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  • Cloud software companies like Salesforce or Okta, rely on a subscription business model, one that typically bills per user/per month, an approach that’s become the envy of the tech industry because it creates a steady flow of revenue.
  • Cloud software companies have even been considered to be all but immune to economic downturns because their customers rely on software to run their businesses.
  • But the COVID-19 pandemic is different. Customers in hammered industries simply can’t pay their bills. Others have been forced to reduce their IT budgets and want to pay less for their cloud software, analysts say.
  • Customers are going to their cloud software vendors asking for new payment terms.
  • This could forever alter the once ultra-stable subscription business model, predicts Gavin Baker, founder of the hedge fund Atreides Management.
  • Visit Business Insider’s homepage for more stories.

“Spoke to the CEO of a large private software company. The CFO of one of the largest airlines called him to ask for extended payment terms on a $250k bill. 250k,” tweeted Gavin Baker, founder of the hedge fund Atreides Management, who is also well-known for his time managing Fidelity’s OTC fund.

Baker explained to Business Insider that the situation shocked him because that airline has a multi-billion dollar IT budget. If the CFO was renegotiating this relatively small $250,000 bill, many other software vendors must be fielding similar calls from their customers big and small, thanks to the economic crisis brought on by the COVID-19 pandemic.

“I would suspect that every software vendor in the world who services anyone in the travel industry or the leisure industry is getting calls like that,” he said.

The pandemic has hammered industries including travel, hospitality, restaurants, sports and other events, gambling, as well as the suppliers that support them, including oil companies. All of those companies spend a lot on cloud software from vendors like Salesforce, Okta, ServiceNow, Workday, Zendesk and startups, powering their customer management systems, loyalty programs, and accounting.

The problem is that amid the uncertainty caused by the pandemic, many of those companies can’t — or simply won’t — pay those cloud bills. Until the economy is back up to speed and their revenue returns, they’re looking for ways to cut expenses and stretch their cash. Some of those companies won’t make it, and will close their doors for good. 

“One thing we can all agree on is, if a business goes away, it’s not going to pay its software bills,” Baker said. 

But it’s not just the companies in danger of going under that are rethinking their software bills — it’s every company, he contends, and it’s the top issue on the software industry’s collective mind. 

The situation inspired Baker to pen an essay which argued that for the first time since the beginning of the cloud revolution, many cloud software companies, also known as software-as-a-service (SaaS) vendors, may not be getting paid by a lot of customers, whether or not they’re under a contract. 

“Software payment terms will change significantly as a result of this recession. I suspect that fewer customers will pay cash up front and that we will see payment terms lengthen significantly,” he argued in his essay. 

IT departments are desperately trying to trim costs because many of them are dealing with shrinking budgets and mandates to conserve cash. Some surveys estimate that IT budgets will decline by 5% this year, SiliconAngle reports. And with purse strings suddenly tighter, customers need ways to cut expenses. For the first time, they are looking at software vendors for that help.

That’s why Baker received an outpouring of response from his tweet and article, he told Business Insider, including the story of how one IT pro, after reading, called his vendors and told Baker that an hour’s worth of phone calls helped him reduce his bills by 30%. 

A first for most cloud software vendors

Historically, SaaS vendors were typically the first to get paid, even in a slowdown, because a company can’t run its business without its software tools. That’s why cloud software companies are traditionally considered to be all but immune to economic downturns.

This has allowed SaaS vendors to have a different and far less flexible business model than infrastructure cloud platforms like Amazon Web Services or Google Cloud.

Gavin Baker

Gavin Baker, CIO and founder Atreides Management

Gavin Baker


Infrastructure cloud companies tend to bill like a utility company — customers receive a monthly bill for how much they actually used their cloud services.

By contrast, software-as-a-service companies tend to bill on a subscription basis, typically charging per user, per month. Smaller organizations often have the flexibility to pay month-to-month, while larger companies sign annual or multi-year contracts with their cloud software vendors.

This subscription billing model makes SaaS a fixed monthly cost, which doesn’t expand or contract with usage. And that’s “less customer-friendly from a cashflow perspective” compared to the Amazon clouds of the world, Baker says.

Baker argues that this economic crisis will be the tipping point, forcing vendors to modify their contracts if they want to keep any customers at all. “Software contracts will be adjusted to reflect lower utilization rates and fewer seats,” he says.

From bravado to warnings

Baker isn’t the only one noticing that SaaS vendors are not being paid in full by all their clients anymore.

Wall Street equity analysts have also been warning their clients that change is coming to the cloud software world.

“Our survey work, channel conversations and macro data all point to a very difficult software spending period over the next several months,” Morgan Stanley analyst Keith Weiss wrote in an April research note on the software industry entitled “Looking through the Valley of Darkness.”

Weiss writes that the talk consuming the software industry these days is “companies asking for pricing concessions, aggressively cutting user bases or not paying for subscriptions outright.” He says the “durability” of the subscription model is being tested.

Pat Walravens at JMP Securities, another long-time software equities analyst, has a similar warning in his research note of April 20th.

While he’s more upbeat that many SaaS companies are in a position of strength, he writes, “depressed billings are likely to persist for 4-5 quarters. We base this on what happened in the last recession, where it took 4-5 quarters for billings growth of the SaaS companies of that era.”

He adds: “IT budgets, once reduced, are not likely to snap right back as enterprises may want to make sure they are in a better spot before loosening the pursestrings.”

In fact, the top story on CIO Magazine last week was “6 tips for renegotiating service contracts” which was chock full of advice for tech executives who are facing cash shortages thanks to the COVID-19 pandemic.

The vendors react

We are already seeing even the most stable SaaS vendors getting their wake-up calls from this changing dynamic. 

At first, the SaaS industry felt safe because of their recurring revenue model. The king of that world, Salesforce founder and CEO Marc Benioff, said in late February after reporting a solid earnings that coronavirus wouldn’t likely have a major impact on Salesforce’s business. He said then that “93% of our revenue is deferred, so that just gives us tremendous visibility into the future.”

But just few days later as the economy began to shut down, its formal quarterly report to the SEC was littered with warnings about how its business could be impacted, including if its customers slashed their IT budgets.

Such examples are all over the SaaS industry. For instance, at its April investor conference, Okta’s CFO, Bill Losch, said a similar thing: “Our highly recurring business model enables a high degree of predictability and allows us to maintain confidence in our revenue outlook for the first quarter and fiscal year 2021, which we are reaffirming. We do, however, expect some near-term billings headwinds as customers adjust to the current business environment. “

As Baker concludes, “At the end of the day, there is no such thing as truly recurring revenue.”

Are you a software sales professional at Salesforce or another SaaS company with insight to share? Contact Julie Bort via email at jbort@businessinsider.com or on encrypted chat app Signal at (970) 430-6112 (no PR inquiries, please). Open DMs on Twitter @Julie188.  

More:

Software
Software As A Service
Cloud Computing
Economic Collapse

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