Over the past decade, tech company valuations have dramatically increased with topline growth rates as the driver. Subscription technology and SaaS companies have been the beneficiaries of revenue multiples that have grown to almost inexplicable levels. Even with perceptively questionable behaviors, they have been doing what works. Why change behaviors that are being rewarded with positive reinforcement?
For a new company with bright hopes for the future, growth at any cost—e.g., huge investments in R&D and S&M—makes sense. The problem for these companies, particularly in the tech sector, is that this reliance on outside investment continues long past the start-up phase. Like children who must eventually take off the training wheels, these companies must stop asking investors to support them.
The Situation
We have all heard of technology companies that have massive valuations in the public markets without ever making a profit. The problem is that when you are valued based on revenue multiples, any dollar of top-line growth is a good dollar. In this respect, the end justifies the means when it comes to generating new revenue. In my experience, even pursuing cohorts of customers with an average lifetime of only 3.7 years and a 5-year customer acquisition cost (CAC), payback works in this climate.
Years ago, when I was in private equity attending a sales conference for a large publicly traded company, I said to a colleague: “If this company was owned by private equity, at least 35% of the people in this room would not work here.” The governance was broken. Like other similar companies, it appeared no one was minding the store. But the companies and their management teams were not lazy or inept. On the contrary, they were winning at the game they had been rewarded for playing.
But living in fear of a recession as we are now—the game has changed. The cost of capital is up, and for the companies described above, the bell is ringing. Their tactics are giving companies a black eye in the public markets and course correction can't come fast enough. They need to make a change or it will be made for them.
The Solution
I believe companies need to go back to focusing on their bottom line. Gone are the days of being satisfied with unprofitable customers who leave before meeting their CAC payback. Companies must shift away from prioritizing top-line growth and instead focus on the cost of capital versus return in the P&L, their internal rate of return, and what generates the greatest value.
Growth at any cost has been the name of the game. But now it might be wise to start asking questions like, "Can we accelerate growth without increasing operating expense or even just maintain growth in exchange for the ability to keep operating expenses flat and drop more money to the bottom line?"
Levers To Turn Things Around
To support this shift, companies will have to look at the levers available to them and consider the following:
- Wait and see is not a strategy. Know precisely where your productivity potential lies. Get your GTM data in order and have your operations teams prioritize market segments. You need reliable information to make fact-based decisions about where and when to allocate resources.
- Beware of overcorrecting for a possible recession. Focus on recognizing immediate efficiencies within your GTM system so you can adjust your value creation model. Avoid taking reductions in marketing, sales enablement and sales operations, and customer operations expenses.
- Headcount is not always the way to think about sales capacity. Analyze revenue per employee and where people are focusing and spending their time. Organizations should look at every role in the organization and ask themselves if that role pays for itself. If a sales rep does not bring in enough revenue to cover their salary, drive growth and drop money to the bottom line, you must ask yourself how to increase productivity in sales training or methodology.
- Analyze sales and marketing spend as a percentage of bottom-line revenue. Shift from top-of-funnel to account-based marketing (ABM) and narrow ICP (ideal customer profile) activation. Focus on driving qualified opportunities with higher win rates and shorter sales cycles. Identify and address buyer stall points by prioritizing ease within their internal buying process.
- Confirm you are getting our products in front of the right buyers in the most efficient manner. Ask if your channels get products in front of the most ideal customer profiles with the highest willingness to pay and the best profitability. If not, ask yourself if you need to focus on different categories of existing customers—or new customers—and keep in mind the significant acquisition cost difference of the two.
Public tech companies should challenge themselves to consider the above, because if they do not, they may face the prospect of living under a new governance model. Private equity firms have amassed a huge amount ($1 trillion plus) of dry powder. They have been waiting patiently for opportunities to do “take private” deals, and they are experts at pulling the levers outlined above. We've seen this trend over the past couple of years with tech companies now accounting for 50% of take privates up from 30% a few years ago. So, if you are an executive in a publicly traded tech company, you can either change and control your own fate or wait for a PE sponsor to take you private and do it for you.
Mike Hoffman is a contributor to Forbes Business Council. To view the article in Forbes, click here.
