Why most SaaS companies are not, and will never be profitable?
A single zero times a great sum equals zero.
Zero-cost of replication
Let's talk about the beating heart of the tech world, the boiling center of the current ongoing revolution: the SaaS industry. Because you know, I know, everyone knows: software is eating the world, however, it may not be exactly the type of software you imagine. Even worse, some software is getting eaten by their market.
The last decade has seen explosive fundraising toward the SaaS industry, and the emergence of thousands of new solutions, some of them bootstrapped, others fundraised. The best talents are attracted by the best software companies, and they generally are the most public and praised success by the who's who on LinkedIn and the greatest Forbes journalist. Yet most SaaS companies are not profitable, an astonishing majority of them die before selling to their first dozens of customers. A concerning amount of big established SaaS still struggle to make a penny of profit 1, flirting dangerously with leverage and laying off their employees by the batch of a thousand 2.
SaaS companies are the quintessence of the highly sought-after product-market fit and its consequential exponential growth: Get your first couple of thousand customers, and let compounding work its magic. However, this fairy tale is anything but common, and an overwhelming majority of software builders, especially the ones that appear successful, are built on terribly fragile foundations3.
Most software companies operate on broken business models, and many of them take shortcuts with catastrophic long-term effects, at the expense of what made them so attractive in the first place: their software.
Marketing shortcuts and short-termism are particularly appealing in the SaaS industry for several reasons. There are no other business domains that allow pushing the "fake it until you make it" method further. As software has zero replication cost, you can effectively sell a thousand pieces of broken code to customers, rushing later to update your application – and it can actually work.
But why has creating profitable software companies that aren't simply cash incinerators become so challenging?
Codeless commanders
No, not all CEOs should code and build software – don't get me wrong. Many great SaaS leaders of highly profitable companies have never opened a terminal. Yet, they possess a keen understanding of their product's architecture and its technological distinctiveness.
A competent leader must operate on foundational principles and grasp the core modules of their company's product, including the technological underpinnings that make it function.
Astonishingly, numerous tech founders lack an understanding of their own technological challenges and are practically incapable of providing relevant direction to their development teams. Why does this matter, and why does it ultimately lead to unsustainable business positioning?
The answer is quite straightforward: Beside distribution and marketing, the toughest challenges SaaS companies face are technical. Without a proficient technical founder, these challenges can become fatal. They often lead to accumulating silent, hidden technical debt that will exact a heavy toll later on.
The recent fundraising frenzy gave rise to numerous companies led by well-connected CEOs from prestigious business schools or fashionable startups, yet they often lack technical knowledge. In recent years, the role of engineers and technical founders in company development has diminished, with a growing number of startups led by individuals ignorant of their underlying architecture. Interestingly, most successful companies from the PayPal mafia were led by technical founders with high skills in product or engineering.
There is a generation of newly funded leaders with extraordinarily sparse technical knowledge, which later resulted in almost complete inability to build high-quality, consistently innovative products for several years. A lot of them follow technical hypes.
An inability to innovate and build good products eliminates the possibility of up-pricing and up-selling, key strategies for revenue growth in the tech industry. This stagnation often results from a lack of technical expertise at the leadership level. Furthermore, a high level of technical debt renders the tech team significantly more costly. Maintaining old, legacy code is usually far more expensive than developing well-structured code from the outset4. This financial burden can strain resources and impede the company's ability to adapt and evolve in a rapidly changing market.
Subsidized sales
And so unfolds the anti-fairy tale: Numerous companies bombard users with ads and unsustainable discounts, incurring hefty cumulative losses. First, they hemorrhage money on indiscriminate marketing and distribution spending. Second, they struggle with the influx of customers on poorly designed architectures, leading to haphazard engineering hires and ballooning infrastructure costs. Third, they suffer the gravest loss when dissatisfied clients defect to better-constructed competitors, leaving behind spaghetti code, a slew of unproductive designers and product managers, and an exorbitant advertising budget.
In another article, I highlighted the perils of price-based marketing: companies struggling to forge a brand identity and overly reliant on pricing strategies are doomed to languish in low-margin quagmires. This rings especially true for software companies. Escalating growth on everything except product quality and service is a blueprint for failure.
Many SaaS companies mirror their client interactions with their fundraising tactics: overselling future results and promises. This approach is critically flawed. While VC investors risk someone else's money expecting returns in a decade, SaaS customers spend their own money and demand immediate fulfillment of promises.
Under-investing in product development and over-spending in marketing aren’t the only issue plaguing many companies; equally detrimental is poorly directed investment. This often manifests as a barrage of useless features, stemming from a lack of clear focus and strategic vision.
What am I buying again?
A lot of software companies frequently fall into the trap of adding features indiscriminately5, mistakenly believing this will enhance their product's value. Instead, it leads to bloated, unfocused offerings that fail to meet core user needs or differentiate the product in a meaningful way in the market. Let’s dig in.
If you're an engineer who's worked in early-stage startups, you've likely encountered this type of CEO: the one brimming with ideas, urging you to develop a plethora of unrelated features, each supposedly guaranteed to attract a constant stream of new clients. How can that fail? Imagine selling an online insurance application and adding a buy-now-pay-later functionality. Wouldn't that attract new clients? In marketing, 1+1 never equals two, whether you're selling software or Walkmans.
Here's an anecdote: the inventor of the Walkman, Akio Morita, removed the recording button from the device 6, a feature standard in dictaphones, to avoid confusing users with unnecessary functionality. This decision was a masterstroke in simplicity, ensuring the device's success by focusing on its core purpose.
Software products must be simple to use and easy to sell, encapsulating complexity for the user, whether they're buying or selling. Piling on unrelated features can result in bloated architecture and a confusing user experience, often devoid of objective usage data. CEOs may be startled to learn what users actually do with their software. It’s simple, but not easy.
Too many SaaS companies squander vast sums developing unneeded products, guided by numerous pricey product managers and UX designers, while overlooking valuable client feedback—feedback that is not only more relevant but also comes free with their paid subscription. Pursuing the illusion of sophistication at the expense of usability is a common trap. Keep things simple, focus on solving a problem better than anyone else, and build not just a product, but a brand and identity7.
Know your business
How did Google and Facebook became so filthy rich if their products are free? Of course you know the sentence, if you don’t pay for the product, then you are the product. Let’s not dig into this cliché, but rather says a bit more about its consequence : Google and facebook knew the business they are in, and it was not the SaaS subscription business. Most SaaS leaders have no clue what business they are in, and totally ignore who are the 20% of clients whow ill bring them 90% of their revenues, as well as why any price discount in their saas would make no difference at all.
Google and Facebook are predominantly in the data business, selling this information to advertisers. Many SaaS companies perceive themselves as subscription services, assuming a linear scaling by selling more features. However, often the real value lies in a single functionality. For instance, QuickBooks now offers payment solutions and has significantly reduced its presence in countries where financial services are less profitable.
Another example of a business model where the revenue stream isn't immediately obvious is Amazon. Often perceived primarily as an e-commerce platform, a substantial portion of Amazon's profitability actually comes from its cloud computing division, Amazon Web Services (AWS), which provides a significant portion of its operating income. The money printing was so good they kept it secret for years.
Conclusions
Simplicity is the soul of efficiency.
Find your Pareto features.
Don't invest in any work that doesn't appear useful to your end-customer.
Know the business you are in.
Avoid placing yourself in an unsustainably costly, leveraged position solely for the sake of growth.
If you're a venture capitalist, refrain from investing in founding teams that lack understanding of the technology they're selling. After all, you wouldn't buy a car at a grocery store.
You sell tech, understand it, or don’t sell it.
Customers are paying product managers : listen to them.
Interests on technical and product debts are high, pay that debt early when you can.
1+1 does not equal two.
And please don’t fucking post on LinkedIn that all your clients are thrilled when they are not. Don’t talk to us, talk to them. I post daily btw.
Keep the faith,
Voss
Square and Toast are still money losing machine for example.
Company culture rarely survive layoffs, as stated by Ben Horowitz.
Let’s not be unfair on new SaaS : Old SaaS tend to be horribly flawed as well, and blow up spectacularly later on. Tax systems are built on Cobol in most countries.
Building fast and breaking stuff is fine, as long as the technical debt is manageable.
Nequi, the worst fintech in the modern era among all the multiverses, sells so much bullshit, while the actual money wiring button is off for hours every payroll day.
Against the opinion of all his engineers
Shazam is the best example : one button, one usage.