6 ms·

Gross margins and SaaS companies

161 points by janvdberg 7y ago

OnlineGladiator 7y ago
The article is useful and worth reading for its analysis, but the title makes me curious: are there people that don't think gross margins matter?
- dfcagency 7y ago
  Kinda a click bait title, commenter above said they should add "for SaaS companies"
  - dang 7y ago
    Ok, we've changed the title along those lines.
- elihu 7y ago
  Employees (as long as it isn't negative and their job isn't at risk). Customers. Anyone who doesn't own stock.
  - OnlineGladiator 7y ago
    I think those are examples of people that don't care, not people that don't understand.
- PopeDotNinja 7y ago
  > are there people that don't think gross margins matter? I hope not. If you sell it for less than it costs you to make it, eventually you're gonna have a bad time.
- sqrt17 7y ago
  The pertinent question would be: why would you exclude sales and marketing from the gross margin, but include support costs. Ostensibly you are able to scale back sales and marketing without alienating your existing customers, but realistically optimizing for GM then potentially leads to an organization that oversells (high sales and marketing costs) and underdelivers (low value of what's actually in the product)
deleted 7y ago
[deleted]
cs702 7y ago
It took me a moment to realize that the plot showing current market capitalization multiples versus gross margin for SaaS companies is not showing earnings multiples, nor EBITDA multiples, nor gross margin multiples for that matter. That plot is showing revenue multiples ranging from 10x to 50x. In other words, for every dollar of revenues today, it seems shareholders expect many dollars of actual honest-to-good net profits in the future. Alas, many companies on that plot, in fact, reported net losses over the past 12 months. Let's hope for the sake of these companies, and for the sake of their shareholders, that aggressive spending to fuel growth today ultimately produces future profits that justify those revenue multiples.
- texasbigdata 7y ago
  Agree. While not an expert, I've tried the regression the author has done with CapitalIQ before. There's a third hidden axis which is whatever you want to define size/maturity/runway to be. That potentially explains some of the lift in multiple as well. Similarly his example of investors not paying attention to gross margin seems a bit stretched. While I've never personally participated in a venture deal, pre-public private equity investors scrutinize gross margin a lot, and so does equity research converign listed firms. While conceptually interesting, saying that a 30% EBITDA company that adds 1500 basis points of COGS goes to 15% margins and therefore ROIC falls (or valuation) is relatively boring. But his point about margins persevering post IPO was super interesting. I wonder if for the existing incumbents, after entry of one of these sexy unicorns, gross margin goes down after...
jmpman 7y ago
I’ve argued that Gross Margin Dollars is more important than Gross Margin percent. Most business school grads are focused on the percent because it’s good for the stock price, when it’s the gross margin dollars which pays the light bill. I worked an account where we made 60 points of margin on our base product, which we sold $50M/year. We then sold $100M of an add-on product at 25 points of margin. There were people arguing that we should stop selling the add-on product, until I pointed out that it contributed almost as much margin dollars as our primary, with almost no engineering effort.
- aqme28 7y ago
  Why would you ever axe a product that generated $25M, "no effort" or not?
  - csa 7y ago
    Cynical reply... sloppy MBA thinking. Slightly less cynical reply... it will lead to someone’s promotion by writing something like “doubled gross margin percentage by streamlining product lines to focus on core competencies” in an annual review. Sad to say that this happens all the time.
    - jmpman 7y ago
      I agree. My theory is that it was partially our MBAs and partially the stock analysts MBAs. In our industry, normal margins were 60 points, so when our company was generating 36 points, it looked wrong to the analysts, so it needed to be fixed....
      - formercoder 7y ago
        Nothing in my MBA curriculum has taught me that low margins are bad, just that low margins with high capital intensity is bad. At the same time, absolute numbers are critical and should be analyzed independently from margin.
        7y ago
bch132 7y ago
Gross MARGIN Matters... Gross MARGINS might describe an issue of Hustler in a 1980s frat house...
mbesto 7y ago
Yet another article that loves to talk about how important gross margin in SaaS is, but tip toes around its definition. Out of curiosity - how does this audience calculate what is included in the 'cost' / 'cogs' part of the equation? My take - if the cost is required to maintain the continued ability for the customer to meaningfully use the SaaS application, then it's a COGS. This would mean the following should be typically COGS: - Fully loaded infrastructure costs (Hosting / Web Services / sys admin personnel) - Support personnel (fully loaded personnel costs) Also, GM for professional services and SaaS subscriptions should be maintained separately. If you calculate GM for subscriptions appropriately, you can tell A LOT about profitability or potential for profitability of a SaaS company.
- sudonim 7y ago
  We used to calculate gross margins as hosting & other services we paid for to deliver our service and got 85% gross margins. We recently learned that’s not quite right and added in salaries for our support team and site reliability engineers and it’s 75% gross margin. The definition absolutely matters and it would have been great if they stated an opinion.
- marcus_holmes 7y ago
  I was totally confused in that whole article about what they were talking about when they said Gross Margin. How can professional services be included in Gross Margin? What are they including in COGS? Traditionally, any direct sales costs are included in COGS, but that doesn't seem to be the case here. My take: - Fully loaded infrastructure (as parent) including bandwidth costs - The entire support department (management and office expenses included) - Maintenance coding (if possible to split out from feature coding) I'm assuming all revenue is subscription-based. I agree that any other revenue should be split out and calculated separately. Again, I'd be really tempted to include at least some Sales and Marketing costs in there, too. If you couldn't get the sale without the advert, then technically the cost of the advert is a COGS item. But I get that this is debatable (half of your marketing spend is wasted, etc).
gigatexal 7y ago
In the top most graph which SaaS companies have gross margins > 90%??!
zupa-hu 7y ago
The example is so skewed in favor of the article. Why on earth would you spend fixed % of revenues on sales, marketing, R&D, G&A? They add up to 57% of revenues. So, the conclusion of the example could equally be that a SaaS company has to generate 43% gross margins or there is NO WAY for it to make a profit. Come on.. What about Square that is working with 41% gross margins according to the chart above it?
lifeisstillgood 7y ago
So we o my simple mind Gross Margin is the Expected Annual Revenue from a customer, minus "everything but the price paid for acquisition (ie google ads)" - leaving the per customer acquisition cost as the point the article is making. I mean, if you have high gross margins then you have low per customer acquisition costs - which has been the whole point of most articles on Saas Slow ramp of death for the last decade.

161 points by janvdberg 7y ago

The article is useful and worth reading for its analysis, but the title makes me curious: are there people that don't think gross margins matter?

dfcagency 7y ago
Kinda a click bait title, commenter above said they should add "for SaaS companies"
- dang 7y ago
  Ok, we've changed the title along those lines.
elihu 7y ago
Employees (as long as it isn't negative and their job isn't at risk). Customers. Anyone who doesn't own stock.
- OnlineGladiator 7y ago
  I think those are examples of people that don't care, not people that don't understand.
PopeDotNinja 7y ago
> are there people that don't think gross margins matter? I hope not. If you sell it for less than it costs you to make it, eventually you're gonna have a bad time.
sqrt17 7y ago
The pertinent question would be: why would you exclude sales and marketing from the gross margin, but include support costs. Ostensibly you are able to scale back sales and marketing without alienating your existing customers, but realistically optimizing for GM then potentially leads to an organization that oversells (high sales and marketing costs) and underdelivers (low value of what's actually in the product)

deleted 7y ago

[deleted]

cs702 7y ago

It took me a moment to realize that the plot showing current market capitalization multiples versus gross margin for SaaS companies is not showing earnings multiples, nor EBITDA multiples, nor gross margin multiples for that matter. That plot is showing revenue multiples ranging from 10x to 50x. In other words, for every dollar of revenues today, it seems shareholders expect many dollars of actual honest-to-good net profits in the future. Alas, many companies on that plot, in fact, reported net losses over the past 12 months. Let's hope for the sake of these companies, and for the sake of their shareholders, that aggressive spending to fuel growth today ultimately produces future profits that justify those revenue multiples.

texasbigdata 7y ago
Agree. While not an expert, I've tried the regression the author has done with CapitalIQ before. There's a third hidden axis which is whatever you want to define size/maturity/runway to be. That potentially explains some of the lift in multiple as well. Similarly his example of investors not paying attention to gross margin seems a bit stretched. While I've never personally participated in a venture deal, pre-public private equity investors scrutinize gross margin a lot, and so does equity research converign listed firms. While conceptually interesting, saying that a 30% EBITDA company that adds 1500 basis points of COGS goes to 15% margins and therefore ROIC falls (or valuation) is relatively boring. But his point about margins persevering post IPO was super interesting. I wonder if for the existing incumbents, after entry of one of these sexy unicorns, gross margin goes down after...

jmpman 7y ago

I’ve argued that Gross Margin Dollars is more important than Gross Margin percent. Most business school grads are focused on the percent because it’s good for the stock price, when it’s the gross margin dollars which pays the light bill. I worked an account where we made 60 points of margin on our base product, which we sold $50M/year. We then sold $100M of an add-on product at 25 points of margin. There were people arguing that we should stop selling the add-on product, until I pointed out that it contributed almost as much margin dollars as our primary, with almost no engineering effort.

aqme28 7y ago
Why would you ever axe a product that generated $25M, "no effort" or not?
- csa 7y ago
  Cynical reply... sloppy MBA thinking. Slightly less cynical reply... it will lead to someone’s promotion by writing something like “doubled gross margin percentage by streamlining product lines to focus on core competencies” in an annual review. Sad to say that this happens all the time.
  - jmpman 7y ago
    I agree. My theory is that it was partially our MBAs and partially the stock analysts MBAs. In our industry, normal margins were 60 points, so when our company was generating 36 points, it looked wrong to the analysts, so it needed to be fixed....
    - formercoder 7y ago
      Nothing in my MBA curriculum has taught me that low margins are bad, just that low margins with high capital intensity is bad. At the same time, absolute numbers are critical and should be analyzed independently from margin.
      - 7y ago

bch132 7y ago

Gross MARGIN Matters... Gross MARGINS might describe an issue of Hustler in a 1980s frat house...

mbesto 7y ago

Yet another article that loves to talk about how important gross margin in SaaS is, but tip toes around its definition. Out of curiosity - how does this audience calculate what is included in the 'cost' / 'cogs' part of the equation? My take - if the cost is required to maintain the continued ability for the customer to meaningfully use the SaaS application, then it's a COGS. This would mean the following should be typically COGS: - Fully loaded infrastructure costs (Hosting / Web Services / sys admin personnel) - Support personnel (fully loaded personnel costs) Also, GM for professional services and SaaS subscriptions should be maintained separately. If you calculate GM for subscriptions appropriately, you can tell A LOT about profitability or potential for profitability of a SaaS company.

sudonim 7y ago
We used to calculate gross margins as hosting & other services we paid for to deliver our service and got 85% gross margins. We recently learned that’s not quite right and added in salaries for our support team and site reliability engineers and it’s 75% gross margin. The definition absolutely matters and it would have been great if they stated an opinion.
marcus_holmes 7y ago
I was totally confused in that whole article about what they were talking about when they said Gross Margin. How can professional services be included in Gross Margin? What are they including in COGS? Traditionally, any direct sales costs are included in COGS, but that doesn't seem to be the case here. My take: - Fully loaded infrastructure (as parent) including bandwidth costs - The entire support department (management and office expenses included) - Maintenance coding (if possible to split out from feature coding) I'm assuming all revenue is subscription-based. I agree that any other revenue should be split out and calculated separately. Again, I'd be really tempted to include at least some Sales and Marketing costs in there, too. If you couldn't get the sale without the advert, then technically the cost of the advert is a COGS item. But I get that this is debatable (half of your marketing spend is wasted, etc).

gigatexal 7y ago

In the top most graph which SaaS companies have gross margins > 90%??!

zupa-hu 7y ago

The example is so skewed in favor of the article. Why on earth would you spend fixed % of revenues on sales, marketing, R&D, G&A? They add up to 57% of revenues. So, the conclusion of the example could equally be that a SaaS company has to generate 43% gross margins or there is NO WAY for it to make a profit. Come on.. What about Square that is working with 41% gross margins according to the chart above it?

lifeisstillgood 7y ago

So we o my simple mind Gross Margin is the Expected Annual Revenue from a customer, minus "everything but the price paid for acquisition (ie google ads)" - leaving the per customer acquisition cost as the point the article is making. I mean, if you have high gross margins then you have low per customer acquisition costs - which has been the whole point of most articles on Saas Slow ramp of death for the last decade.