Investors are starting to look at SaaS gross margins and the cost structures driving them. It’s not just about achieving your total margin; revenue sources include professional services, which depend on what type of business you’re in. We’ll take a closer look at what gross SaaS margins are and how it affects your company.
This article is about how to calculate and improve your gross SaaS margins. The importance of it in the SaaS industry will be discussed, and some tips on how you can increase yours.
What is Gross Margin, and how does it work?
Gross margin is the money that you make after subtracting expenses from sales. This includes what’s leftover for operating costs and reinvestment in your company as a percentage of overall revenue.
Simply put, gross profit equals all the cash you have left over after accounting for goods or materials sold at a higher price. Click To Tweet
For example, if you buy a product wholesale for 10 dollars and sell it to your client at 20, half of the revenue is paid directly from that sale.
What is SaaS Gross Margin?
Your company can achieve your gross SaaS margins by subtracting COGS from sales. This is an old-school word, but this supports all income sources directly.
COGS is not just about your cost of goods sold. I also include:
- Customer success and operating support.
- Services.
- Expenses in my COGS calculation.
Precisely what are COO expenses? It covers hosting expense, capitalized software amortization for R&D or product resell if applicable. There may be other COOS expenditures, but those are the biggest.
What are Gross Saas Margins and why are they important?
It is essential to consider how different revenue sources work together for SaaS companies. For example, combining services and recurring services with other income streams is necessary.
You might be losing out on higher SaaS margins because your service margin is too low, or you may not have the resources to onboard and set up customers, which lowers your overall income.
Gross Saas Margin Formula
The gross margin formula that I first came up with was a little too general for our SaaS company.
When we consider the costs of goods sold, additional categories need to be considered. For example, revenue and cost centers can use different buckets for calculation purposes. I broke COGS into four separate sections: fixed costs, variable costs, overhead allocation (set), and indirect expenses (variable).
The future salesforce comprises four components: customer success, support services, total revenue, and dev ops. Together these represent gross margin.
I assume that we only have subscription and service revenue in our business model with this example. If you also want to include transaction or hardware revenues, add a COGS cost center.
We need to have the right divisions of profit and loss for financial management to adequately analyze our company’s P&L.
SaaS Goods Sale Cost (COGS)
I include Customer Success (CSM), Support Services, and DevOps. I use these departments to house hosting costs and capitalized software R&D cuts that are not included in COGS because they’re an expense from a previous year.
It depends on your business model what kind of costs you have. For example, if you are a services company without any transactional revenue, then I would not expect to see transaction expenses in the COGS category because it doesn’t make sense for them to be there.
Revenue margins in SaaS on a recurring basis
If you are trying to identify which departments fund your recurring revenue, look at the ones that directly impact it. You can use CSM and COO for this purpose because they will help with income if needed.
What constitutes a healthy SaaS gross margin?
You can look up the average gross margin for your company in many reports on the internet. According to OpenView’s SaaSBenchmarks, 75% of companies have a median gross Saas margin, and 82% are top-quartile.
The SaaS Survey of KeyBanc is a survey with some interesting results. One respondent posted a 78% gross subscription margin and 73% total gross margin according to their latest survey, which in my opinion constitutes an overall profit rate of 80%. Furthermore, the respondents have experienced significant growth since they started using this software-as; as one person said, “we are growing so fast that I’m not sure how much more we can grow.”
Gross margin is an important metric for investors because it shows how profitable a company will be. Click To Tweet
It also helps show the sustainability of SaaS businesses.
Suggestions for Increasing Saas Gross Margin
One way to improve the margin is by increasing sales or decreasing COGS.
Starting, you are likely to profit less because there is no scale. Once you have more clients on board, supporting each one becomes cheaper, reducing your COGS while increasing the company’s margin.
Cutting costs and raising prices is a tempting short-term strategy, but it can be detrimental to the company in the long run. You may find that your product quality becomes subpar, or you cannot keep up with customer demand if too many people leave because of high prices.
If you want to increase your gross SaaS margin and improve the net profit, there are a few other ways.
- Prices Increment
- Direct goods cost reduction
- Reduce waste inventory
- Readjust the mix of sales
- Integrate new services
- Leverage predictive analysis
- Upsells
Price Increases
Most small business owners think they will lose customers quickly if they increase rates and compensate for the potential increased benefit. Although not always a popular decision, higher prices can be beneficial.
If you are looking to improve your SaaS pricing, do not just copy the competition. Instead, study what they offer and then come up with a better deal for yourself.
Cost-cutting on direct goods
To keep your profit margins high, you can raise what you sell. However, try to negotiate better deals with suppliers for lower-cost products that will save money in the long run.
If you are having trouble finding better rates, consider purchasing more bulk products or becoming a trustworthy customer for the company. This will provide leverage when negotiating lower prices.
Inventory waste is being reduced
There are a lot of ways to make sure that you don’t lose any money from spoilage or pillaging. One way is by preparing for your inventory and making sure it’s well managed.
Reorganize your sales mix
If you are looking to make a lot of money from your business, you must identify the products with the highest SaaS margins. You may need to tweak this mix as time goes by and figure out what types of goods or services people want.
New services should be integrated
If you only have one or two products in your company, then consider adding a new product to the mix. But before doing so, be sure that it complements what is offered and will generate more customers.
Use predictive analysis to your advantage
A decline in usage and interest is sure that customers are about to cancel their subscriptions. This information can be used by SaaS companies who use analytics tools to measure how often users log into the software, what features they explore, etc. Careful analysis of these metrics will help pinpoint any pain points, which can be addressed with retention strategies like improved customer service or better training for existing employees.
Upsells
One way to increase your sales and make more money is by upselling. However, you need to be careful because if people feel annoyed with the constant promotion of new features, then they will start feeling frustrated.
Conclusion
Your small company might not be making enough money. It’s time to shift your focus, and the easiest way is by turning an unprofitable business into a profitable one. For example, if you are currently struggling with landscape photography but have success doing weddings – then it would make sense for you to start focusing on wedding photography.
