Published March 2, 2023 | 3 min read
Key Points
- Software revenue growth is set to dip further this year, and potentially – given the time lag from bookings to revenue – in 2024 too.
- Layoffs in the tech sector may spread to software, among other sectors.
- A company’s business model and its track record in customer focus will be key to its resilience in recession.
- Companies that can sell to existing bases, and offer better customer value, are strongly placed.
- Other trends include a focus on margin enhancement, a pick-up in M&A, and efforts to rationalize the costs of cloud migration.
Further decline this year – and next?
2023 may see further dips in revenue growth in the software sector, following a 4% drop in estimates over the course of 2022 – and there may be yet more pain to come in 2024.
Macro challenges see companies braced for further dips this year. Given the lag from bookings to billings and then revenue, even if the first quarter of 2023 represents the trough of bookings, this may mean further decline into 2024.
Software companies broadly sound over-optimistic, in our view. However, some could be in a position to accelerate revenue growth once economic conditions start to improve and bookings pick up.
Software layoffs possible, but will they pay off?
Recent tech layoffs have been widespread, and we believe software companies are at risk too. We may see further tech layoffs in 2023, potentially spreading to other sectors.
While reductions in workforce can help increase efficiency, they are a sign of slowing demand. They could compound the impact of economic slowdown, especially where companies go too far with reductions.
Given the impact of layoffs on productivity and innovation, we are also uncertain that they can truly lead to long-term margin expansion.
“We may see further tech layoffs in 2023, potentially spreading to other sectors.”
Who is more vulnerable to recession?
We believe consumption-based, pay-as-you-go business models will be most sensitive to recession, but also recover the fastest. Seat-based subscription models – licensed per individual user – will see medium sensitivity. Volume-based subscription models are more defensive in the near term, but pricing pressure may expose them to the highest longer-term vulnerability.
Businesses that have failed to put enough emphasis on customer success will also be more prone to macro pressures, we believe. These include companies that have focused on raising prices for customers; those with a significant amount of unsold stock; those with business models that are not fully aligned to customers, or are misunderstood by investors; and businesses that over-promise and under-deliver.
“Consumption-based, pay-as-you-go business models will be most sensitive to recession, but also recover the fastest.”
Big players and platform vendors are well placed
Vendors who can sell back to their customer base are in a better position than those relying on new customer acquisitions. This favors larger, more established vendors with a large renewal base.
Platform vendors are likely to be winners too – ideally those with a single software-as-a-service (SaaS) code stack, which can help customers do more with less in times of IT budget uncertainty. For the same reason, incumbents are more strongly placed than vendors seeking rip-and-replace deals.
Margin focus, M&A and cloud trends
One welcome development is that margin expansion has become a focus for companies and their management teams. We hope this is a sustained trend and not merely a short-term reaction to economic downturn.
We expect to see a continuing pick-up in software mergers and acquisitions during 2023, with strategic buyers, private equity firms and even sovereign wealth funds together holding billions in dry powder.
Finally, we foresee continued migration to the cloud, but accompanied by an increasing focus on rationalizing cloud costs and reducing spend on specific vendors.
“Margin expansion has become a focus for companies and their management teams – and for investors.”
Rishi Jaluria, Matthew Hedberg, Matthew Swanson, Dan Bergstrom, Richard Poland, Anushtha Mittal and Simran Biswal authored “Software: 10 Key Themes Heading into 2023,” published on December 19, 2022. For more information about the full report, please contact your RBC representative.
