SaaS models are great due to the recurring revenue and high product margins, but one fixed cost excluded from the margin analysis is ongoing development expense. Building out, maintaining, and upgrading a technology stack requires a constant commitment to developers and engineers, so what is an appropriate level of development or R&D expense for a successful SaaS business? We looked at 73 publicly traded SaaS businesses at the time of IPO and 2 years prior to get a sense for how successful SaaS businesses allocate to R&D. The raw data and observations are below:
R&D spend is 23% of revenue. Leading up to the IPO, SaaS companies spent on median 23% of revenue on R&D. As you can see there is almost no deviation between the financials reported at IPO and 2 years prior. For many of these companies, they were in their Series B or Series C two years prior to IPO, so it’s safe to say that spending a quarter of revenue on R&D is the right level for a SaaS business even at earlier stages. No matter where your SaaS business is in its lifecycle, as one founder put it to me, “managing a large and growing stack for a cloud application is damn tough” so you’re going to be spending materially on the stack no matter how fast you’re growing or how mature you are.
Median spend is $19mm. The median level of revenue at IPO for these SaaS businesses was $96mm so with 23% of revenue going to R&D, that means R&D spend was $19mm on median at the time of IPO. That’s a lot of dev talent.
The range of spend is wide. Hortonworks and Castlight spent more on R&D than they generated in revenue, with R&D/revenue of 110% and 117% respectively. On the other end, Paycom software spent only 2% of revenue on R&D, and that business did $108mm in revenue prior to IPO.
Smaller businesses spend more. Not surprisingly, given the fixed cost nature of R&D, the 10 smallest companies by revenue spent 41% of revenue on R&D while the 10 largest spent 24%, closer to the overall median. Smaller businesses are likely going to have to expend a larger percent of revenue on R&D than their more mature peers. Note that those smaller businesses are faster growing, with average revenue growth of 127% for the 10 smallest on the list versus 47% for the 10 largest.