So you want to start a SaaS company?

A guest memo from a YC founder

Post written by Grant Margerum, Cofounder of Quantic (YC W24)

SaaS has come a long way since its inception in the late 1990s. What began as a revolutionary business model pioneered by companies like Salesforce has grown into a near $250 billion market with over 10,000 startups searching for product-market fit.

However, as the industry has matured, the landscape has become increasingly complex and challenging for new entrants. I have been working in SaaS for my entire career thus far and just completed Y Combinator’s most recent batch, Winter 24. In this memo, I'll explore the good, the bad, and the ugly of starting a SaaS company in today's world.

The Ugly: An Uphill Battle  

Perhaps the biggest challenge facing SaaS startups today is the dominance of incumbents. Companies like Salesforce, Microsoft, and Adobe have established themselves as name brands, with deep pockets and vast customer bases. They are sticky, with broad product portfolios and high switching costs. And they are increasingly adopting bundling strategies, offering suites of products at discounted prices. 

A Bundling Era 

Many believe that B2B SaaS can be broken up into periods of bundling and unbundling. Periods where buyers prefer a single, all-encompassing solution (bundle), and periods where buyers prefer to mix and match solutions (unbundle). While bundling can offer better pricing and more seamless integrations, unbundling can offer more control and best-in-class capabilities. 

The incumbents are not dumb; they have been acquiring/building tangential products for decades. Salesforce is notorious for buying new businesses (Slack, Tableau, Mulesoft, Demandware) with the intention of bundling & cross-selling. 

And now the timing is right. In the last few years, we have seen increased economic uncertainty and reduced software spending. Preparing for the worst, CFOs are implementing zero-based budgeting, reassessing IT spend, and tightening belts where they can. When Salesforce offers an "App Consolidation" with a net 40% cost reduction, many teams are taking it.

High Switching Costs

Moreover, the high switching costs associated with enterprise software create a significant barrier to entry for startups. Businesses have invested heavily in customizing and integrating their SaaS applications, making it costly and time-consuming to switch to a new provider. Even if a startup offers a better solution, the perceived benefits may not outweigh the costs and risks of migration.

Saturated Market

Another challenge is the saturation of mainstream SaaS categories. The most obvious and lucrative opportunities have long been exploited, leaving new entrants to target niche markets with tougher economics and accessibility. 

The Bad: Tech Sales Sure Ain't What It Used to Be

Tech sales is undergoing a massive transformation, and it doesn't bode well for unestablished brands. Buyer trust is at an all-time low, engagement channels are oversaturated, and procurement cycles have gotten more burdensome. Buyers today won't try new tools unless there is an abundance of social proof, something that is very hard for a budding startup.  

A Trust Crisis

Over the past decade, startups have relied on aggressive sales tactics to drive growth, oversaturating prospects with cold calls/emails and overselling product capabilities. On top of that, the sheer volume of startups has completely overwhelmed buyers. This has led to a pessimistic mentality; buyers are increasingly skeptical of vendors and seek out unbiased information at every turn.

A Generational Shift 

Speaking of buyer mentality, millennials look at procurement differently. They have grown up with the internet, having infinite options & information at their disposal. They know they are always being sold to and they sniff out motives. When they do need to buy something, they want the BEST option for them, which means running a fair, thorough, and trusted evaluation. 

The Demise of Cold Outreach

As stated, traditional engagement methods, such as cold calling and emailing, are becoming less effective due to high volume. The rise of AI is only accelerating this problem. Early AI-powered sales tools are targeting the "AI-SDR" & "AI-BDR" use cases. These tools completely automate outbound engagements and will further flood the channels. 

AI Sales Software Market Map

My prediction is cold calling/emailing engagement will effectively converge to zero, meaning demand generation (social proof, influencer, brand marketing, etc) will become the most important lever in growth. Again, areas early-stage startups find it difficult to succeed.

The Procurement Process 

As if the challenges of reaching and engaging buyers weren't enough, startups must also contend with complex, time-consuming procurement processes. Buyers today require extensive security and compliance reviews, detailed ROI analyses, and multi-stakeholder approvals before a purchase. Another area where existing players have the advantage due to their maturity, and resources.

The Good: There is Gold in Them There Hills 

Despite the challenges, there is still hope for SaaS startups. Startups are nimble, they are modern in architecture, and can execute on much more ambitious plans. 

Float Like a Butterfly, Sting Like a Bee

Startups have an advantage: the ability to start fresh and leverage the latest technology available. Unencumbered by technical debt, startups can build systems that are fundamentally more efficient, modern, and scalable than ever before. Modern problems require modern solutions. 

They can also rethink the business model. In today's world, AI can automate more work than ever before. Meaning a business can be built more efficiently than ever, unlocking new markets entirely. 

We are still early in this AI wave, but it seems incumbent technologies really have something to worry about - cheaper, faster, more efficient competitors are coming. 

Rethinking the Model

Speaking of new business models, a bold new strategy has emerged in recent years: the Compound Startup. Evangelized by Parker Conrad and Rippling, compound startups build end-to-end software systems that span multiple tangential software categories. This requires significant upfront investment & development (for Rippling, it was 2+ years of building in stealth with a well-funded team). But if done well, it can unlock more integrated systems with better pricing/margins than the powerful incumbents.

Compound Stattup Playbook - Parker Conrad via SaaStr 

You might be thinking, "well, the incumbents do the same thing too, don't they? They have multiple products and pricing power too." But no, it's not quite the same.  

Let's take Salesforce as an example. While the general public may believe Salesforce's product suite is seamlessly integrated, the reality is it has been cobbled together over 20 years, mostly through tech acquisitions. The ease of use, management, and complexity of these bundles is actually quite horrendous. The costs (for Salesforce) are much higher, adding new features is harder, and things break constantly. Salesforce could and should consider rebuilding the whole thing from scratch, though migrating customers would be horrendous. 

Salesforce Product Map 

Conclusion

Starting a SaaS company in 2024 is not for the faint of heart. The industry is crowded, competitive, and dominated by powerful incumbents. The sales landscape is changing dramatically with customer trust at an all time low. Startups can still succeed if they find the right tack, but the odds are generally against you.

The next generation of software will not look the same as the past. Major technology revolutions breed new business models and new opportunities. In the last 15 years we have seen many businesses come and go - marketplaces, the gig economy, and blockchain to name a few. But the real question is, what business model is unlocked by AI long term? Is it the sale of completed work? The consumption of infrastructure? Undercutting existing SaaS vendors? Or something completely different? 

If you are bold enough to start a company today, think long and hard about the business model you embark on. Ensure it is a business incumbents won’t pursue, that has long term viability & defensibility. In this period of revolution and uncertainty, your business model will determine your fate.

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Thanks for letting me drop in this month! My name is Grant Margerum and fun fact, I actually introduced Paul and George! I am the third amigo :)