Is the golden era of SaaS in China truly over?

Lately, a prevailing pessimism concerning the future prospects of SaaS, particularly enterprise-facing ones, has been gaining traction within the country’s technology community.

In an extensively circulated article titled 'China Doesn't Need SaaS,' the author criticizes that Chinese customers are difficult to serve because they are price-conscious and they always require a lot of customization, even if they are paying a floor price.

The piece further asserts, “The industry as a whole is unattractive for investment, as most of the players grapple with profitability even though they've been around for years.”

As the economy displays signs of faltering and investors grow wary, SaaS startups in China find themselves navigating turbulent waters.

The statistics paint a vivid picture. According to data sourced from business data provider IT Juzi, during the period from January to July, the SaaS industry sealed 50 financing deals, totaling 4.352 billion yuan ($597.65 million). This showcases a sharp decline from 120 deals at 14.237 billion yuan in the same period of 2022 and an even steeper drop from 153 deals equating to 25.82 billion yuan in 2021.

While the heyday of the SaaS industry appears to be behind us, is it not overly pessimistic to pronounce the complete demise of SaaS in China?

What is a SaaS company, and how does it make money?

SaaS companies are organizations that use software to deliver cloud-based services to their clientele.

For instance, Salesforce is recognized for its CRM solutions, Shopify for its e-commerce website construction services, DocuSign for its e-signature provisions, and Grammarly for its copy-editing tools, among other examples. Typically, these companies generate revenue through recurring fees, such as monthly or annual subscription charges.

In most cases, the services or products they furnish adhere to standardized formats. As they scale and acquire a larger customer base, the advantages of economies of scale come into effect, allowing them to spread out their research and development (R&D) costs. Consequently, by attracting and retaining more customers who utilize these standardized offerings, they can offset substantial R&D and operating expenses, thereby achieving profitability.

SaaS companies are often likened to “Apple” in the eyes of investors due to their rapid growth prospects, predictable revenue generation, and customers' growing digital transformation demands.

Why do SaaS companies struggle to turn a profit in China?

To understand the profitability challenges faced by SaaS companies in China, we were in dialogue with sales representatives and founders from several enterprise-facing SaaS firms. Here are the key obstacles they highlighted:

**1. High Customization Demand: **Standardized services often fall short of meeting the unique needs of customers. This is largely due to companies undergoing rapid transformations over the years, resulting in ever-evolving demands and workflows. Consequently, employing a one-size-fits-all approach becomes impractical. However, the trade-off is that customizing these services not only escalates costs but also makes them challenging to replicate for other clients.

2. Sales-Driven Over Product-Centric Environment: In China, constructing an exceptional product that effectively addresses industry-specific challenges isn't solely sufficient. Instead, companies must prioritize assertive sales and marketing strategies over product development.

Many organizations exhibit reluctance to transition from their current, seemingly cost-effective practices to more efficient and sustainable solutions. This necessitates proactive outreach from sales teams to effectively convey the value of their offerings.

**3. High Churn Rates: **While the median churn rate for SaaS companies in the US lingers around 7%, major Chinese SaaS firms experience rates that surpass 30%, as highlighted by Wu Haiyan, Managing Partner at China Growth Capital.

The churn rate serves as a metric quantifying the proportion of customers who terminate their subscriptions within a specified timeframe. A soaring churn rate can signify that the SaaS company is incurring losses on customer acquisition expenditures while also complicating the task of predicting forthcoming revenue.

Furthermore, alongside a general inclination towards lower willingness to pay, the high churn rate could be attributed to the relatively shorter lifespan of small and medium-sized enterprises (SMEs) in the nation, averaging 3.7 years, in contrast to the US average of 5.8 years.

**4. Price Wars: **In the past decade, the SaaS sector has attracted significant investor interest, leading to companies being flush with funds. This has spurred aggressive pricing strategies to outdo competitors and capture market share, making profitability elusive.

5. Talent Shortage in Sales and Customer Relations: Senior sales professionals have the experience and knowledge to understand the needs of customers and tailor the sales pitch accordingly, while skilled customer relations talents are key to retaining existing customers. But the SaaS landscape in China is still nascent, leading to a scarcity of seasoned professionals in sales and customer relations. In the meantime, China's tech industry is often criticized for its demanding work culture, which results in a shorter average tenure for employees, exacerbating the talent shortage.

Given that organizations with fewer employees have lower demand for SaaS and a weaker willingness to pay, while those with more employees typically prefer to deploy on-premise or use in-house developed solutions, sales representatives expressed a preference for targeting organizations with 500 to 10,000 employees. Unfortunately, this preference hinders the scalability of SaaS companies, as these types of organizations are limited in China.

**The journey to profitability in the SaaS industry is often a marathon, not a sprint. **

It took Salesforce 17 years to reach profitability, Dropbox 14 years to achieve financial equilibrium, and DocuSign, despite being in business for two decades, only started generating a tiny profit of $539,000 for the fiscal quarter ended April 30.

This underscores a universal truth: patience is paramount in the software sector, and for markets like China, the potential of SaaS remains vast and untapped.

Some experts offer advice on how to scale and generate enough revenue to keep a business afloat.

Dai Ke, a senior consultant in the SaaS industry, believes that SaaS companies should add more customer success roles. These roles can help drive customer loyalty, reduce churn, and ultimately contribute to long-term business growth.

SaaS companies should also build a deeper moat to retain customers and prevent them from being poached by competitors. This involves evolving from merely "software as a service" to "platform as a service" (PaaS), enabling customers to design, test, and launch applications within the platform's ecosystem.

Take Salesforce, for instance. It provides a wide range of tools and services that can be used to develop custom applications, as well as a marketplace where developers can find and purchase pre-built applications.

Another strategy for staying afloat is dual-market targeting. By catering to both domestic and international markets, companies can secure a consistent revenue stream from global clients while simultaneously expanding their domestic footprint.

Compared to developed markets, China's SaaS companies seem to be sprouting in a "less fertile" environment.

However, as cloud computing gains traction and there's an intensified emphasis on harnessing technology for enhanced efficiency, flexibility, and scalability, the landscape will shift. The upward trend in labor costs will further accelerate SaaS adoption and may even eventually lead to profitability.