Measuring whether SaaS scales
How do you measure whether your SaaS business is benefitting from economies of scale? There are two easy to measures of cash efficiency you need to compare. They are life-time cash efficiency versus current cash efficiency.
The first metric we look at is life-time cash efficiency. We measure life-time cash efficiency as revenue / [equity + debt — cash] or simply put, revenue / historical net investment. The data below for the last 73 SaaS IPO’s shows at the time of IPO, SaaS companies generated on median $0.59 of revenue for every dollar of net investment up to the IPO. The average is higher at $0.91 of revenue for every dollar of investment.
In order to show that SaaS scales, we compare the life-time cash efficiency of $0.59 to another metric we really like, which is current cash efficiency. Formulaically it’s [current year revenue — last year’s revenue] / current year operating loss, or simply put new revenue / current operating loss. If SaaS companies get more efficient over time and truly scale, we would expect to see this figure, which is a more current metric, be higher than the historically looking life-time cash efficiency. Sure enough, it is. The new revenue / operating loss median is $1.00 and the average is $1.62. Those metrics are materially higher, meaning SaaS companies have been more efficient in generating recent revenue as opposed to revenue since day 1. They’re scaling and benefitting from economies of scale.
The math shows SaaS does scale as companies get bigger, so while profitability is great, so long as you’re growing cash efficiently (not necessarily profitably) and retain the customer (100%+ net dollar retention), you’ll build a fantastic business. Eventually, profitability comes with cash efficient scale and you’ll create a lot of value.
Thank you for reading. Sammy is the Managing Partner and Co-Founder of Blossom Street Ventures. Visit us at blossomstreetventures.com for more blogs and SaaS metrics.
