Have you ever wondered what makes a Software-as-a-Service (SaaS) company successful? If so, you’re in luck. I was curious and so I did some work yesterday to figure it out.
SaaS companies like Salesforce, Responsys (a Redpoint company) and others take advantage of the web to distribute software to customers. Because all the software is operated from a central server, the marginal costs to maintain and update the software are low. Therefore, SaaS companies should be very profitable.
But that’s not necessarily the case.
SaaS Profitability Varies Widely
There are 14 public SaaS companies. They provide software for HR, expense management, customer relationship management, and even classrooms. Below is a chart of their net profit as a % of their total revenue.
Their profitability varies widely. On one end of the spectrum, Cornerstone posts losses about 110% of their revenues. On the other end, Financial Engines books 56% of its revenues as profit. That’s quite a disparity.
So what distinguishes these companies’ performance?
I used a series of scatter plots to research these relationships. If we can draw a diagonal line through the graph, and touch most of the points, we can conclude the two factors are related.
Is it company age?
I suspected older companies would be more profitable because they are more established. They have built their customer base and have established sales processes. But that’s not the case. You can see below that there’s no such relationship. Date of founding and company age have no impact on each other.
Is it the number of customers?
Next, I thought that companies serving a small number of large enterprises might be more profitable than those serving thousands of small businesses. Fewer customers means fewer support people, fewer sales cycles and presumably higher contract values.
Wrong again. The most profitable company, Financial Engines, serves more than 400,000 customers. No explanation here either.
Is it the price?
Then, I wondered if more expensive software might be more profitable. After all, those $250,000 enterprise installation must have some fluff in the pricing.
Setting aside the outliers, there’s no relationship here.
Out of options, I resorted to comparing the cost to sell the software across these companies. Sales costs explain 60% of the difference in profitability across companies. In other words, the more efficient a company is selling their products, the more profitable they are.
So for your SaaS startup, how do you reduce sales costs? By shortening the sales cycle in some of the following ways:
- Move to an inside sales model
- Prequalify customers
- Measure, measure, measure
- Free trials
- Improve the effectiveness of advertising
- Distribution partnerships
I’ll be talking about these topics in upcoming blog posts. The great part about these tactics is that we know they apply across the board to all SaaS companies – ones serving big and small customers, old and new.