Recessions give us the heebie-jeebies for all sorts of reasons. After all, the economy is shrinking. You get that...
unsettled feeling just reading this, right? It's normal and -- in a clinical way -- good to feel that way. If you didn't, we'd all be worried about you.
Companies go through expansions and contractions along with the economy. Big companies may be able to weather the storm, while smaller companies may feel more pressure. However, there are no good rules of thumb here. Just look at General Motors. This recession is not your garden-variety downturn, either. It has revealed structural economic problems that can make even the largest companies look unstable.
The instability we worry about affects SaaS companies just as much as conventional operations. You might think that SaaS vendors will be fine because they have a cool business model that keeps a steady stream of cash coming in. Well, many of them will be fine, but that doesn't mean we can assume that all SaaS software companies will be.
SaaS vendor research is crucial
You need to do your homework if you are in a purchase cycle. Not only do you need to ask about company health, you also need to do a little digging. A salesperson might tell you about all of the company's customers, implying that with so many revenue sources, the SaaS vendor is financially safe. But not so fast.
It's true; SaaS companies have cash flow from all their customers coming in each month -- at least in theory. And it's true that SaaS companies can run extra-lean. But these companies still have overhead -- payroll and all of the other typical company expenses. They adjust their spending so that it doesn't exceed their income.
In a downturn, SaaS software's lower cost of ownership ought to make SaaS companies' services highly desirable. But just like any other company, a SaaS company has customers that will spend less in a downturn and perhaps even lay off employees. One of the beauties of SaaS, for customers, has always been the ability to add and drop users almost at will. Right now, customers may be dropping more seats than they are adding.
The companies' attrition rates speak volumes
Many SaaS companies find that they fight a monthly battle against attrition even in good times. If you want a measurement that tells you about the health of a SaaS company, it's hard to do better than the attrition rate. Other measures, such as "months of committed cash on hand" (cash that customers have paid in advance for future months) and "contract-user months in backlog" (total seats under contract for months into the future), are useful too.
The attrition rate and the win rate tell you how volatile the company's customer base is. A high win rate, coupled with a high attrition rate, suggests that the company is treading water -- or it is a revolving door. A high win rate and a low attrition rate tell you the company is growing. Growing companies tend to have the cash to serve customers, make enhancements and generally wait out the downturn.
How do you find these numbers? You can ask for them. Public companies frequently share this information with investors, and it is available online. A quick search on the Internet or the EDGAR site published by the SEC can give you official documents like quarterly 10-K forms that go back years. Quarterly reports often discuss wins and total seat count. Some quick arithmetic will give you the attrition rate.
If the company is private, you can negotiate for information during the sales process. But don't stop there. A prosperous company issues momentum press releases that announce important new customers, seat count increases and the like. Look for patterns in either case. A company with the same seat count or customer count quarter after quarter is not telling you something. The same goes for a company that does not issue such information.
Finally, ask an analyst. No analyst follows all companies, but analysts are good third-party sources of information about the companies and industries they cover. Often, their work is available online free of charge or for modest fees, and it will show up in an online search of the company.
Just as an outgoing tide lowers all boats, a recession affects everyone, SaaS vendors included. All vendors need revenue streams, and while the SaaS model offers some protection against financial downturns, it is still wise to do your homework to find out as much as you can about a vendor's viability before making a purchase.