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2024 has been a volatile year for the Software as a Service (SaaS) industry. After a strong Q1, publicly traded SaaS companies performed poorly in Q2 with contracting valuation multiples and a dip surrounding the Yen carry trade unwind. There’s been a rebound thus far in Q3, which will undoubtedly be tested by the upcoming U.S. election.
This trading behavior has sparked myriad concerns in SaaS-land, extending from the public to venture and growth markets. Some wonder whether SaaS could face secular disruption from AI. One problem is that as software production costs decrease due to AI-enabled code generation, software vendors may race to the bottom on price with limited ability to differentiate on product. Another concern is that there could be a fundamental shift from the graphical user interface towards a newer interface like voice or AR/VR. Lastly, from the buyer’s perspective, there’s been greater budget scrutiny and a desire to bundle purchasing from fewer vendors.
The future is inherently unknown. “It’s tough to make predictions,” Yankees legend Yogi Berra famously explained, “especially about the future.” That said, we will look back on concerns around SaaS as overblown. There are reasons to be as excited about SaaS today as ever before.
Globally, GDP is $110 trillion (+3% YoY), IT spending is $5 trillion (+7% YoY), software spending is $1 trillion (+13% YoY), and cloud SaaS represents $250 billion of the software spending (+20% YoY).
The recent Microsoft and CrowdStrike “Blue Screen of Death” incident grounded planes, froze financial systems, and even halted Las Vegas casinos, reminding us that SaaS is ever-present. Yet, despite its pervasiveness, the SaaS industry is still dwarfed in size by areas like healthcare, financial services, manufacturing, real estate, retail, and transportation, among others.
Looking ahead, GDP, IT, software, and SaaS spend are all projected to grow. Technology buyers want to improve their businesses, increase revenues, decrease expenses, and become globally competitive. Software continues to be an attractive way to accomplish those goals.
With that growth in overall demand, the question is determining which SaaS players are well-positioned to benefit. Due to competition, some software areas will likely be commoditized. Commoditization will drive down prices and erode profit pools in those areas. However, we may see the opposite in other places, as AI should drive more excellent utility for software buyers and end users.
Labor is an expensive way to accomplish any organizational goal. Businesses are trying to avoid throwing people at problems given persistent salary inflation and scarcity of talent in many industries. Even the world’s most influential companies struggle to attract, train, and retain top employees.
Estimates put labor services at $65 trillion of the $110 trillion global GDP. Unsurprisingly, the world’s largest enterprises spend millions with consultancies to analyze how to optimize and streamline their most important resource: people.
Software, on the other hand, tends to be modestly priced relative to salaries. Toast, a publicly traded all-in-one SaaS platform for restaurants, offers a good case study. In 2023, restaurants using Toast made $126 billion in revenues. That’s a lot of hungry eaters! In return for its SaaS and payments products, Toast earned $1.2 billion of net revenues (1% of sales). By comparison, restaurants spend 25-30% of sales on employee salaries. Salaries dwarf software spend today, but in the future, restaurants may be willing to spend more on software if functionality and utility continue progressing to the point where those customers can save on labor costs.
AI can potentially make SaaS more intelligent, promising to augment or replace human-led tasks. In some use cases, this may take the form of a copilot, which subtly makes intelligent recommendations. In other instances, the software could evolve into a fully autonomous agent where the pricing model may look similar to a full salary rather than a fraction of a salary. We should see an increase in contract sizes for software companies that can deliver against the promise of humans and technology working seamlessly alongside one another to produce high-impact business outcomes.
Customer support exemplifies a workflow that can benefit from technology. European buy-now-pay-later leader Klarna has been vocal about implementing AI for support workflows. Their AI assistant can resolve errands more than five times more quickly than before implementation, accomplish the work of 700 agents, and save the organization $40 million in 2024.
The concept of humans and technology agents working together, often imagined as robots, has long captured widespread interest. It may soon be a reality.
The 2020/2021 time period was an anomaly for SaaS. All companies succeeded during that time, and growth was abundant. In most other periods, the industry has been consolidated with a small number of large winners that grow faster for longer and generate impressive underlying unit economics. This is the natural status quo for software development. To borrow a quote from renowned industrial designer Dieter Rams: “Less, but better.”
To draw upon the Toast example, it would be illogical for every restaurant in New York City to develop its software. Ten vendors producing similar software would be better but still imperfect. In that case, each vendor would hire separate product and go-to-market teams to compete against one another. The natural evolution of any software market is a small number of leaders.
As SaaS increases in size and capability, the number of winners may narrow. Still, there will be massive companies that capture a more significant share of wallets, driving enormous outcomes and progressing the industry forward. This should be an exciting and welcome opportunity for the world’s most ambitious founders to make their dent.
