It’s common to hear “SaaS has great margins,” but that’s not true. The margins in SaaS are terrible as the data below show. The table shows the last 73 publicly SaaS IPOs and their marings. Median revenue is $167mm meaning they’re well past the startup stage and margins should benefit from their scale and maturity. Regardless, median operating margin is -21% as 53 of the 73 companies generate operating losses.
While variable costs in SaaS are low (hosting, servers, etc), the fixed costs are high, especially for engineering talent and developers. Given the speed at which technology becomes obsolete, the hiring of engineering/dev talent never really ends as each company has to constantly improve and evolve its product. Additionally, the fixed costs are all human talent, making cost cuts/layoffs painful for morale, culture, and productivity of other personnel.
Investors love SaaS businesses because so long as you’re retaining the customer, the revenue is an annuity and in many cases a source of growth (when customers upgrade more often than they downgrade). For mission critical software, recession resilience tends to be very high (we saw this in 2008 and 2020). If customer acquisition costs can be held within reason and retention is strong, the business will eventually be profitable, and large. By way of example, the average and median operating margins for the profitable companies above is 16% and 14% respectively.
So why does SaaS work? Traditionally SaaS companies collect their bookings up front. In other words, if you sell a 1 year contract for your software, the norm is to collect the cash up front for all 12 months as opposed to collecting 1/12th of the contract each month. Cash flow is therefore much better than operating profit/loss.
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