March 2022 Japan SaaS Roundup

Welcome to the first edition of ALL STAR SAAS FUND Monthly Roundup - a monthly series  where we invite various team members to share their observations around Japan SaaS! 

In this month’s roundup, Hiro, Masa and Tatsuya discuss the current market environment and key considerations when evaluating Japan SaaS companies. 

Here’s a couple of interesting highlights from their discussion, which you can also watch here (in Japanese). 

The larger the scale of a company, the more likely it is to be a market leader.

As a fast-growing SaaS market, Japan has no shortage of successful companies that have made it big in their own verticals. But when it comes to market valuation, investors are often concerned with who are the true market leaders that have the potential to eventually shape the industry.

Hiro shares that the most straightforward method is by comparing a company’s size against its competitors. 

Very often, a company’s growth rate is highly correlated with its Price-to-Sales ratio (PSR). For instance, if you look at market capitalization of Japanese SaaS companies, those with Annual Recurring Revenue (ARR) of over $100 million and 25% annual growth rate have a median PSR of 13.7. However, the median PSR for all Japanese SaaS companies is just 5.9, so there is an obvious difference between the high-growth companies and everyone else.

Large companies which can maintain annual growth rates of 25% and above are also likely to be addressing a larger Total Addressable Market (TAM), compared to its competitors. As a result, these companies with large sales figures and huge growth potential tend to be more attractive to investors, and can be viewed as market leaders. 

Before going public, companies should set benchmarks of either ARR $100 million or 25% annual growth rates - and hit at least one of these targets. 

Going public is never an easy decision to make. While it is entirely up to the company to decide when it is best to go public, Hiro shares two benchmarks that could be useful:  achieving ARR $100 million or 25% annual growth rate. 

This is because SaaS services tend to gain more leverage as they grow bigger in size. Compare an ARR $100 million company with $30 million to spend on sales and marketing against an ARR $10 million company with only $3 million to spend; as you can imagine, the ARR $100 million company is able to enjoy far greater economies of scale in sales, marketing, R&D etc. versus its smaller competitor. 

Interestingly, Masa observes that while a growth rate of above 25% and ARR $100 million is the bare minimum for companies to go public in the US, it is not yet the norm for Japanese SaaS companies.

Startup founders should aim to capture as much market share as possible, as opposed to chasing after short term profitability and early IPOs. 

Another observation shared by Masa is that there are plenty of individual investors within the Japanese market, and these investors tend to evaluate companies by considering whether they can reap profits in the short run. This leads to a fundamental question of which is more important for startups: profits or growth?

For companies around the ARR $100 million and 25% growth rate benchmark, investors are likely to value long term growth potential instead of short term returns. 

But for startups with a smaller market capitalization, individual investors tend to form a larger part of the investor bench and are naturally more interested in short term profitability. This  would then affect the timing which these companies choose to IPO. 

From Hiro’s point of view, this is a path which startup founders should avoid. Even if it seems like investors favour profitable companies that IPO with a smaller market capitalization, startup founders should still aim to capture an overwhelming share of the market and be in a position to leverage large economies of scale. 

Therefore, it is also essential for companies to work with investors and shareholders that believe in the same strategy. 

Even though Japanese SaaS companies currently display slower growth rates, there is plenty of potential for them to grow in the long run.

While there are Japanese SaaS companies experiencing accelerated growth now, such as B2B cloud service Money Forward which achieved over ARR $120 million and 38% annual growth and enterprise cloud Rakus with a 5 year plan to reach ARR $448 million by March 2026 (as shown below), many other SaaS startups and smaller companies continue to display low growth rates.

Source: Money Forward Inc. Financial Results Briefing for the Fiscal Year ended November 2021

Source: RAKUS Co. Ltd 2022年3月期決算説明資料

 Hiro shares some possible reasons why:

The timing that companies go public

• Based on recent figures, US companies tend to IPO at around ARR $300 to $400 million, which also implies that they have sufficient funds to invest in growing the company, building up their products etc. This will give them a huge advantage in keeping growth numbers high. 

On the other hand, Japanese companies could IPO at around ARR $40 million, which means that they have less resources to invest in their products and sales strategy etc. 

Differences in competitive environment

• The Japanese market is also comparatively less competitive than the US market. For instance, a company could face up to 10 competitors in the US but a similar company is likely to only have 1 to 2 competitors in Japan. As a result, there is a sense of urgency to constantly stay ahead of the competition in the US - and this urgency is not yet present in Japan.

However, it is important to also keep in mind the long term potential of these companies and dive deeper into how investors can help them maximise their growth in the long run. 

Startups should focus on finding the Product Market Fit before moving into product diversification. 

When thinking about long term growth, many startups often deliberate over whether they should develop single or multiple products. While product diversification is definitely something to consider as part of a company’s blueprint, it would require plenty of work and coordination across multiple business units and is not a strategy suited for every company. 

At an early stage, Hiro notes that launching multiple products could lead to lack of focus. Companies could find themselves drowning in a barrage of multiple customer voices and lose sight of what are the key product features to build. This would lead to further complexities in the product development process and cause the company to lose its chance to build strong foundations.

What is more important is for each company to find the correct Product Market Fit and create a successful Go-to-Market strategy.

When should companies start thinking about making new products and services?

Masa, Partner