Software and online services are in a period of dizzying growth. Year-old companies are turning down billion-dollar buyouts in the hopes of multibillions in a few months. But we have seen similar industry phases before, and they have often ended with growth and valuations fizzling out. The industry’s booms and busts make growth, an essential ingredient in value creation, difficult to understand. To date, little empirical work has been done on the importance of revenue growth for software and Internet-services companies or how to find new sources of growth when old ones run out.
In our new research, we analyzed the life cycles of about 3,000 software and online-services companies from around the globe between 1980 and 2012. We also surveyed executives representing more than 70 companies and developed detailed case studies of companies that grew quickly and others whose growth stalled. The research produced three main findings.
Growth trumps all. Three pieces of evidence attest to the paramount importance of growth. First, growth yields greater returns. High-growth companies offer a return to shareholders five times greater than medium-growth companies. Second, growth predicts long-term success. “Supergrowers”ócompanies whose growth was greater than 60 percent when they reached $100 million in revenuesówere eight times more likely to reach $1 billion in revenues than those growing less than 20 percent. Additionally, growth matters more than margin or cost structure. Increases in revenue growth rates drive twice as much market-capitalization gain as margin improvements for companies with less than $4 billion in revenues. Further, we observed no correlation between cost structure and growth rates.
Sustaining growth is really hard. Two facts emerged from the research. Companies have only a small probability of making it big. Just 28 percent of the software and Internet-services companies in our database reached $100 million in revenue, and 3 percent reached $1 billion. Of the approximately 3,000 companies we analyzed, only 17 achieved $4 billion in revenue as independent companies. Moreover, success is fleeting. Approximately 85 percent of supergrowers were unable to maintain their growth rates, and once lost, less than a quarter were able to recapture them. Those companies that did regain their historical growth rate had market capitalizations 53 percent lower than those that maintained supergrowth throughout.
There is a recipe for sustained growth. While every company’s circumstances are unique, the research found four principles that are essential to sustaining growth and from which every company can benefit. First, growth happens in phases: from start-up to billion-dollar giant, growth stories typically unfold as a prelude, act one, and act two. In act one, there are five critical enablers of growth: market, monetization model, rapid adoption, stealth, and incentives. A third principle is that the drivers for growth in act two are different. Successful strategies in act two include expanding the act-one offer to new geographies or channels, extending the act-one success to a new product market, or transforming the act-one offer into a platform. Finally, successful companies master the transition from one act to the next. Pitfalls include transitioning at the wrong time and selecting the wrong strategy for the next act.
More SaaS + Software Stats
The median average contract length is 1.3 years and the average billing term is seven months in advance in 2016. Comparable to 2015, with average contract length shortening from 1.5 to 1.3 years and average billing period increasing by one month from 2015 to 7 months
Because of the losses in the early days, which get bigger the more successful the company is at acquiring customers, it is much harder for management and investors to figure out whether a SaaS business is financially viable.