The Pull Factor in SaaS

My good friend Charles Zedlewski put together a great analysis of SG&A costs at the four major SaaS business application companies that are either public or have filed to go public.

"The true factor driving SG&A for these SaaS companies is growth, not scale. This is logically consistent as the economics of most any subscription business is based on the cost to acquire a customer versus the future returns of that customer relationship. I took the financials for all four companies and lined them up not based on year but based on when they are at a comparable size (comparable stage in their evolution)."

Charles is an excellent analyst (perhaps he missed his calling as the next Chuck Phillips!) with an ability to quickly get to the essence of the issue at hand. More significantly, he has the rare ability to abstract observations into "what it means" statements that can be applied across an entire industry segment.

The points that Charles makes about SG&A being a pull factor for growth in these companies is irrefutable. Having said that, I’m tempted to say "of course sales expenses drive growth!" but that misses a larger point. Since the inception of SaaS we have been told that it’s a more efficient business model yet the numbers don’t lie, SaaS is dependent on disproportionate investment in sales at the expense of R&D.

You really see this played out to it’s extreme with Salesforce.com, where SG&A is 67% of the P&L, versus 24% for SAP, and R&D is 8.8% and 14% respectively. Perhaps it apples to oranges given the legacy code that SAP has to support, so substitute your own favorite software company and compare the numbers.

The minute any of these companies turn back the dial on sales and marketing the growth falls almost immediately. This is important because in the public markets these companies are valued not on current cash flow but on growth as a proxy for future cash flow.

In the final analysis I would suggest that R&D investment is a form of long term savings for companies, as opposed to sales expenses which are, for lack of a better term, unlevered in the larger business model.

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