Among public tech companies, “product-led growth (PLG) companies — those who educate and convert buyers with product rather than sales and marketing (SLG) — operate at about 5% to 10% less profitability than sales-led motions,” venture capitalist Tomasz Tunguz highlighted in a blog post.
This data point may be specific to the moment we are in: First, because public tech companies overall are less profitable than a mere year ago. Second, because not so long ago, PLG companies had higher net income margin than their sales-led peers. But just because this reversal might be temporary doesn’t mean it isn’t worth looking into.
Product-led growth these days is no longer the exception to the rule: Following the footsteps of Atlassian, Zoom and Snowflake, many private startups adopted this model. If it is inherently less profitable, founders will want to know — especially now that investors once again pay attention to a company’s path to profitability and no longer reward growth at all costs.
As usual, things aren’t clear-cut. There are some reasons why PLG companies would be less profitable now that could turn into reasons why they might be more profitable in the near future. To add perspective to what’s going on, we reached out to Kyle Poyar at OpenView Partners.
OpenView is a Boston-based VC firm known for advocating for product-led growth, so it definitely has several horses in the race. But this also means it’s invested in ensuring that PLG is a recipe for success and keen to look into what can make it happen. Here’s what Poyar had to say on the topic:
Do Tomasz Tunguz’ findings seem right to you?
The findings do seem right at a high level. We’ve seen similar trends within OpenView’s 2022 PLG Index (caveat: this was last updated after the Q2 2022 earnings season). While publicly traded PLG companies are still growing faster on average than their sales-led peers, they’re spending more as a percentage of revenue to do so.
Public PLG companies tend to outspend their peers on R&D since their products play a major role in revenue generation. Historically this has been offset by lower spend on sales and marketing and therefore a fundamentally different ratio of R&D to S&M spending.
As the market turned in 2022 and public investors began rewarding profitability rather than growth at all costs, sales and marketing budgets were scrutinized much more closely than R&D spend. PLG companies have been left with elevated R&D spending that may not reflect the incremental return from that spend.
Are investors really paying more for profits than growth today?
What do you think of the hypothesis that this gap might be due to companies adopting PLG when they shouldn’t?
I don’t necessarily agree with this hypothesis. Most of the public companies on our PLG index have been adopting PLG for years, if not from the beginning, and it’s the traditional sales-led companies who’ve been sprinting to adopt PLG (ex: ServiceNow, Salesforce acquiring Slack, Adobe acquiring Figma). PLG is a major part of what propelled these companies to this point. Furthermore, PLG companies dominate the latest Cloud 100, which reflects the next batch of companies that are poised to go public in 2023 and beyond.
In my mind, there are two hypotheses at play.
First is that PLG companies have been rapidly increasing their sales and marketing spending, layering expensive marketing and sales investments on top of their PLG motions in order to accelerate revenue growth. Many of these investments haven’t had enough time to pay off or reach the efficiency seen in a mature sales-led business. These investments made financial sense when the market prioritized growth at all costs and when PLG companies had more efficient business models than their peers. Now there will be greater scrutiny into the incremental return of these investments in accelerating PLG companies’ natural rate of growth.
Second is that PLG companies spend substantially more than their peers on R&D and they haven’t closely scrutinized those costs in the current market environment. Measuring the efficiency of R&D spend is notoriously tricky. It’s easy to tell whether a quota-carrying sales rep is productive — just look at their performance — but it’s far harder to say the same for an incremental software engineer. R&D investments also tend to be investments in the future performance of a company: future products to monetize, future market segments to target, future competitive advantages. Some companies may be willing to fund these investments today with the expectation that they’ll pay off when the market improves.
What about the hypothesis that this is just a case of midterm versus long term?
I agree with the hypothesis that this is probably more of a short-term or midterm difference rather than something structural or long term.
The most profitable software companies with the best Rule of 40 are still PLG companies, and that’s because PLG companies are less reliant on headcount to grow. Products — rather than just people — are responsible for acquiring, converting and expanding customers.
I suspect that PLG companies have experienced the downturn more immediately than their sales-led peers. That’s because sales-led companies have longer deal cycles and a greater share of revenue locked into long-term committed contracts with enterprise customers. Recall that in Salesforce’s Q2 FY2023 earnings call, which happened in August of 2022, they specifically mentioned that they “saw slowing in our create and close, Slack self-serve and SMB businesses, which tend to be leading macro indicators.”
The bright side: When the buying environment does bounce back, I suspect we’ll see the bounce happen first in PLG companies, too.
More generally, what can PLG companies do to improve their profitability?
- Optimize pricing and packaging. Many SaaS companies — and PLG companies in particular — haven’t aligned the prices they charge with the value they deliver. A successful price increase is one of the most powerful ways to increase profitability and doesn’t require cutting spend or laying off team members. While that can feel counterintuitive in the current macro environment, that doesn’t mean it isn’t effective. We’ve been conditioned to price increases in our personal lives; why shouldn’t that apply to our PLG products as well? Two recent examples are Notion, which effectively doubled self-service pricing, and DigitalOcean, which shared that a July 1 price increase led to $13 million in incremental revenue in Q3.
- Disentangle the incremental return generated by paid sales and marketing investments versus the core PLG engine. For example, do you need a sales rep involved in closing SMB customers or would those customers still buy via self-service, therefore saving you money? Momentive recently shared that in this current environment they’re moving away from outbound and SMB sales for landing small deals and instead are routing those to the self-service channel.
- Scrutinize R&D performance and the efficiency of R&D investments.
What would you tell to PLG/R&D skeptics?
PLG isn’t a fad, and it isn’t going anywhere. What drew OpenView to PLG in the first place was that the best PLG companies were able to grow faster than their traditional sales-led peers and were able to grow more profitably (because growth wasn’t as reliant on hiring armies of people). That thesis still holds true and is even more compelling than it was before.
But we’re in the early innings of PLG, and very few PLG companies have experienced a tech downturn of this magnitude. The PLG playbook is still being written — and what’s happening today will be an important chapter in that playbook.
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