Managing Profit and Growth

Abstract: Few business models are as hyped right now as the Software as a Service (SaaS) model. But how sustainable is it? In the last decade, SaaS has reshaped the software industry and has become a leading delivery model of B2B enterprise software. During this period, the disruptors that pioneered the model and the incumbents that transitioned to it have created tremendous shareholder value. However, the incredible growth has not come without a cost: industry profitability has tumbled and is now only half of what it was just a decade ago. As a result, the technology community is increasingly pushing for sustainable growth, balancing high growth rates with a clear path to profitability. This study – building on an extensive literature review, a company survey and interviews with five CEOs of Swedish SaaS companies – investigates the current growth and profitability among Swedish SaaS companies. The result? Companies are sacrificing current profitability for the promise of growth and much larger future profits. Furthermore, the loss-making pattern among SaaS companies is very much a result of the current market dynamics and a managerial decision rather than any shortcoming in the SaaS model itself. Considering the study sample of 57 Swedish SaaS companies, the average revenue growth and operating margin in 2019 was 25.5% and -17.5% respectively. This pattern cannot be expected to change in the short-term unless the economic cycle suddenly takes a downturn. It the medium- to long-term, the profitability in the Swedish SaaS industry is expected to increase once the companies mature and sales, marketing, and product development can be reduced or if the capital markets decide that profitability contributes to more value creation than growth. Furthermore, the low profitability is based on traditional accounting principles, thus ignoring values such as customer lifetime value and unit economics associated with the SaaS model. Moreover, the research identified several factors steering companies towards growth: 1) Growth is premiered over profits when it comes to increasing firm valuation, 2) objectives of the founders is often to increase company valuation and therefore also growth, 3) growth is important to position the firm in the market and gain market share, 4) to position the firm for a future exit, growth is seen as the main instrument while profits can be improved short-term, 5) most SaaS companies share the characteristics of being in the growth and early maturity stage of the company life cycle. Compared to traditional software businesses, SaaS businesses have a particularly hard time generating profits during start-up and early-growth phases. Whereas research has primarily emphasized the technical aspects of SaaS, this study primarily looked at SaaS from a business perspective. The results reinforce several management theories while bridging the gap between what is known to SaaS managers and experts, but yet to be studied in an academic setting. Furthermore, this work is the first trying to look at the Swedish SaaS industry as a whole.