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I’ve written posts in the past aimed at helping founders benchmark theirrevenue growthandsales efficiency. This new post is focused on helping benchmark SaaS operating expenses (S&M, G&A, R&D) in more detail.Are your expenses in-line with other peers at your scale?
Historically, I would guide founders to benchmark their growth and expenses by using the“Rule of 40”which is a formula to analyze the health of a software business. Simply put, your growth rate and profit margin should add up to at least 40%. While this is a helpful rule of thumb, it is fairly high-level and doesn’t differentiate between costs allocated to different parts of the business. If you aren’t meeting the “Rule of 40” benchmark, how do you know where to better optimize? I recommend combining the “Rule of 40" with the benchmarks I’ve created below.
A quick overview of the methodology:
- Gathered historical GAAP revenue and operating expense detail (S&M, R&D, G&A) from 100+ enterprise SaaS IPOs between 2010 and 2019. The data excludes stock-based compensation expenses.
- Calculated expense ratios (“Y”) for each revenue data point (“X”).
- Estimated percentiles (75th, 50th, 25th) from power trendlines based on a regression of the data.
Sales & Marketing Benchmarking
If your company generated $100M in revenue, the median S&M spend for a company of this scale is 48% of revenue. Spend (as a % of revenue) is typically higher in the early stages of a company’s lifecycle as they are in the expansion phase and are actively building out their sales organization.
S&M Efficiency Targets
Given sales and marketing costs are a close driver of revenue growth, the % of S&M spend is less relevant in isolation. It’s important to also understand the efficiency of this spend.See my prior blog post on this topic (LINK). If your S&M spend is highly efficient in driving growth, it might make sense to increase investments in this area! If not, you need to re-evaluate your sales motion and/or product-market fit.
Research & Development Benchmarking
R&D refers to the activities companies undertake to innovate and introduce new products and services to the market. Some companies are in industries that are more competitive and must dedicate larger resources to product development in order to maintain market share and to drive growth. For example, when Slack generated $105M in revenue in 2016, it spent 59% of revenue on R&D which benchmarks much higher than other comps. In their public filings they note the following:
“To remain competitive, we must continue to develop new features, integrations, capabilities, and enhancements to Slack… Our failure to maintain adequate R&D resources or to compete effectively with the R&D programs of our competitors would give an advantage to such competitors and may harm our business, results of operations, and financial condition.”
R&D Efficiency Targets
To benchmark the efficiency of your R&D spend, follow the forward-year growth targets below. These are multiples of forward-year revenue growth rate divided by % revenue spend on R&D in the current year.
Returning to our example, when Slack generated $105M in revenue, the company spent 59% of sales on R&D which benchmarks well below the 25th percentile. However, Slack’s R&D expenses are somewhat justified given the growth. The company grew revenue 110% year-over-year in 2017, representing a 1.9x multiple (110% / 59%) which near the 50th percentile of efficiency.
A few caveats: 1) The data here is noisier than for S&M efficiency, 2) these ratios do not control for spend in other areas which may also contribute to that growth, 3) the data doesn’t account neatly for investments that may take years to pay-off.
If anyone with a statistics background wants to volunteer some time to help me with a follow-up regression project, email me at parsa@ivp.com!
General & Administrative Benchmarking
G&A expenses are incurred in the day-to-day operations of a business and may not be directly tied to a specific function or department within the company (e.g. operational overhead, rent, utilities, insurance, legal fees, etc.). G&A is often the target of cost-cutting when a company has cash-flow problems.
When evaluating G&A spend, make sure to ensure that the spend is associated with and directly impacts business results. Do these investments improve a company’s productivity and efficiency on a daily basis?
Final Thoughts
These figures should be used only as guidelines to help you benchmark if you’re in-line with your peers. Where you fall on the charts will depend a lot on your target customer base and whether you are a product-driven or sales-driven organization, as well as your company’s growth rate. Many companies can justify higher spend in S&M and R&D if they’re in hyper-growth mode. However, if your metrics fall above the 75th percentile or below the 25th percentile it’s still worth digging in to better understand if you’re over- or under-investing in these areas. Combining these benchmarks with the “Rule of 40” should give to a great lens into the health of your business on both the top- and bottom-line.
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