SaaS Gross Margins

It’s a very simple concept. It is the net amount of money that a company keeps from its revenue. Gross margins have a lot of impact on a Software-as-a-Service(SaaS) business. 2 forms of leverage a SaaS company has are scale and lower operating costs. SaaS companies have 2 forms of leverage. Firstly, the ability to scale at a fraction of the cost of actually expanding across geographies. Secondly, their relatively lower operating costs which means that they can keep most of their revenues. Gross margins are hard to improve. They usually rise in the initial months and stabilize thereafter. As a SaaS business scales up, it is adding more inertia to the company. It becomes more complex to run a multi-feature large scale app, and this eats up from the gross margin. Gross margins affect the valuation as it is a direct indicator of the business’ ability to create value. Value of a business can be expressed as the discounted sum of its current value/assets in place and the systems/products in place that can create more value in the future. And the two parts of this equation should be worked out for separately to avoid double counting.

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