Software, pricing, and the inflation-deflation conundrum
Can softwares' deflationary power trample tomatoes' inflationary tendencies?
Rising prices have become a fact of life. We feel the pinch every day, whether it’s at the petrol station, grocery store, or our favourite restaurant. On the bright side, some are enjoying new-found limelight — tomatoes and onions, to start with. They seem to be taking turns at frontpage headlines.
The villain here is clearly the interest rate, some would say the Fed specifically. It’s a dangerous situation. The surge in interest rates around the world has led to a spate of bank failures and blowups like the UK’s pension fund crisis. There’s serious risk tied to everything we thought the safest — whether it’s bonds or banks. As the saying goes, “Fed hikes until it breaks”.
Well, the real question that concerns me is, “Will software break under the rate hike pressure?”
Is tech in crisis?
Last year alone, 84 percent of publicly listed software companies saw their valuations drop, and more than a quarter experienced a decline of more than 50 percent as per Mckinsey’s analysis of S&P global data. This is true of India as well. Our tech stocks ended 2022 with their worst phase since the 2008 global financial crisis.
The message from the market is clear: top-line growth alone is not enough. There’s a clear shift in investor sentiments to bottom-line growth. Software companies will have to grow both revenue and margin simultaneously to be able to thrive. While this may be the story of public companies, the one of private companies is not too different.
Young tech firms that have grown used to free-flowing money are realising the hard way that there ain’t no such thing as free lunch. In this rate hike regime, private firms are left with just two options; either accept a lower valuation or face the daunting prospect of having to show they can turn a profit.
Given these conditions, pricing has made its way to the top of the agenda of leaders of software companies. Why? Because pricing is viewed as a critical lever to grow efficiently and capture value. This explains why software and services prices have been picking up, thereby raising new challenges for CIOs and IT buyers.
Is SaaS pricing causing IT overruns?
Over the past two years, there’s been about 18-20% rise in enterprise client (laptops and PCs) pricing, approximately 10-15% rise in server and storage pricing, and 5-7% increase in enterprise software pricing, including IaaS cloud prices (Azure, AWS, Google), according to International Data Corporation.
Earlier this year, Microsoft announced a hike in prices of commercial software and services in India by up to 11%, and blamed currency fluctuations for the same. Oracle raised its prices by 8% in the US, IBM has announced a 24% price increase in certain currencies, and SAP is increasing its support fees by 3.3%.
Overall, 38% of software providers have raised their prices in the last six months alone, and a survey from SaaStr found that 54% of them are planning on doing so in 2023.
Having said that, not all SaaS companies make it obvious. Some have been covert in their fight against inflation. They introduce pricing models that involve feature unbundling and rebundling.
What’s unbundling? Basically, features which were part of a bundle are made line items and charged a fixed price. Combined, these features end up costing the user more than the previous ‘bundled’ plan did, despite being the same offering as before. Then there’s the opposite of it, what’s called rebundling — a move that results in users paying for more functionality than they often require.
Overt or covert, one thing is for sure, SaaS price hikes are not unjustified, because inflation is real. The degree of hike may be questionable in some cases, but the general hike is only natural. What’s concerning though is that this general rise in prices has brought one question to the front and centre — whether to invest in technology at a time of high inflation?
Absolutely, yes. I say this for obvious reasons. However, beyond selfish gains, I have a sound rationale for why you should invest in SaaS, especially now.
One may have to rationalise their SaaS purchases which is true for all times — inflation or not. I had written about this in one of my earlier pieces — the need to map each function to mission criticality or expendability as per individual organisation’s priorities. Discussing this would be putting the cart before the horse. Let’s go back to why you should invest in SaaS, in the first place, during inflationary periods.
SaaS — a powerful deflationary force
Early last year, Satya Nadella had talked about how digital technology is a powerful deflationary force in an inflationary economy. There’s no complex profundity here that requires unpacking. The enormous increases in productivity that technology brings is beyond doubt. Here are a few.
Dematerialisation
Software has enabled the transition from physical products and services to digital ones, reducing production costs considerably and, in turn, lowering prices for consumers.
Disintermediation
Software has revolutionised several sectors, including finance, travel, and retail by cutting out the middle men, thereby, lowering the overall cost of a process or transaction.
Productivity gains
Software has been a game changer when it comes to freeing up resources and enhancing productivity. It equips enterprises to reserve human capital for higher-value functions.
Scalability
Software design has espoused scalability. An analysis of U.S. venture-capital data showed that two-thirds of value creation is achieved through scale-ups, something software has successfully enabled.
Cost efficiency
From automating manual processes to streamlining workflows, software has been a driving force behind cost efficiency of businesses.
Now, the underlying assumption here is that these cost benefits translate to lower prices for consumers. Hence, software is a deflationary force. Now it’s not always true that cost benefits get transferred to the final consumer, but it will eventually have to.
Because, in a competitive market, businesses are constantly looking for an edge over their rivals. That’s the beauty of free markets. Circling back to where we started, in the long run, software’s deflationary power will trample, if not tomatoes’, at least tomato ketchups’ inflationary tendencies or so I think. What do you say?