SaaS needs to focus on Gross Margin as much as on revenue growth.
You have developed a fantastic tool, sold it to your first customers and are currently working out which target profile you should focus on. Should these be SME-clients, Mid-market companies or maybe large enterprises? Each segment is characterized by different qualities, each one will open new opportunities and will present you with various set of challenges. Finally, each will necessitate a different organizational structure, customer interaction and internal processes. If you want to raise money, an investor will compare multiple of your metrics with the Gross margin (not revenue) you are generating to understand whether you can scale or not.
What is your gross margin (GM)?
It is the net revenue after the onboarding and hosting costs, that stays with your Company to cover your OPEX expenses such as Sales and Marketing, R&D or G&A.
What does the gross margin say about your business?
If you are a SaaS company selling your subscription at 10€ per month and need to spend 4€ per month on supporting your clients or onboarding them, then you will generate a 6€ gross margin per client every month. If the lifetime value of the client is 12 months than you have essentially generated only 72€ during the lifetime of your average client. This shows, that to get above the 3x of CAC:LTV ratio, you should not be spending more than 24€ to acquire the customers.
Imagine, you have introduced a self-onboarding process for your customers, and below certain MRR thresholds, your clients need to use self-help functions on your website. It effectively costs you now 50 cents a month to onboard and supports your customers, hence you generate 9,5€ of gross margin per customer per month, or 114€ during his lifetime. This increases your CAC flexibility by 58%, and you can spend now up to 38€ for customer acquisition and still sustain healthy 3x CAC:LTV ratio.
In general, it is OK to have a lower gross margin in the early phase of your business, however after you have hit a certain ARR, you should start optimizing the onboarding and support processes to work at scale. Focusing on generating low gross margin sales will likely result in burning through the money without reaching the unit economics you or your investors would have wished for. It will also necessitate raising larger funding rounds and diluting the founding team. Sustainability is built by optimizing the growth for gross margin.
What gross margin should you aim for?
The expected GM is a function of your customer focus:
- Below 500€ MRR (SME) — should carry very little onboarding or support costs, your GM should be over 90%.
- Below 5,000€ MRR (Mid-market) will inevitably require your help during the onboarding process, and will expect a certain level of support. This is OK, as long as your GM stays above 80%.
- Enterprise clients usually expect tailor-made solutions with 24h support. You can commit to it, should you sustain a GM above 75%.
The numbers above vary between the industries however are mostly in-line with what I observe in the general market.