Software market watch: the pivot from correction to recovery mode

For many software founders, the journey from 2020 to date has been characterized by uncertainty. A turbulent economic and geopolitical environment has many founders questioning implications for their own company’s growth prospects.

Leveraging Pulse, our proprietary market intelligence engine monitoring more than 15 million companies daily, we set out to answer founders’ most burning question:

What does the macro environment signal for software industry growth in 2025?

Our analysis utilizes alternative data points such as employee growth rates, software vertical types, business models and funding stage classifications, to unlock powerful multi-dimensional proxies for company and market momentum.

Key takeaways:

• The headcount cuts that dominated headlines in 2023 are easing, with companies returning to neutral ground in H2-24. Overall, software companies demonstrate strong resilience as their headcount “only” contracted to the same relative extent as non-software companies, despite much more significant hiring in prior quarters that would have suggested more drastic action.

• The software industry is on the cusp of a coordinated global recovery, with Europe and Israel tracking the United States’ lead in the return to growth. Companies operating internationally can expect reduced regional risk and similar patterns of recovery, signaling confidence in the sector’s long-term prospects.

• Looking towards the future, we see a tale of two markets, with private companies stabilizing, while public companies remain on a corrective path. Despite the glimmer of hope provided by the “Magnificent 7”, public software giants are responding to heightened pressure for profitability through significant workforce reductions. This creates an opportunity for startups to secure key talent and out-innovate industry stalwarts.

The headcount cuts that dominated headlines in 2023 are easing, with companies returning to neutral ground in H2-24.

To understand market momentum, we assessed employee headcount evolution: a leading indicator of a company’s health and expansion plans, reflecting confidence in future demand.

(1): Last three month headcount change in % multiplied by four.

2023 was a year of size reduction across both software and non-software industries with the annualized last three months headcount growth bottoming out around -5% in 2023.

This marked a stark contrast to the hiring frenzy of 2021 and 2022, largely driven by economic recovery from the initial shock of the pandemic, the stimulating ZIRP (zero interest rate policy) environment, and millions of people feeling emboldened to switch jobs in search of better pay and working conditions. Nowhere was this expansion drive more evident than in the software sector with annualized headcount growth rates peaking above 15% in early 2022.

Incredibly, despite the software industry’s substantially higher growth rate in organizational expansion in 2020–22, it did not have a disproportionately harder correction to go through than the broader market in 2023. On the contrary, since June 2020, software companies have seen a 23% average increase in headcount, nearly double the 12% of non-software companies.

The software industry continues to follow a similar trajectory to the overall market for the past quarters, following a return to modest net growth in H1-24 and remaining around net neutral territory for H2-24 thus far.

(1): Cumulative headcount change rebased to 100.

The return to neutral ground in recent quarters took place amidst a high base rate environment, which only recently started easing in light of slowing inflation and dovish commentary from central bankers as they attempt to secure a “soft landing.”

We anticipate these improving macroeconomic conditions to act as an accelerant to company investments and drive subsequent headcount expansions. While this is likely to impact industries across the board, the software industry is well positioned to disproportionately benefit from digital investments and associated software purchases.

The software industry is on the cusp of a coordinated global recovery, with Europe and Israel tracking the United States’ lead in the return to growth.

Over the past few years, European and Israeli software companies and their US counterparts experienced a similar growth cycle at an aggregate level, although there are minor differences worth noting.

Overall, US companies tended to grow a bit faster and correct slightly harder than their European and Israeli peers. While US headcount is down 3% from the peak and European and Israeli headcount is down 2%, both regions are still 20% higher than they were four years ago, and overall software industry employment in both regions has stabilized. This underscores the global nature of the software company headcount growth cycle we have observed over the past quarters.

(1): Cumulative headcount change rebased to 100.

Looking towards the future, companies operating internationally can expect reduced regional risk and similar patterns of recovery. Companies can remain confident in the long-term prospects of the software sector considering how multiple major regions have not only stabilized but are even recently rebounding in parallel.

Looking towards the future, we see a tale of two markets, with private companies rebounding swiftly, while public companies remain on a corrective path.

Throughout 2023, as interest rates soared to combat inflation, many public software giants implemented significant workforce reductions. Against this backdrop, the rise of the “Magnificent 7” — a group of leading tech companies that showed exceptional stock performance (GOOGL, AMZN, AAPL, META, MSFT, NVDA, and TSLA) — provided a glimmer of hope.

(1): Broad set of 95 listed software companies.

However, beyond the Magnificent 7, the broader index tells a different story. Since the beginning of 2021, public SaaS company performance has significantly lagged the S&P 500. Public capital markets have grown much more demanding around profitability, with less tolerance for open-ended, unprofitable growth stories. Public companies have responded to these signals from the capital markets by shifting their focus towards profitability at the expense of growth, marked by significant headcount reductions.

This is also evidenced by a marked shift towards margin optimization across software companies making up the One Peak SaaS Comps (a broad set of 95 listed software companies). Diving deeper, our analysis demonstrates a strong correlation between workforce reduction and the drive for profitability.

(1): Broad set of 95 listed software companies.

(1): Broad set of 95 listed software companies. (2): Cumulative headcount change rebased to 100.

The above chart shows that headcount growth and NTM Free Cash Flow (FCF) Margin were positively correlated (0.38) in the period from H2–20 to H2–21. This highlights the effect of strong topline growth lifting boats across the board, enabling companies to realize FCF margin improvements while expanding their headcount i.e. cost base in parallel thanks to disproportionate revenue growth.

However, this trend materially reversed from the late 2021 peak levels onwards with a very strong negative correlation (-0.98) between NTM FCF Margin development and headcount growth. In the absence of strong revenue growth, companies prioritizing FCF margins are faced with difficult decisions to realize necessary cost reductions, often resulting in significant headcount cuts.

We anticipate this increased focus on high growth efficiency to persist into 2025 in the absence of any short-term catalysts boosting topline growth. However, should central banks implement faster than anticipated base rate reductions, we may see a pattern reversal here.

While public companies continue to adjust to the new market realities, undergoing corrections and valuation resets, private venture and growth-backed companies have shown stronger signs of recovery with headcount levels having by and large stabilized for the past year.

(1): Cumulative headcount change rebased to 100.

Private companies have stabilized more quickly than public companies and are generally less encumbered by the pressure of immediate returns and nimbler in their operations.

Notably, bootstrapped companies have demonstrated the strongest resilience of all software companies barely making any cuts in 2023/24 but have equally so not experienced nearly as significant headcount growth as venture and growth-backed companies in the 2020–22 period.

The divergence in recovery paths will likely persist. Pressure on pre-IPO and public companies to continue to deepen operational cuts may be to the detriment of future competitiveness and innovation, presenting an opening for disruptive startups to seize opportunities and capture market share.

How will software industry hiring trends evolve?

In conclusion, the software industry has navigated a tumultuous period marked by significant upheaval and adaptation. While the broader economy contends with uncertainty, the software sector demonstrates resilience relative to other industries, emerging from a correction phase and entering a period of recovery. However, the journey is far from over.

The stark contrast between the hiring approaches of private companies versus their public counterparts highlights a bifurcated market. While the former group has stabilized, the latter continues to grapple with pressure to deliver immediate returns.

This dynamic creates fertile soil for disruption. The odds may be stacked against private companies when it comes to very capital intensive innovation, such as developing foundational models and the associated infrastructure/data center requirements, where the Magnificent 7 are leading the charge. However, we see it as a clear sign of the times that scale-ups are going to yet again prove “the innovators’ dilemma” with history repeating itself. Public companies are returning to their core businesses, focusing on defending profits and incrementally improving what they already do well, leaving innovation on the table for the startup and scale-up generation to seize (and make for attractive acquisition targets down the line).

Looking ahead, we see private market companies with strong growth backing to be primed for the years to come. Like their bootstrapped counterparts, they have the benefit of not being pressured by quarterly earnings reports, enabling them to take long-term decisions to invest in growth. Perhaps even more advantageously, they’re also equipped with the right financial backing to aggressively seize opportunities, tap into the most sought-after talent and ultimately reach category leadership.

The future of the software industry will be shaped by those startups and scale-ups who can effectively balance short-term pressures with long-term vision, and who are adept at navigating the complexities of a rapidly evolving market landscape.

- The One Peak Team

By closely monitoring market trends and leveraging data-driven insights, businesses can stay ahead of this dynamic environment. Soon, founders and the broader software industry can access this data themselves through our soon-to-launch insights product. Be the first to know when it’s live by contacting platform@onepeak.tech to learn more.