For example, the distribution of LTM operating margin by revenue size is as follows:
- $75-300m in revenue = 7% operating margins
- $300-500m in revenue = 11% operating margins
- $500m-$1bn = 12% operating margins
- $1bn-$5bn = 18% operating margins
- >$5bn = 33% operating margins
The scale effect, as noted by Larry Ellison and Barron's, is driving rapid consolidation of the industry as vendors seeks to consolidate capacity, drive volumes, and get to minimum efficient scale. Consolidation, while good for exits in the near term, has troubling long-term implications wrt the market's expectations for future small cap software company growth, profitability, and viability.
Start-up companies and VCs, by definition, cannot rely on scale to help us achieve profitability. Rather, start-up companies must innovate their business models and strategies in order to reach attractive profitability metrics independent of scale.
As important as technical innovation, successful start-ups must innovate how we do business and prosecute R&D, marketing, sales, and operations.
If we simply innovate technically and rely on traditional business practices, we will suffer from the fate illustrated in the table above.
How we rip costs out of the software model while delivering value will be critical.
I would enjoy hearing from start-ups and investors on novel, optimized business practices that are helping to realize scale-free profitability. While open source software, offshore development, and channel based selling are well-known strategies, any fundamentally novel approaches would be great to share.