How hard will corporate cost cutting hit startups?
A question for 2023
Coverage of corporate cost cutting tends to focus on layoffs. Reductions in force are simple to understand, their impacts easy to put into personal context, and they’re easy to spot, as cut staff tend to make noise on their way out the door.
This isn’t the case with cost cutting in other areas, like technology spend. Apart from the occasional Southwest-style blowup reminding the market at large that investing in IT infra is critical to long-term corporate success, a company working to consolidate its software vendor list is hardly news.
This is why most of the news you have read about tech cost cutting has focused on the humans impacted, whether it’s Big Tech looking to eject humans from gilt offices, or startup downsizing explained through the lens of executive contrition. You might think that the only story in tech’s present era of cost control is the shedding of potentially excess staff. There’s more going on.
Reading Janelle Teng’s 2023 startup predictions — she’s an investor at Bessemer, where Mary and Elliott also work — is a good place to start. She predicts in 2023 that the tech market will see “increased vendor consolidation and re-bundling.” In this new year, that could mean, she writes, “more rationalization of spend […] especially within fragmented vendor landscapes in particular layers of the tech stack.”
Most companies could compress their technology vendor list, either by cutting redundant services, or simply looking to larger bundles of functionality that exclude narrower startup offerings.
Either way, the current press by tech companies to get to a greater level of profitability will ding technology spend; and as other industries are also dealing with the same more conservative public investor cohort, it’s not hard to anticipate similar dynamics playing out in corporate America more broadly.
The question that I have been sitting on for a few days is just how bad the new climate for software spend — less, and from fewer providers — will prove for startups.
Startups grow in a few different ways. One is landing new customers, and another selling more of their products to existing accounts. The problem, so far as I can see it, is that the new economic climate impacts both methods of revenue accretion. Potential customers looking for fewer vendors that can offer a broader set of tooling will put startups at a net-new customer add disadvantage compared to legacy providers, and raised cost scrutiny more generally should impinge upsells from existing customer lists.
Put in more startup-y terms, I suspect that both gross and net retention will be under pressure this year at every software company, and more than average at smaller, younger startups.
Bad news never arrives alone, so that we are seeing the sales landscape for startups get trickier at the same time that investors are demanding more profitability along with maintained growth is not a shock. It is, however, a tough set of headwinds for startups looking to defend prior valuations and get through to the other side of the present downturn. (Unsurprisingly Teng also predicts that in this year we’ll see less stigma around flat, and down rounds; it’s better to lose shine than to die.)
An optimistic take here would be to presume that net retention will return to prior norms in time. By that we mean that when economic clouds part, tech customers will go back to buying more seats, or units of use, from their software vendors. In a sense, this perspective shifts attention from net retention to gross retention, as tech companies will want to hold onto customers at all costs so that they can bank them for future revenue growth.
Other tech companies are focused on net retention over new logo adds, which is another way to try to defend growth rates:
What Sim — an investor at Boldstart — outlines here is essentially a customer quality bar; is a sales person bringing in new customers that are a good fit for the company’s product, or simply an account that will either fail to grow or wither on the vine? This nests somewhat into our point concerning gross churn, though imperfectly.
I do not know how long the present trough in tech sentiment, valuations, and spend will endure. Our perspectives are still too distorted by the 2020-2021 zenith of the recent tech boom to know if we are too pessimistic today, or not pragmatic enough. But what does seems clear is that startups will have to work harder to land new contracts and to defend existing accounts. They will have to do so while executing a contemporaneous push to drive upsells when possible, all while the pendulum of corporate power has swung back to the CFO suite providing ample friction.
This could lead to lower startup growth rates across the maturity ladder that we tend to demarcate in Series lettering.
But don’t despair. SaaStr’s Jason Lemkin, an tenured venture and startup hand, found the silver lining:
[I]t’s worth remembering even with much more buyer scrutiny today, SaaS spend overall still grew at epic rates in 2022. SaaS spend and SaaS software didn’t shrink in this crazy years. Market valuations did, no doubt 🙂 But not the overall trends of both SMBs and enterprises buying more SaaS than ever.
Given the number of major startups that cut staff this year citing over-hiring in anticipation of faster growth, I would quibble a little with Jason, but not too much. Software sales did grow this year, if less than in 2021.
Welcome, 2023. Let’s see what you have up your sleeves, and if startups will buck the tech slowdown narrative, or become its most visible casualty.