Over the past few years many SaaS companies have been operating with a “growth-only” mindset, which is what investors wanted. With this approach, growth becomes more or less proportional to the spend required to generate it, and that’s not sustainable.
Recently however, investors have signaled a strong shift to a more balanced approach and have begun prioritizing SaaS companies that can show more sustainable, profitable growth. This shift happened fast, largely in response to broader changes in the economy. As a result, many SaaS companies, particularly those previously wed to a growth-only approach, have had to adjust quickly making fast and deep cuts in their budgets to conserve cash and extend their runway (a “cuts-only” playbook).
A pitfall you may not see if you act too fast
For SaaS businesses, which are complex by their very nature, the ability to make fast, proactive decisions is something of a Holy Grail. However, in the situation described above, making a decision too fast can lead to a dangerous pitfall. And it’s one that’s very easy to fall into when the pressure to cut your spending is high.
Absent an influx of cash (which is becoming increasingly scarce right now), the only way to extend your runway is to reduce your expenses. You have a few options here:
- Option 1 – Implement a hiring freeze, which could be selective, focused in specific areas, or applied across the entire company.
- Option 2 – Reduce discretionary spending, which is usually related to your GTM functions (e.g. marketing and sales teams).
- Option 3 – Cut spending across all teams, including your R&D and G&A teams. Often, these cuts start with layoffs as payroll is a significant part of any company’s operating expenses but may also include cuts to discretionary spending, too.
That pitfall when you’re trying to reduce your spend is making cuts without fully weighing the potential impacts to your business first. Seems obvious, right? Maybe, but in order to avoid unintentional negative consequences, you have to first understand how each option could affect your business.
Let's take a closer look at your options for making spending cuts
Option 1 – Implementing a hiring freeze
On the surface, this option appears to be the least impactful of the three. The thing to remember here is that with regard to cutting costs, hiring freezes don’t result in immediate savings. Rather, the reductions in spending occur as people leave the company and you don’t backfill their positions.
Depending on your current situation, that fact may make this option a nonstarter. For example, if you need to act quickly to preserve cash, a hiring freeze alone isn’t going to do that for you. However, if you still have a decent runway, this might be a good approach to start with.
What’s a “decent” runway you ask? Well, that’s hard to tell right now. According to Openview’s SaaS benchmarks report for 2022, even companies with 25+ months of runway are cutting their spending to preserve their cash, which the authors suggest might be an indicator that current conditions in the market are likely to continue.
By the way, the report also found that the number of companies planning to implement hiring freezes grew from 0% to 19% between Q1 and Q3 of 2022. It’s not clear whether this is the only option they’re implementing, just that they didn’t waste any time in freezing their open positions.
Option 2 – Reducing your discretionary spending
Reducing your discretionary spending would appear to be a middle-of-the-road option, but is it a safe road to travel right now? That depends on how well you understand the interdependencies between the different teams in your company, particularly between your marketing, business development, and sales teams.
Marketing, which is a key GTM function, often stands out here because it is one of the easiest places to make cuts (e.g. spending on ads or PR and sponsoring events). As a result, the marketing department is often the first place SaaS companies look to make cuts.
However, cutting marketing budgets without considering the ripple effects will invariably lead to a shortfall in new ARR generation, which for companies already in a tenuous position can create an existential threat to the business.
This is because it’s the marketing team that’s responsible for bringing in many (if not most) of the leads you need to generate new ARR. Making deep cuts to your marketing budget may make you feel safer in terms of your runway, but that’s going to be short lived if you haven’t assessed the impact on your sales pipeline and adjusted your ARR target accordingly.
For example, let’s say that in your original plan, based on your ARR target, you need a certain number of opportunities for your sales team to close. Most of those opportunities start with your marketing team’s lead generation activities.
If you suddenly reduce your marketing team by half, the number of leads they can generate will almost immediately drop off. You probably won’t see the impact of this right away because you’ll likely still have a number of leads working their way through the pipeline. But, if you haven’t adjusted your original ARR target, you’re in for a very unpleasant surprise down the road.
There are ripple effects, too...What happens when your leads dry up? Without enough leads to keep your sales team busy, it’s hard to justify keeping them on staff. So, let’s say you decide to let them go. Now, you’re fully caught in a negative feedback loop. Fewer account executives translates into lower sales capacity, which of course means less revenue and an ever decreasing runway.
Even if you course correct by hiring some new AEs, you’re still months away from a positive impact there because they’ll need time to ramp up before becoming productive.
Option 3 – Making cuts across the board
Obviously, this option is the most drastic, especially when it involves layoffs (which it usually does). In the SaaS industry, layoffs can have severe and negative consequences for your business. This is because when you lay a bunch of people off, you’ll save some cash, but your company’s reputation will suffer some negative PR. Every company has to deal with a little negative PR from time to time. So, no big deal, right? Well maybe, maybe not. Before jumping to this option, you need to ask yourself, what does that layoff say about your company? More specifically, what does it say to your customers?
To some, it says that you weren’t properly managing your money, that you didn't have strong fundamental business dynamics internally, and therefore you blew through your cash. If I’m one of your bigger customers, maybe an enterprise customer for example, I might begin to wonder if I’m with the right vendor. Can your company continue to meet my needs? If I have a problem, are you going to be able to provide adequate and timely support? Once these questions begin to arise in your existing customers’ minds, they become a higher risk for churn.
That negative PR also impacts your prospects for winning new customers, too. With news of a layoff at your company, your prospects might start hesitating to sign their contracts. If I’m a prospect, I’m now worried. After all, if your company misfired in your strategy to control expenses, how can I be confident that you can successfully execute on a big contract? At this point, what may have seemed like a safe bet now feels more like a big risk.
Whether you’re talking about existing customers or prospective customers, the smaller your company is, this crisis of confidence can become an existential threat.
How to avoid the pitfalls inherent in these options
There are pitfalls in all three of these options, and the key to avoiding them all is to carefully evaluate your options to determine which will have the least negative impact on your business. Instead of making highly reactionary, ill-conceived cuts that could put your business at risk, you need to know what the consequences will be before you make your decisions.
There are two ways to do this: 1) defining the ROI for each aspect of your business, and 2) scenario planning.
1. Defining your ROI
In addition to the negative PR you’ll experience, making blanket cuts across the business will compromise your growth. The key is to start with those areas in your business that directly impact your operations and top-line revenue growth – your GTM and sales teams.
To minimize the impact of budget cuts in these areas, it’s important to first know the relative ROI you’re getting from each.
Calculating the ROI helps you see beyond the sum of line-item expenses and gives you insight into the relative value you’re getting from those expenses. The best way to do this is to use the Q factor, which links results to the expenses incurred when producing those results. The Q factor measures efficiency from a resource allocation perspective, which allows you to make like-for-like comparisons between different expenditures.
In the context of sales, the Q factor is the ratio between ARR and sales payroll. A Q factor of 2 indicates that a rep generates $2 in revenue for every dollar you pay them.
While originally developed as a sales quota management tool, you can use the Q factor to figure out the ROI not only for your sales teams but other teams as well. Here’s a few examples:
- Sales teams or individual AEs – divide the new ARR generated by compensation.
- Customer success teams – divide their book of business by the earnings generated by those customers.
- Professional services teams – divide the number of onboardings by the revenue earned from those customers.
- Marketing teams – divide the ARR from new deals by the number of leads it took to generate them.
The idea here is to understand, dollar for dollar, which teams and more specifically, which activities are generating more or less growth in your business. Once you know this, you can make better decisions about where to cut and/or reallocate your budgets across different teams and start investing more in activities that help grow your business while at the same time, saving money and extending your runway. For example, you can:
- Calculate optimal team sizes in every market segment and resize teams.
- Choose between implementing a hiring freeze versus layoffs.
- Decide whether backfilling positions in underperforming teams is justified.
- Allocate resources efficiently to teams depending on their pipeline status and needs.
Q factor is most effective when coupled with sales capacity planning, which like Q factor, can also be extended to other teams to determine the minimum number of people you need in sales, CS, and marketing to meet your ARR target.
Once you know the minimum number of people you need in each area of the business, if layoffs are necessary, you can look at your Q factor results to determine where in your business they make the most sense.
2. Scenario Modeling
Scenario modeling should be a part of every SaaS company’s planning process because it’s hard to know all the twists and turns the market will take. If you’re proactively modeling different scenarios, you’ll be better prepared to respond when necessary with well-informed decisions. And most importantly, you’ll know ahead of time what the impacts of those decisions will be and can make the cuts you need more strategically to minimize them.
Modeling all the different scenarios you might expect to encounter can take a lot of time, especially if you’re still using spreadsheets for your financial planning and analysis (FP&A). If you find yourself in a situation where you need to quickly extend your runway, time is definitely not on your side. Despite the laborious, time-consuming, and error-prone nature of using spreadsheets to do your scenario modeling, you still need to do it to avoid making a bad decision that could end up threatening your business.
Drivetrain can eliminate the time dilemma so you can make critical, well-informed decisions quickly. With automated data aggregation from all your source systems and powerful modeling capabilities, including scenarios you can run quickly, you can have the answers you need in just a few days, if not hours.
And figuring out the ROI? Drivetrain makes establishing baselines and monitoring key ROI metrics in real time so you instantly have the information you need to identify the cuts that will have the least impact to your business.
So, if you’re feeling the pressure to make quick decisions without all the information you need, let us know. We’ll show you how Drivetrain can help you make faster, data-driven decisions you can feel confident in.
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