The global software industry has experienced significant volatility over recent years, shifting from rapid growth to a pronounced focus on margins. Following a decade of market outperformance, the sector saw valuations peak in 2021 as digital transformation accelerated. However, the subsequent slowdown in IT spending and rising interest rates have led to decreased growth efficiency and substantial valuation compression.
Between 2021 and 2023, median growth efficiency fell by over 50%, and software companies, facing increased cash flow pressures, have increasingly prioritized margin expansion overgrowth. This shift has led to a notable overcorrection, with high-performing companies missing potential value-creation opportunities by focusing excessively on cost reduction.
McKinsey's analysis of 116 North American public software companies reveals that while prioritizing margins was initially justified to preserve valuations, it resulted in a significant loss of potential enterprise value. The report suggests that had companies maintained their 2021 margin levels and reinvested savings into growth, they could have realized an additional $500 billion in value. Moving forward, the report advocates for a balanced approach of "efficient growth," which seeks to optimize both growth and margins to enhance long-term value amid ongoing market challenges.
