Software sales don’t scale

Do big software companies benefit from economies of scale? While the default answer may seem like ‘yes’, we wanted to see if that was really true.

We looked at new revenue divided by sales and marketing spend of SaaS companies at the time they went public. We then compared that figure to the same calculation the year prior to going public. In other words, if in a given year revenue grew from $100mm to $150mm while S&M spend was $80mm, the ratio would be ($150-$100)/$80mm resulting in $0.63 of new revenue for every $1 in S&M spend that year. In a situation where there were real economies of scale, we would expect that $0.63 to improve the following year as the company gets bigger.

Our data set has 83 SaaS companies who went public (filing their S1 prospectus). At the time of filing, the figure above was $0.64 cents on median and $0.97 on average. In other words, the typical SaaS company generated $0.64 of new revenue for every dollar of marketing spend. The year prior to the public filing though, the figure was $0.66. In other words even though these companies had median revenue of $100mm in the year they filed to go public and $64mm the year prior, they actually got less efficient as they grew. The data is below.

The median year these companies went public was 2014, so how does that same metric look today? For the companies that were still public, we did the same math for the year ended 2017 and only arrived at $0.54 on median and $0.76 on average. At the same time these companies had median revenue of $259mm and S&M spend of $94mm whereas in 2014, median revenue was only $100mm and sales and marketing spend was $42mm. So, while you may expect larger companies to benefits from economies of scale and be more efficient in selling, they’re really not.

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