Congratulations everyone –another loss this month!

Congratulations on another loss! Can you imagine that from the CEO or CFO at the monthly company meeting?

Well, OK, maybe not really in those words. It’ll be more like, “Congratulations on meeting top line revenue targets again!”

But since the focus in SaaS companies is always on top line growth and never on the growing red numbers at the bottom of the income statement, the headline has some truth in it.

As I have written before, I really question this business model as being sustainable. I know there are some companies that are getting on in years that are still surviving, but they only do that with continuing rounds of funding by VCs and other investors who believe in the top line “uber alles” growth strategy.

In addition is the nagging thought that VCs, who by nature support lots of losers to get a couple of big winners, will only play that game with your company for so long before they decide you are one of the losers.

When you look at income statements for big SaaS companies, you see large numbers under “Operating Expenses > Sales and Marketing”. Here’s an example from a well-known company I’ve been following for a couple of years, Hubspot (HUBS)(https://www.hubspot.com/) in their Sept 2016 10-Q:

 

HUBS loss

 

Sales and marketing accounts for 64.2% of their operating loss, and loss from operations in total accounts for 98.4% of the total loss. But investors look at the gross profit increase from 2015 to 2016 and are happy that it is up 55%. And that even though “Net loss per share, basic and diluted” is shown as ($0.91)!

Later in the 10Q comes this, as a warning?

“We have focused on rapidly growing our business and plan to continue to make investments to help us address some of the challenges facing us to support this growth, such as demand for our platform by existing and new customers, significant competition from other providers of marketing software and related applications and rapid technological change in our industry.

We believe that these investments will result in an increase in our subscription revenue base. This will result in revenue increasing faster than the increase in sales and marketing, research and development and general and administrative expenses, exclusive of stock-based compensation, as we reach economies of scale. With this increased operating leverage, we expect our gross and operating margins to increase in the long term. However, we will incur losses in the short term. If we are unable to achieve our revenue growth objectives, including a high rate of renewals of our customer agreements, we may not be able to achieve profitability.” (Emphasis  mine)
This is, however, a typical financial report from companies in this space. So far, I’ve only run across one such company that is shifting its focus to profitability and that is Cornerstone on Demand (CSOD). In his Q4 2016 earnings call transcript on Seeking Alpha (http://seekingalpha.com/article/4045582-cornerstone-ondemand-csod-q4-2016-results-earnings-call-transcript), CEO Adam Miller said this” I’m also very pleased to report that 2016 marked our first year of profitability…”

Hats off to Mr. Miller!

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The SaaS Industry

SaaSI have been following the SaaS (Software as a Service) industry for a number of years and in spite of the fact that most of them lose huge amounts of money every year, the industry is growing rapidly.

They survive on repeated rounds of funding from investors and VCs who seem to think that the only metrics that really count are the following, at least when you are looking at scaling the business:

MRR – monthly recurring revenue. It is the base measure of scale. It is a simple multiple of the number of subscribers times their subscriptions. You increase it by growing the numbers of customers. Or up-selling existing customers to higher value packages. MRR is the lead indicator which shows the growth of your SaaS business.

Churn – this is a measure of how many customers are coming in, but more importantly, going out. The reasons for churn are not always obvious. Your SaaS may work like a dream. But does it add enough value? Is it worth paying for? More important, do your customers find it is worth the time and effort to have your SaaS as part of their lives?

Customer Acquisition Cost (CAC) – In SaaS, CAC is a measure of the efficiency of your sales, marketing and distribution model. It is governed by two things: Conversion and Sales Model.

Cornerstone on Demand (CSOD) finally gets it!

Notice nowhere is there a mention of profitability. Top line revenue trumps net income every time in this industry. The only exception I’ve found in the last 2 years is Cornerstone on Demand (https://www.cornerstoneondemand.com/). They have now, after 19 years of existence, begun to think that profitability is a metric that they need to be looking at. Congratulations, Adam Miller, CEO!

I’ll be doing more posts on the SaaS industry as time goes on.

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