
Gross margins and SaaS companies - janvdberg
https://twosigmaventures.com/blog/article/why-gross-margins-matter/
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jmpman
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.

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aqme28
Why would you ever axe a product that generated $25M, "no effort" or not?

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csa
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.

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jmpman
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....

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formercoder
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.

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aflag
I think I don't understand what capital intensity means here. If the margin is
low, doesn't it mean that it's capital intensive? In the example, $75M is
required to get $25M. Isn't that intensive?

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formercoder
Capital intensity has to do with net operating assets (PP&E, working capital).
It’s capital intensive if you have to build a $1B plant in order to make a 1%
margin.

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arethuza
ROCE (Return On Capital Employed) is a common measure in capital intensive
businesses.

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mbesto
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.

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sudonim
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.

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cs702
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.

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texasbigdata
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...

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OnlineGladiator
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?

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elihu
Employees (as long as it isn't negative and their job isn't at risk).
Customers. Anyone who doesn't own stock.

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OnlineGladiator
I think those are examples of people that don't care, not people that don't
understand.

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zupa-hu
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?

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lifeisstillgood
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.

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

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bch132
Gross MARGIN Matters... Gross MARGINS might describe an issue of Hustler in a
1980s frat house...

