For nearly a decade, the Rule of 40 shaped how investors evaluated software-as-a-service (SaaS) firms. The formula — that a company’s revenue growth rate plus operating margin should equal or exceed 40% — seemed to balance growth and profitability. A firm growing at 35% with a 5% operating margin, for instance, would meet the benchmark. But that simple arithmetic no longer captures the market’s logic.
An analysis of 12 major SaaS companies between 2016 and 2025 shows that the correlation between revenue growth and market-capitalisation growth has collapsed from 0.57 during 2016–21 to just 0.17 since 2022 — a 70% erosion in predictive power. Meanwhile, revenue per employee (RPE) has held up far better, with its correlation to market-cap growth declining only marginally from 0.55 to 0.51.
This isn’t a statistical quirk; it is evidence of a structural shift. The market’s focus has moved from celebrating top-line velocity to rewarding firms that can grow efficiently. Artificial intelligence, higher capital costs, and tighter investor scrutiny have forced a reckoning: in today’s environment, operational efficiency trumps growth for its own sake.
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The great decoupling
The years between 2016 and 2021 were an age of cheap money and exuberant optimism. In that low-interest-rate world, investors chased growth and rewarded speed. Companies such as Salesforce, ServiceNow, and Zoom that showed faster revenue expansion were automatically assigned higher market valuations. “Growth at any cost” was not merely tolerated — it was celebrated.
That equation broke down after 2022. With the Federal Reserve raising rates at the fastest pace in decades, capital became expensive and future earnings were discounted more heavily. Investors began to prioritise profitability and resilience. The correlation between revenue growth and market performance evaporated, signalling the end of an era when growth alone could guarantee valuation gains. The market began to ask harder questions about how that growth was achieved and whether it could be sustained.
Rise of operational leverage
In this new environment, revenue per employee has become the more telling measure of strength. Between 2016–21 and 2022–25, the median RPE growth across leading SaaS firms almost doubled — from 4.1% to 8% — even as median revenue growth fell from 28% to 14.5%. Companies were generating more output per employee despite slowing top-line expansion.
This shift reflects a deeper re-engineering of business models. Firms are not simply cutting costs; they are redesigning processes to do more with less. The result is higher productivity per head, driven by a new generation of tools powered by artificial intelligence and automation. The ChatGPT boom of 2022 marked an inflection point in this transformation. From sales to customer support, automation now defines the new competitive advantage in enterprise software.
AI productivity revolution
The rise of RPE as a key valuation metric mirrors the growing role of AI in reshaping business operations. By embedding generative models and predictive analytics into customer acquisition, onboarding, and support, SaaS firms are scaling output without corresponding increases in headcount.
Tech giants have led this shift. Google reports that roughly 30% of its code is now AI-generated, improving overall engineering velocity by 10%. Amazon’s CEO, Andy Jassy, has said that generative AI will allow the company “to grow ten-fold with fewer employees.” Salesforce’s Marc Benioff recently disclosed that his company reduced its support staff from 9,000 to about 5,000 after automating large parts of the function.
The impact is even starker among AI-native startups. Firms such as Midjourney, Cursor, Mercor, and ElevenLabs have achieved RPE levels between $2 million and $5 million, compared with the traditional SaaS average of about $550,000. Across a sample of major firms, the median absolute increase in RPE was about 50% during 2021–25, compared with just 15% in the earlier five years.
Investors have taken note. The market now rewards companies that display operational leverage — the ability to scale output without scaling input. The old premium for pure revenue acceleration has given way to a premium for efficiency, productivity, and adaptability.
Why the rule of 40 fails
The Rule of 40 was never meant to endure in a world of rising interest rates and AI-driven transformation. Its flaw lies in its equal treatment of growth and profitability, when in reality, growth has historically influenced valuation multiples twice as much as margins. By ignoring that imbalance, the rule misrepresents how value is created.
Equally important, it fails to distinguish the quality of growth. Two companies may both post 30% growth and 10% margins, scoring a neat 40. Yet if one achieves that through AI-enabled efficiency and the other through unsustainable customer acquisition spending, their investment profiles are fundamentally different.
The rule also omits key indicators of SaaS health. Metrics such as net revenue retention (NRR), lifetime value-to-customer-acquisition-cost (LTV/CAC) ratios, and capital efficiency tell a more accurate story. A company with 130% NRR—meaning existing customers spend more each year—has a dramatically better outlook than one with 90%, even if both meet the Rule of 40 threshold.
The verdict is clear: the simplicity that once made the rule appealing now renders it obsolete.
A smarter framework for SaaS valuation
To replace the Rule of 40, investors and executives need a framework that integrates growth, efficiency, and quality into one coherent assessment. Such a model would weight growth more heavily than margins, incorporate RPE growth, and add indicators of customer stickiness and capital discipline.
A company growing 25%, with 8% operating margins and 15% RPE growth, should be valued higher than a peer focused solely on top-line expansion. Net revenue retention above 120% demonstrates strong product-market fit; above 130%, it suggests that a firm can grow 30% annually even without acquiring new customers.
Healthy unit economics matter just as much. Firms with LTV/CAC ratios above 3:1 and customer acquisition payback periods under 18 months have self-sustaining growth engines. The most efficient SaaS firms achieve payback in 16 months or less, compared with 24 months or more for laggards.
Similarly, capital efficiency is a critical marker. Companies with burn multiples below 1.5x — meaning they burn less than $1.50 for every $1 of new annual recurring revenue — demonstrate sustainable growth models that can thrive without constant infusions of capital.
Finally, metrics that track AI-enabled productivity — from RPE growth to automated process adoption — are becoming indispensable for assessing management competence and strategic foresight.
Strategic implications for investors
For corporate leaders, the message is unequivocal: the era of chasing scale is over. CEOs and operating executives must prioritise AI and automation that strengthen operational leverage. They need to monitor efficiency metrics as rigorously as revenue, build internal dashboards that track both, and prepare for investor scrutiny that now revolves around unit economics, sustainability, and scalability.
Investors, too, must adapt their models. Valuation frameworks should give greater weight to operational efficiency, focusing on companies that demonstrate rising RPE and disciplined headcount growth. The ability of management teams to scale intelligently with AI will become a defining criterion for investment decisions.
Board members, meanwhile, have a governance role to play. Compensation and incentive structures should reward efficiency gains as much as revenue expansion. Boards should insist on regular reporting of productivity and automation metrics and challenge management teams that chase unprofitable growth.
The Rule of 40 served the industry well during its exuberant growth phase, but clinging to it today risks misjudging the new reality. Companies that recognise the value of operational efficiency and adopt AI-enabled productivity models will continue to command valuation premiums. Those that remain fixated on revenue alone will struggle to justify their worth.
The market’s verdict is already visible: firms that accelerated RPE growth after 2022 have sustained or expanded their valuation multiples, while those relying on revenue momentum have faltered. The transformation is both structural and enduring.
As artificial intelligence continues to reshape business operations, the gap between efficient and inefficient operators will only widen. The winners will be those who treat AI not as a cost-saving gimmick but as a core driver of productivity and leverage. For investors, the task will be to identify these companies early — and to abandon outdated heuristics that no longer reflect reality.
The Rule of 40 is dead. The new era belongs to intelligent efficiency — where technology, not headcount, determines scale, and where value flows to those who can grow lean, fast, and sustainably.
Rupesh Thakkar is a technology executive and MBA graduate of Michigan Ross School of Business. He works at Zoom and has extensive experience in SaaS operations and financial analysis. The views expressed are personal and do not reflect those of the authors’ current or past employers.