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.
I've got one!
ReplyDeleteMinimizing costs....scale free profitability....ummm..
Marketing is expensive. 30% of sales is not unusual.
Viral marketing, or enabling your customers to advertise your product as they are using it, cuts out a large chunk of that.
Sure...the benefits of viral marketing accrue with scale, but nonetheless, it's a significant reduction in variable expenses.
Great post by the way. Keep’em coming Will- you’re doing pretty well. Thanks.
- Yeehaaa
An anomoly that comes to mind in regards to the scalability model is Salesforce.com. They clearly have a scalable software model, but they continue (and have since the very beginning) to pour 40% and 50% of their revenues back into Sales & Marketing, thus eroding their margins. How successful would SF.com had they not invested so heavily into sales & marketing? One could look to SugarCRM as an example, or even RightNow.
ReplyDeleteOne could argue that there is still tremendous scale left in SF.com, but it comes at a very, very high cost of sales & marketing.
Where is the balance?
How much does the Microsoft monopoly distort the numbers?
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ReplyDeleteCan you please post the report from Morgan Stanley or atleast give us some pointers to the source.
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