 million in new contracts and $40 million in upgrades, of which only half was recognized in 2018 but of which the whole $120 million will be recognized in 2019, so we have to add $60 million to that $159 million giving us $219 million in recognized revenue.
They’ve been running a 120% dollar based net retention rate. Let’s say that drops to 5% of upgrades, down from 20%, as some wise companies will want to add money saving software. Well 5% of $160 million is $8 million, so let’s add $8 million to the $219 million and get $227 million.
How about new customers? In 2018 they recognized 40% of new customer revenue (remember our exercise, see above) 40 new added to 100 existing. In 2019 let’s say that drops to 10% of new customer revenue (a real economic downturn).
Well 10% of $160 million is $16 million of new customer revenue recognized, meaning that they now have $243 million in recognized revenue in 2019. Revenue for the year is up 52%, and they “miss expectations” but everyone is ecstatically happy as this is an economic downturn after all!
Their sales and marketing expense is $16 million for the existing customers who re-signed, $32 million for the new customers and $4 million for the upgrades, for a total of $52 million (they had to let some sales people go).
Last year S&M was $100 million on a lot less revenue, and S&M was 62.5% of revenue.
This year S&M is 21% of revenue and everyone says “Hallelujah for the recession” as this means ABC makes a sizeable profit.
Remember this is all gross approximations, but I suspect in the correct directions, if not exactly in the ballpark.
I hope you enjoyed going through it with me.
PS. This is for a classic SaaS company. Shopify is a different beast as they deal with hundreds of thousands of little companies and a lot of them might go bust in a bust, to coin a phrase. But probably not the Shopify Plus big companies that provide a large part of their revenue.