Inflation has increased dramatically in the past months. Most likely, the levels of inflation we are seeing today will not disappear in the near future. Post-pandemic supply chain issues, the rush to the dollar safe haven, and the war in Ukraine have resulted in an energy crisis and a food crisis which has rapidly pushed consumer price increases up to levels not seen since the early eighties.
Here we look at some steps you can take to position your SaaS business in the current environment.
In the Eurozone, consumer prices rose by a record 10.0% in the year to September [1], the highest in the Euro’s 23-year history, whilst in the UK inflation was 9.9% in the year to August [2]. In the Nordics, the inflation is more modest but still high, ranging from 6.5% in Norway [3] to 9.8% in Sweden [4]. However, in the USA numbers are reduced from a peak of 9.1% in June to 8.3% in August [5].
What is the impact of increasing inflation? High inflation leads to high-interest rates, since interest rates are the primary tool used by the central banks to manage inflation. These high-interest rates have resulted in a reduction in the value of growth companies, and those same interest rates cascade down into the cost of capital for the business, which combined with only a limited capacity of customers to absorb higher prices, puts a squeeze on the bottom line of SaaS companies. However, the good news is that the businesses that can grow profitably (and tolerate the squeeze better) are also more likely to maintain good valuations.
So the million-dollar question is, how can you fuel your SaaS company for growth whilst safeguarding your bottom line, in times when you cannot fully pass increased costs on to your customers?
1. Take a look at your cost base and identify efficiency savings
After several years of a growth mindset in the industry, many SaaS businesses are operating with unnecessary costs. Today’s situation gives you an opportunity to take a proper look at your cost base, and consider where you are and what’s essential to your businesses going forward, and what isn’t.
As you look through your cost base, identify possible savings in three categories: 1) fixed costs, 2) variable costs, and 3) efficiency gains. Which costs are purely out of habit, without a clear understanding of related ROI? Which investments can be put on hold? Which costs can be repurposed to yield better returns?
This exercise will help you to look inwards and assess your business as a first step to becoming a leaner, better business, more able to emerge from the current high inflation period as a winner.
2. Adjust customer contracts to strengthen customer relationships
If you are lucky, you have included indexation (CPI, RPI, or other indexes) in your customer contracts and will receive a significant uplift to your ARR in the upcoming period.
If not, then consider amending your standard contract to include this clause as a default for all future customers. Of course, this initiative will only impact future customers, and not all new customers will accept an indexation clause anyway, but it is still worth having it in there.
For existing customers, a repricing discussion could be an opportunity to strengthen customer relationships, provided the conversation is focused on a common purpose. An article by McKinsey & Company explores this issue and the broader issue of dealing with inflation [6].
In short, you will be better able to withstand inflation if you are constantly looking for ways to pass some of your increased costs on to your customers. Keep in mind that there are creative ways to do this, and ask yourself the following:
- On which customers do I have lower gross margins?
- For my low-margin customers, which components are costly for me to provide? How can I reduce the cost of providing these components? Are there adjustments that can be made on the product side or within customer success?
- Could I engage my customer in a discussion about increasing the pricing of any more expensive components?
- For high-margin customers, could I look to extend their license period, to lock them in, in exchange for not increasing pricing? E.g. if my typical contract length is 1 year, could I extend it to 2, 3, or even 5 years?
- Can I take a look at what is included in my SaaS agreement and determine which services can be taken out at minimal impact to the customer?
- Which customers have a higher risk of churn?
- Which low-churn-risk customers are good candidates for pricing discussions?
- How can I engage with my high churn-risk customers in a constructive discussion around pricing? Which high churn-risk customers do I need to retain, and which, based on margin and contract size, can I afford to lose?
3. Negotiate with your suppliers
On reviewing your cost base you may have drawn up a list of fixed and variable costs to be taken out. But how about the fixed costs that remain? Could you reach out to some of your suppliers to negotiate better terms? These are similar discussions to the ones you have with your customers but in reverse. Perhaps you could agree to extend the contract period in exchange for a higher fixed price level, as an inflation hedge? Or could you perhaps demand more of those existing suppliers that remain after you have removed any “duplicate” suppliers?
Whilst certain of the larger suppliers are near impossible to negotiate with, it is always worth trying. Remember, it is not necessary to accept price increases upfront, and if there ever was a time to negotiate, it is now.
4. Maintain good dialogue with your employees
A personnel cost increase of 10% on the existing employee base is for many businesses not an option, as this could push them into loss-making positions, which is certainly not a good way to position your company in a period of high inflation.
Salary is based on supply and demand, and in the period we are entering there is likely to be higher supply and lower demand as several tech companies, large and small, are initiating layoffs. We have been experiencing artificially low unemployment rates and high cost of replacement hires for some time now, but this could be about to change as we enter a “higher for longer” inflationary period.
Therefore, use a top down approach to consider which adjustment to the personnel cost base you are able to make in the current situation. Once you have decided, ensure you have good dialogue with your employees, and clearly communicate why it’s necessary for your company to act in the way it’s doing, whether this is to ensure your company can continue to provide employment to its employees in the future, to reduce the risk of future layoffs, or simply to be prepared for a tougher economic climate.
The more you are able to create a sense of meaningful work to your employees, through good communication, the more likely you are to build a more resilient company. Remember that softer factors, such as a feeling of being trusted, a sense of belonging and flexibility in work schedules could actually be more important to your employees than hard factors such as pay and development.
5. Look for sensible M&A opportunities
The current economic climate can provide an opportunity to acquire decent companies at sensible valuations. So, engage with the companies on your target list and determine if you can find common ground with any of them in discussions on a future business combination.
Profitable companies are easier to consolidate financially, and smaller companies may wish to find new havens in larger companies. The benefit of making acquisitions at this time, apart from reducing competition in the market, is that if the price is right and the merger executed effectively, there is an accretive effect on your own company’s valuation. Synergies both on the cost and revenue side can help make your business well-equipped to weather the current climate.
Key Takeaways
As we enter a period of “higher for longer” inflation, we must prioritize, and cannot afford to delay important decisions. We now have a golden opportunity to assess our business and find smarter ways of working, by:
- Taking a look at your cost base and identifying efficiency savings
- Adjusting customer contracts to strengthen customer relationships
- Negotiating with your suppliers
- Maintaining a good dialogue with your employees
- Looking for sensible M&A opportunities
In the words of Churchill, “never let a good crisis go to waste”.
Sources
[1] Eurostat https://ec.europa.eu/eurostat/databrowser/view/prc_hicp_manr/default/table?lang=en
[2] Office for National Statistics – Consumer price inflation
[3] Statistisk sentralbyrå
[4] Statistikmyndigheten
[5] U.S. Bureau of Labor Statistics
[6] Navigating inflation: A new playbook for CEOs
