Insights | Insights

SaaS Perspectives: Matt Harney (Cloud Ratings)

Patrick Mc Govern

Patrick McGovern

June 26, 2024
MH B Logo

The Bowery Capital team is launching a new interview series featuring some of the leading thinkers in B2B SaaS to get their view on the state of business software and how they see the category evolving. This week, Matt Harney, Founder & CEO of Cloud Ratings and the publisher of SaaSLetter sat down with us to answer some of our questions. This is the inaugural edition of our SaaS Perspectives series and we will be continuing to publish these interviews over the coming months.

How do you see today's SaaS market differing from when you launched Cloud Ratings? And how does it differ from when you were buying software businesses as a private equity investor 10-15 years ago?

I have been in the cloud industry for about 15 years now, and as you would expect, the industry has matured. Things were quite new then. Many of the playbooks, like the “Predictable Revenue” model of cold outbound, were just being introduced. When you look at the transition from on-premise to cloud, and the much smaller number of competitors in any given category, it was truly a greenfield opportunity. However, there was still substantial customer education needed around the concept of software delivered in the cloud on a subscription basis and valuations were very different then. It was also less of a career path, whether to be a founder or a seller, and there was much less transparency than we see today with things like the SaaStr-type conferences, where companies come and lay out exactly what they are doing, and there are widely understood metrics that are universally tracked.

Now, in 2024, we are at the end state of all that knowledge, talent, and capital entering this industry. Things are more competitive, the products have gotten better, there are more opportunities, more alternatives for customers, more sellers, more marketers. While it is a more mature industry, the market size, the ability to exit via IPO or sell your business, have also grown materially. A whole new wave of buyers from private equity has also entered and are now participating in this same space. We have seen software companies go on to achieve market caps north of $150 billion and we are 20 years on from Salesforce’s IPO - things understandably look different, and in technology, that is a particularly long time. As you saw from my slides at Bowery Capital’s Annual Meeting, I call SaaS a “maturing growth industry.”

Given that SaaS has reached this level of maturity, how do you see the software business evolving over the next ~15 years?

In technology, there is always a playbook that you can run which I call "be so good they can't ignore you." From Cloud Ratings’ primary research in partnership with G2, we have found that if you can deliver a product with a 20% better NPS, even in a crowded category, you will take share more efficiently than the market leaders, and in turn enjoy recurring revenue, gross margins, availability of capital, and all the other hallmarks of success in SaaS. You will get the right fuel and succeed - but you have to be a category leader in terms of product, team, customer support, everything.

NPS is interesting because the trend for a number of years in growth-stage SaaS and public-stage SaaS was to grow customer success to drive retention, and now the trend is we see companies trimming their customer success headcount. If NPS is what allows you to stand out in today's field, shouldn't companies be investing that much more heavily in their customer success function?

The number one driver of software NPS, based on the research Cloud Ratings and G2 have done, is quality of support. That is the number one predictor. But it depends on what you call customer success. Much of customer success has moved to another form of sales. This is also an element of how software is now sold. For good reasons, it is somewhat undersold at the time of closing. You are not maximizing every seat, and these glide paths are built in, with much of that expansion work falling under customer success. There are downsides to treating customer success as just another form of sales. Poorly executed customer success feels like you are just dealing with the sales team, which is not ideal for the customer. SaaS is a business, and these companies need to generate incremental revenue. And it is cheaper to generate revenue from your customers, but the industry has become overly addicted to NRR and not new logos, which causes its own problems. As an investor, you want to see that sales machine working, and the best way to see a sales machine working is through new logos.

Am I sensing some skepticism about the emphasis SaaS businesses and investors place on NRR?

NRR is great. If you can win a customer and their revenue grows forever, these companies should be worth infinite amounts according to a DCF model. But companies can lose sight of what the customer is really getting in terms of value and the true ceiling on NRR at the customer level. If you are selling into a particular function, like supply chain or HR, a 15% NRR is a 15% increase out of their budget. In real companies, budgets are finite and don't grow particularly rapidly. Expansions will have a limited duration unless you are fundamentally unlocking ROI. If your software is truly linked to generating new revenue and profit, that changes things. But many businesses will run into a wall when the new logos stop.

It is interesting how SaaS spending got so large that many companies are paying third parties (i.e., Vendr, Tropic, etc.) to cram it back down, which runs head-on into the need for endless ACV expansion. It feels to me like many software buyers are not open to expanding or even maintaining their current SaaS spend; they are trying to shrink spend, which is in direct tension with ISVs needing to grow.

Average annual software spend per employee has crept up from ~$2,000 to ~$10,000, depending on the business and role. This means software is becoming a cost to businesses on par with employee healthcare and rent. For many businesses, this software is still positive in ROI terms. Wasteful spending should be addressed, but if you are enabling an employee with a $90,000 base salary to do their job 15-30% better or faster, the last thing you should be doing is optimizing $800 of spend that drives these gains.

How do you see buyers thinking about ROI, especially with budgets and purchase approvals tightening up? What are the examples of ROI or sources of ROI that resonate with today's SaaS buyers?

ROI has been a core focus of mine, both in my investment career, and in my current role at Cloud Ratings where we have done extensive benchmarking on the key drivers of ROI. What resonates with IT buyers is stuff that hits their P&L and KPIs. Software buyers are looking out for their own interests and their company's interests. If you can orient your product to what moves the needle for them, they will be more favorable. We have found that 92% of IT ROI has a clear P&L impact, defined in terms of labor productivity, revenue or profit increase, cost savings from IT spend, and cost savings in general. Labor productivity is by far the biggest driver of P&L gains. Regarding software buyers' perspective on ROI, 47% of enterprise buyers wished it was easier to calculate software ROI. To fill this gap in the marketplace, we launched a True ROI practice area at Cloud Ratings, where we work with vendors to quantify and provide 3rd party validation of their product’s business value.

On the AI front, how do you think about the introduction of AI into the B2B software landscape? Can it provide a second act as we see trends like categories maturing, growth slowing, and spending tighten?

My honest feelings about AI are incredibly positive. It is a great way to reset the maturity cycle and unlock a 15 or 20 year growth curve for the software industry as software and AI merge into unified applications that drive efficiency. What cloud and mobile did for software, AI could do better since it has a higher ceiling on efficiency gains. AI shifts software from tools that help organize work - like a CRM or project management app - to actually participating in and automating the work itself. Automation is so powerful; humans have a hard time competing with automation that is faster, better, and cheaper. Software companies, particularly the most successful ones, do a great job of selling on value, and on average, they are able to capture ~30% of the ROI they create. When you are driving automation and delivering results for buyers, the ROI is quite apparent.

If you had to start a software company today, what B2B software category would you choose?

If I had far better product management and technical capabilities, and could hire the world's best to support me, I think a really underserved area is quality assurance. In the coming years, there will be an explosion of mainstream software products that heavily incorporate AI. The models powering these applications are going to be deployed widely throughout our world and we need something to test their quality and security, which is hard because AI is inherently non-determinative. Automated testing with security parameters around AI-enabled products is a really exciting area. These models are black boxes, and testing their quality or security will be overwhelming for traditional methods and IT teams; we need something like an AI version of Underwriters Laboratories which will make it easy to test these models against various benchmarks and standards.

What trends have you been seeing in the B2B AI interest index over the last year?

We are still early and the interest is often at the ‘atomic’ level; think individual user productivity tools like copywriting or code assistance. Today, few AI applications are ‘compound’ - that is, weave multiple workflows or individuals together the way traditional, sophisticated SaaS applications have. Many AI tools are being rushed out and even the largest vendors have only integrated AI in limited ways, like Google Gemini into Google Sheets.

Do you see ‘platformization’ coming for AI? I am envisioning more grown-up AI products where there is enterprise quality like in traditional SaaS, and the product is more of a platform than a point solution?

Yes - many existing tools with AI features are substandard right now. Some AI native tools can be more compound with layered functionality. We are so early, and in terms of the buyer interest we track through our B2B AI Interest Index, some things hit a hype cycle and wane - like copywriting apps - while broader interest cycles can have had a nice uptrend. The core interest in the top 340 SaaS companies we track has been flattish. The largest software vendors are the bellwethers. If you want an indicator of how CIOs perceive AI, look at Microsoft, and, to a lesser extent, ServiceNow and Salesforce.

If you liked “SaaS Perspectives: Matt Harney (Cloud Ratings)” and want to read more content from the Bowery Capital Team, check out other relevant posts from the Bowery Capital Blog.