How To Measure The Profitability Of A SaaS Business? Plus How much you should be spending on R & D or Sales & Marketing

The general rule of thumb for spending in SaaS is 40/40/20.?In other words, 40% of operating expense should be on R&D, 40% should be on sales and marketing, and 20% should be on G&A.?Rules of thumb are just generalizations, so we wanted to see what the data really is.?73 SaaS companies have gone public since October 2022 and below are their margins.?Perhaps the rule of thumb should be 30/50/20.?The data is below.?

30/50/20.?On a median, 26% of opex is R&D, 48% is on sales and marketing, and 22% is on G&A.?So we believe “30/50/20” on R&D/S&M/G&A may be more accurate.?

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There are outliers.?Rules of thumb are just general guidelines, and sure enough there are significant outliers.?45% of Dropbox’s spend was on R&D while only 13% of Zoom’s spend was on R&D.?Similarly, 73% of Zoom’s spend was on sales & marketing, Dropbox spent only 37% on S&M, and Bill.com spent 28% on S&M.?Snowflake spent a whopping 130% of revenue on S&M and indeed their EBITDA margin is the worst of the bunch at -192%.

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Don’t let G&A be the outlier.?Obviously, you should minimize spending on G&A.?Building products and selling them should be the priorities.?Cloudflare, Sendgrid, Snowflake, and Palantir are violators of this mantra (they spend 36%, 34%, 37%, and 43% of opex on G&A).

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COGS isn’t 20%.?The other rule of thumb that needs to be debunked is that COGS is 20% of revenue.?As you can see, the median and averages are 29%.?

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Where is the profitability??We put together simplified operating income calculations based on the data (Revenue – COGS – R&D – S&M - G&A).?Only 20 out of the 73 companies had positive operating income at IPO.?Not only that, but the median and average operating income margins are an anemic -21% and -27%.?

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Indeed, the software is forgiving: so long as you’re growing fast, have excellent retention, and marquee customers, you’re allowed to burn cash as recurring revenue that doesn’t churn is an annuity with tremendous value.??????

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Overall we found the data to be really compelling: 30/50/20 is the new 40/40/20 for more established SaaS businesses, unprofitability is ok so long as your business fundamentals are solid and you’re growing, and COGS is allowed to be slightly higher than 20% of revenue.???