The Legible Lever: Why AI Might Hit SaaS Before It Creates Growth
Et ceteris paribus, growth is undoubtedly harder to obtain than margin improvements.
Improving margins is often painful, but the levers are known. You can tell a company to reduce SaaS spend by 20%, and there is a reasonably clear path to execution, especially now with AI. You can tell a company to reduce personnel expenses by 20%, and it can just freeze new hires, letting natural attrition do the work. To use the cringe term du jour, improving margins is a legible challenge for management teams.
Conversely, you cannot tell a company to “grow more” and expect the same probability distribution of success. New products may fail. New customer segments may not convert. New geographies may disappoint. New channels may look promising and then stop scaling. Even when growth initiatives work, the feedback loops are slower and attribution is messier.
By the way, growth is also more valuable. Bessemer Venture Partners’ Rule of X says something that most software investors intuitively understand: growth is worth (much) more than profitability. For late-stage cloud (~SaaS) companies, Bessemer argues that revenue growth should be weighted roughly 2 to 3x more than free cash flow margin when assessing valuation.
That makes sense. Growth is open-ended. You can grow 20% per year for a looooong time. A company can keep expanding into new customers, new products, new use cases, new geographies, new channels, and new price points for a very long time. Some companies, like the hyper scalers, have even shown that growth begets more growth, a phenomenon W. Brian Arthur, from the Santa Fé Institute, dubbed “increasing returns”.
Profitability improvement, on the other hand, is more bounded. You just can’t reduce expenses and costs by 20% per year for a very long time. You can freeze headcount, even make a small rif. Cut vendors. Renegotiate contracts. Reduce waste. But eventually you run into a floor. Accounting physics says expenses cannot go below zero. And well before that, cost-cutting starts damaging the business - cuts cut muscle and reach the bones, harming future prospects for the company.
This is the important asymmetry: Growth is more valuable, but cost-cutting is more legible.
AI makes this legibility asymmetry much more dangerous for SaaS. Replacing a SaaS product with an AI-generated copy is a legible management project. You know the vendor-to-be-replaced. You know the contract value. You know the workflows. You know the users, and they’re much more forgiving than customers. You know which features need to be replaced. You know what “good enough” looks like. You know what the savings will be if the project works.
Aside from legibility, there’s also the incentives picture. Public company management teams are mostly compensated for short term results, even when they get stock, because stocks move up, mostly, when a company beats the Street’s earnings/cash flow estimates. The perfect story is the “beat and raise” story. Management teams are incentivized to post guidance they can beat, beat it, and raise guidance just enough to beat it again next quarter.
Given the legibility issue, the sure-fire way to get more earnings/cash flow next quarter is to cut costs and expenses. This is why the “SaaS apocalypse” may be less about software suddenly becoming useless and more about software spending becoming a highly valued target for cutting, for lack of better options (and/or lack of management competence).
Some SaaS products will be extremely hard to replace, of course. ERPs, regulated workflows, highly integrated platforms (ERPs?), mission-critical infrastructure, and products with strong network effects will be more protected. But a lot of software is not that. A lot of software is workflow glue, reporting, internal tooling, lightweight automation, dashboards, approval flows, data movement, content generation, support operations, and administrative process.
Growth is the more valuable, high risk, hard to pull lever. Cost-cutting is the less valuable, lower risk, legible lever. And when executive teams are under pressure to deliver, the legible lever often wins.