Reuters/Carlo Allegri
Zoom CEO Eric Yuan
- Industry experts expect cloud software companies - like Salesforce, Zoom, or Slack - to be hit less hard than other parts of the tech industry in any possible recession.
- Their billing models are more flexible than many of their more old-school competitors, making life easier for existing customers to renew their contracts. And the software itself is crucial to how business gets done, dis-incentivizing customers from bouncing off.
- At the same time, one expert tells Business Insider that he's already seeing a "recession-like" environment in the industry, as economic uncertainty means that customers are less likely to seek out new software.
- Similarly, software companies that specialize in selling to small businesses are going to have a tough time amid this turbulence.
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Global markets have been falling as the coronavirus outbreak has spread around the world, inducing panic and uncertainty that's cast a long shadow over the whole economy.
For some, the situation is reminiscent of the Great Recession that began in 2008, which brought hard times for businesses and widespread unemployment. In Silicon Valley, CEOs, investors, and employees alike are bracing for similarly stormy waters.
But venture capitalists and industry insiders expect that the market for software-as-a-service, or SaaS - the industry term for cloud software like Salesforce, Google's G Suite, or Dropbox - will weather any downturn better than some of its peers.
Unlike more traditional software, these products are generally billed on a per-user basis, per month. That means that customers don't have to pay a huge amount up front to get the software for a pre-agreed-upon number of users. Experts say that this gives customers a degree of flexibility that will only get more appealing amid the chaos.
That appeal is only bolstered, they say, by the need to stay operational while having employees work remotely to stem the spread of COVID-19, the coronavirus disease. Cloud apps like Zoom and Slack help employees stay connected, wherever in the world they are.
"If you think about the enterprise software companies that are best suited to thrive in that environment, it would be enterprise software companies that help enable the remote work future," Jake Saper, a venture capitalist at Emergence Capital, told Business Insider.
At the same time, though, there's likely to be some kind of drag on the software industry as a whole, amid the downturn.
Lemkin said that there's already been a change in buyer behavior: As companies look to cut costs, spending money on new cloud software finds itself on the back burner. Given that sentiment, Lemkin said it already feels like a recession-like environment for many software companies, similar to the Great Recession or even the dot-com bubble burst.
"It's already happened, the buyers are already pulling back. There's already a change in buyer behavior...we are already in a SaaS recession this week," said Jason Lemkin, a VC and founder of SaaStr, a company that helps other cloud software startup founders. Previously, Lemkin was the CEO and founder of startup EchoSign, which was founded in 2006 and stayed independent until selling to Adobe in 2011 for $400 million.
Indeed, equity research firm RBC polled people in the software industry on the effects they are seeing due to the uncertain economic environment due to coronavirus.
Over half of the 451 salespeople RBC surveyed said their customer and prospective customer meetings have been postponed or delayed. 45 percent of them have seen deals deferred or cancelled. RBC's survey found that many of those salespeople expect a one to three month delay in closing the deals they expected prior to the uncertainty.
"Approximately half of the 451 salespeople surveyed expect COVID to negatively impact their ability to hit their full-year sales targets, and 75% of them expect the impact to be 11% or more of expected sales," RBC analysts wrote.
Relying on 'recurring revenue'
SaaStr's Lemkin notes that larger customers often pre-pay for a year's worth of their cloud software - still more flexible than the multi-year deals that were common in yesteryear, but enough to give the cloud vendors confidence that their largest customers won't vanish on them overnight.
On the flip side, customers are likely to stick with their cloud software vendor because they rely on those tools, like Zoom or Workday, to literally run their businesses. That means they're dis-incentivized to "churn out," or cancel their contracts.
"At least in the enterprise, the bigger customers, they all budget their top hundred applications. They budget for Zoom, they budget for Slack, they budget for Workday and Salesforce and those budgets aren't going away. And those apps as mission critical apps are all going to be renewed next year," Lemkin said.
Indeed, Lemkin says that this so-called recurring revenue helped buoy Salesforce and its peers through the Great Recession of 2008 and 2009. Even when things were at their most bleak, Lemkin said, big customers still opted to renew their contracts, rather than disrupt their businesses by cancelling.
"That's the power of recurring revenue," Lemkin added.
New deals will be harder
That doesn't mean that cloud software companies won't see any impact. Even if existing customers remain, it will be harder to sign on new ones.
Lemkin estimates that in 2008 and 2009, with the recession in full swing, new bookings at SaaS companies slowed down as much as 50% as customers suddenly found themselves more conservative with their cash. The effect was magnified at smaller companies and startups, like Lemkin's former startup EchoSign, because they don't have the same years' worth of customer relationships that the major players enjoy.
It could be harder still for companies that target smaller businesses, Lemkin said, who are going to have the tightest purse strings and the least flexibility in any kind of downturn. Indeed, Lemkin says, he witnesses several smaller cloud software companies go bust amid the Great Recession.
Saper notes that there's another dynamic at play: Cloud software that solves critical business needs will do well, but those that are merely icing on the proverbial cake for their customers will likely struggle.
"Enterprise software companies that are selling more, what we call vitamins than painkillers, may see increased churn," Saper said.
A brighter outlook for SaaS
One point Saper makes though is that some of the more successful cloud software companies around now were actually founded during the 2008 recession. That's because that tougher environment forced startups to be capital efficient and operate without raising a lot of funding.
One of those companies is Veeva, a company making cloud software for the pharmaceutical industry, which Saper's firm is invested in.
"You can learn to build very, very capital efficient businesses in markets like this and we think that can create really iconic companies," Saper said.
Furthermore, Saper says, the cloud software business is in a better place than many other parts of the technology industry, particularly those that rely on complex supply chains for hardware manufacturing.
By that same token, cloud software companies also have a lot of flexibility for their own operations, Saper said. They generally have high gross margins, since there's no overhead around manufacturing a physical product. That, in turn, makes it easier to get to profitability - which they can do, at least in the short term, by cutting spending on new product development or marketing just to get through the harder times.
"That'll obviously harm the business in the medium term but, because the gross margins are so positive, it allows you to create a fairly profitable business fairly quickly," Saper said. "That's a bit different than some consumer businesses or other models that may operate on slightly more narrow gross margins. And therefore the path to profitability in a world with a major systemic shock, like the one that we may be facing, is hard to find."
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