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, 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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10 thoughts on The Pull Factor in SaaS

  1. Does anyone know what SAP, Oracle and the others spent on SG&A in the heydays of the 1990s? Is the high SG&A spending of the SaaS vendors because of their location in the adoption lifecycle?

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  3. Simon,
    I don’t know the exact numbers, but I’d speculate that in the history of that company SG&A has never been higher than 40%.

    As I said in my post, there may be an apples to oranges comparison because of lifecycle, but as I think about it even more so because of it being SaaS and I’m not up on what they call SG&A and how it differs from the on premise vendors.

  4. IMO the buzz around ‘Saas’, ‘OnDemand’, and whatever 2.0 disguises the fact that if you sell ‘direct’ to SMBs and VSBs, it’s very expensive.

    Software sales to SMBs can be very lucrative (Microsoft, Intuit on down) if you can create, or if there is innate, pull for your product. Or if you can create a high-volume web lead business (WebEx, eFax, etc.)

    But if you have to generate demand directly, via campaigns, noisy PR, outside sales, cold calls, inside sales for very small deals (

  5. Thanks Jason, I really appreciate your comment because you are living in this world.

    Your point about selling direct to SMB is the key point in this debate, and as I have written on many occasions, in a mature industry like software sales and marketing will invariably become the largest expense category. Having said that, the SaaS companies have generally claimed two advantages, lower cost of delivering product (development cycle and to the actual customer) and lower cost of sales through low touch direct sales instead of channels.

    I’m not convinced, and the numbers certainly don’t suggest, that lower cost of sales is a benefit at all.

  6. We must all remember the difference in the business models between traditional and SaaS. While traditional vendors such as Oracle, SAP or Microsoft receive upfront license fees, the SaaS vendors such as, Netsuite,, RightNow, etc depend on monthly and sometimes yearly payments of much lesser amounts.

    Besides, the SaaS model is still young and requires a lot more publicity..That should explain why so much money is going to marketing and sales.

  7. Actually, the numbers do speak to SaaS having a lower cost of customer acquisition than conventional perpetual license models. Take a look at my blog post on this:

    It really is cheaper for SaaS companies to acquire customers than for equivalent sized perpetual companies. In fact, its quite a bit cheaper.

    Companies like Oracle have achieved a level of scale that largely boils down to brand and a huge tail of highly profitable maintenance revenues. Funds like Silver Lake will tell you there is a pronounced knee in the cost for sales and marketing as perpetual companies exceed $1B in revenue. What remains to be seen (SaaS is too new) is whether a similar knee will make it even cheaper for extremely large SaaS businesses.

    Meanwhile, the lack of profitability in most SaaS is self-inflicted–they’re spending for growth because they can.

  8. Tom and Bob,
    First of all, thanks for the comments. I have to take exception with the oft-repeated “SaaS is still too early in the cycle to really know” because these companies are anything but new. Salesforce and Netsuite have been at this for a decade, it’s not like patterns have yet to emerge.

    If the argument then becomes “there aren’t enough large companies on the SaaS model” well then I think you have to ask a different question, which is “can companies get big on this model?”. If so, then why are there not more?

    Bob, I read your post and have a couple of comments. First, when I was with SAP Ventures we invested in Webex so I do understand that business pretty well. I am inclined to take exception to your inclusion of them in your data collection because they were more like a telecom business than any of these SaaS models. However, I won’t object because if one is an orange and the other an apple, well they are both fruit. I would give Webex lower weighting in your analysis but that’s probably not material in the end.

    I will say that you ask a compelling question: why aren’t these companies more profitable? The financial data is clear, they aren’t in investment mode because they spend very little of their dollars on R&D and their datacenter operations costs, while significant, don’t rise to the level of R&D spending. I believe SFdC spent $50m on datacenter buildout over a multi-year period.

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