Contribution Margin in SaaS
Sammy is the Managing Director and Cofounder of Blossom Street Ventures. Email him directly at firstname.lastname@example.org, especially seed to Series C founders.
Bill.com and SumoLogic recently went public. In their prospectus’, each of these companies was generous enough to share beautiful contribution margin data. Specifically, Bill.com shows the contribution margin of customers acquired in 2017 and SumoLogic does it for customers acquired in 2018. It’s a very nice illustration of the first three years of a SaaS customer in a healthy SaaS business. The charts are below. Commentary follows.
Bill.com’s contribution margin:
SumoLogic’s contribution margin:
The definition. Contribution is generally defined as the aggregate ARR from an annual cohort at the end of a given fiscal year, less the estimated associated cost of revenue and estimated allocated sales and marketing expense.
In the first year, you lose money. Generally speaking, the first year of any customer in a SaaS business is an unprofitable one. That’s because the sales & marketing expense to acquire the customer is incurred in year 1. As you can see for Bill.com, for fiscal 2017, the 2017 Cohort represented $6.7 million in revenue billed to these customers, $11.8 million in sales and marketing costs to acquire these customers, and $2.3 million of cost of sales representing a computed contribution margin of -108%. For SumoLogic, the 2018 cohort accounted for $10.1 million in ARR and $19.8 million in associated costs, representing a contribution of -$9.7 million, or a contribution margin of -97%.
In the 2nd year, you start becoming profitable. Since you never incur sales & marketing expense again to acquire the customer, the only cost in any SaaS business is just the “cost of sales”. For Bill.com, in fiscal 2018 and 2019, the 2017 Cohort represented $14.2 million and $17.3 million, respectively, in revenue billed to these customers and $3.9 million and $4.2 million, respectively, in estimated costs related to retaining and expanding these customers, representing a computed contribution margin of 73% and 76%, respectively. For Sumo, at the end of fiscal 2019, the 2018 cohort accounted for $14.6 million in ARR and $7.6 million in associated costs, representing a contribution of $7.0 million, or a contribution margin of 48%. At the end of fiscal 2020, the 2018 cohort accounted for $18.3 million in ARR and $8.2 million in associated costs, representing a contribution of $10.1 million, or a contribution margin of 55%.
The revenue grew. Note that for Bill.com, revenue in year 1 was only $6.7mm. In years 2 and 3, it was $14mm and $17mm respectively, meaning the cohort grew materially. Indeed, good SaaS businesses have cohorts that grow over time, as upgrades in the customer base outpace downgrades and churn. For Sumo, year 1 revenue was $10.1mm, but then grew to $14.6mm in 2019 and $18.3mm by 2020.
Payback is fast. According to Bill.com, “for customers acquired during fiscal 2018, the average payback period was approximately five quarters.” Good SaaS businesses recover the cost of acquiring the customer within 1.5 years.
Bill.com and Sumo’s customer cohorts are a nice example of what a good SaaS business will experience: i) you lose money on the customer in year 1; ii) in year 2 the customer becomes very profitable and you recover the cost of acquiring the customer; iii) over time, your customers buy more product from you rather than less. Maintain these same attributes in your own SaaS business and you’ll be on your way to joining Bill.com and Sumo as a public company.