Freshworks and the age of efficiency for India's SaaS sector

Sloat made about $10.5 million, before any applicable taxes and charges, selling 500,000 shares, according to an August 3 filing with the Securities Exchange Commission, the US capital markets regulator.

Freshworks’s recent strong performance has garnered it the “strong buy” consensus on the Nasdaq, based on ratings from 16 well-known brokerages, over the last three months, with an average 12-month price target of $22.6.

And analysts who have a more conservative view, such as Brent Thill at Jefferies, who has a “hold” rating on the stock, have also taken note that Freshworks could be at the start of a longer-term steady growth scenario.

“Better go-to-market execution drove a sequential acceleration in large-customer growth,” Thill and his colleagues Luv Sodha and Eylon Liani wrote in a research note to clients on August 2 after Freshworks’s Q2 results came out.

And margins came in ahead as well, showcasing Freshworks’s ability to deliver growth improvements and making its operations more efficient at the same time, they added. Freshworks defines large customers as those who contribute $50,000 or more in annual recurring revenue. This segment grew 30 percent in Q1 (Jan-Mar 2023) and 33 percent in Q2 from the same periods a year earlier.

Freshworks’ evolution has also had the customary exits one sees at corporate businesses as they grow and change. The company recently confirmed that two senior executives—CHRO Suman Gopalan in Chennai and CMO Stacey Epstein in the US—have quit, independently of each other. These are perhaps the two most high-profile departures at Freshworks after last year’s exits of co-founder and CTO Shan Krishnasamy and Chief Revenue Officer Jose Morales.

Also read: Freshworks Q2 earnings beat expectations: 5 takeaways on what's next

The Long View

“We like FRSH's large, underserved TAM of $76 billion in four markets, which represents a long runway for growth,” the Jefferies analysts write, in a section subtitled the long view, in their report. FRSH is Freshworks’s stock symbol on the Nasdaq exchange. TAM is total addressable market.

The bulk of the addressable market (76 percent) comes from SMBs with 1-250 employees, which is the company’s sweet spot. And Freshworks has “multiple levers” to keep growing at 20 percent or more, they write.

These include its ability to add new customers (it has added more than 1,500 customers per quarter), expanding by adding more users at existing customers, selling more products and features within its suite of product lines, international growth, and adding new products within the front-office apps space, such as commerce, integration, and analytics, they write.

Some specific customer behaviour trends, across SaaS vendors, have influenced Freshworks’s performance. Over the past 18-24 months, there’s been a noticeable consolidation of tools and renegotiation among customers, says Sa'ad Kaleem Shaikh, lead–innovation, at the consultancy Zinnov, and co-author of its annual report on India’s SaaS sector.

This trend is reflected in the success of companies like Zluri and Spendflo, specializing in SaaS app management and contract renegotiation. In this context, Freshworks has demonstrated the ability to effectively expand beyond IT service management and CRM (customer resource management) into various other business functions, Shaikh says.

“We’re seeing a lot of organisations renegotiate their contracts with Salesforce and trying to reduce their spend,” says Ray Wang, founder and principal analyst at Constellation. Some of this benefits smaller players like Zoho and Freshworks, he adds.

Customers are repurposing the same product for different areas, contributing to its versatility. The trend towards budget consolidation, with a preference for comprehensive suites, has worked in Freshworks' favour, Shaikh says.

While a total addressable market is one thing, Freshworks is succeeding in expanding its “serviceable” market and market share in a competitive environment, outperforming some of the larger players, he says.

And the company’s strategy to win larger customers can be seen even in India: Freshworks’s customers include PhonePe and Paytm, and it has seen an uptick in business from Mahindra Group and Sonata Software, he says.

 “This strategic move has led to substantial dividends as they continue to operate at the same cost, same spend structure and benefit from increased average contract values,” Shaikh adds.

That said, Freshworks CFO Sloat told analysts that he doesn’t expect net dollar retention to improve during the rest of the year – an important metric in the SaaS sector. In fact, he expects it could be as much as two percentage points lower than the 107 percent the company reported for Q2, due to an anticipated increase in customer churn amid the ongoing global macroeconomic slowdown.

In particular, in the area of customer experience, businesses are prioritizing cost savings and keeping a check on net new agent additions, Shaikh says.

 A year earlier, net dollar retention rate, which is one indicator of a SaaS company’s ability to retain and expand business through the sale of subscriptions to its software, was 115 percent for Freshworks. Thill at Jefferies expects that the current levels reflect a “normalisation,” meaning he doesn’t anticipate further big decreases. “Freshworks recently implemented a marginal 4 percent price adjustment in its IT suite for both new and existing customers,” winning favourable response, Shaikh says.

At SaaS bellwether Salesforce, fiscal fourth-quarter growth was at 17 percent for the three months ended Jan. 31, 2023, compared to 27 percent for the same quarter a year ago. The slowdown is across the sector.

Also read: Larger businesses see value in Zoho for their complex needs: Praval Singh

Year of Efficiency

Some experts argue that the current macro environment will help India’s SaaS sector, because the country’s best software companies have a more extensive playbook now than five years ago, when it comes to pulling together the best of build in India and sell in America.

“2023 is the year of efficient entrepreneurship. We believe that in the current macro-economic climate, there is a significant premium on efficiency,” Anant Vidur Puri, a partner at Bessemer Venture Partners, said in a press release on August 8, when the firm released its latest report on India’s SaaS sector.

“Indian companies – which are fundamentally more efficient than their global counterparts - have a significant advantage, and this will be a major tailwind in their journey towards becoming global leaders,” Puri added.

Bessemer, one of the oldest and biggest VC firms in the world, has an optimistic thesis about India’s software products companies. Its latest report projects the sector to grow from $13 billion in sales in 2022 – and Bessemer includes India’s fintech software providers in its SaaS projections – to $50 billion in 2030.

The efficiency advantage comes from “a culture of effectiveness and a multi-product strategy,” according to Puri.

 At Zoho, the only billion-dollar-revenue software company from India, a multi-product strategy is critical to getting more business from customers, according to Co-founder and CTO Shailesh Kumar Davey, as cited by Bessemer in a slide show on its latest Indian SaaS sector analysis.

The strategy allows Zoho to sell solutions for more business problems within a vertical and then tap adjacent opportunities, allowing for horizontal expansion, Davey says.

At Freshworks, CEO Girish Mathrubootham is pursuing a strategy of infusing generative AI, and artificial intelligence tools in general, across the company’s product portfolio. This could potentially make the products cheaper to use as well, because a particular function might require fewer human staffers, but Mathrubootham is betting customers will buy more of his software and also pay a premium for the AI features.

One signal in that direction is the $29/per agent/month pricing that Freshworks plans to offer for its AI assistant Freddy Copilot. That tariff “represents a 20-35 percent uplift to the Enterprise SKU pricing depending on the product,” the analysts at Jefferies note. In the SaaS world, SKU (stock keeping unit) refers to a purchasable instance of a software product on the cloud.

“AI will change how much software we procure,” Wang at Constellation Research says, adding that licenses are going from the per-user-per-month model to consumption or processing based meters. At Freshworks, Mathrubootham and his top executives told analysts on August 2 that there is an ongoing effort to move more customers to annual contracts.

To be sure, it’s early days to say if Mathrubootham’s AI-led strategy will pay off, the analysts at Jefferies say.

An improvement in the macro sentiment, whenever it comes, can only help. While the market has been pulling back hard in the first half of the year on technology spend, “over the last two weeks we have seen an uptick in customer sentiment,” Peter Bendor-Samuel, CEO of Everest Group, an advisory, said in an email on August 2.

This “looks like it is signaling that the market has bottomed out and we have a modest increase in spending,” he added.

Freshworks’s next comprehensive update is expected on September 7, when the company will host an investor day.