Saturday, April 14, 2012

SaaS profits: who cares

There's a story about accounting that wouldn't really pass as funny - even by accountants' standards- but it is instructive.

A CEO was interviewing two candidates for an accounting position. He provided each with the company's most recent financial data and asked each of them: "What would you report for our company's profit?"

The first candidate pored over the numbers, pencil and calculator at hand, carefully constructing an accurate income statement. After that protracted exercise, he dutifully walked the CEO through his arithmetic, subtracting expenses from revenues. The remainder, he proclaimed, would be the company's reported profit.

The second candidate kept his pencil and calculator in his briefcase and, in fact, never even glanced at the numbers. He looked at the CEO and said, "The company's profit is whatever you want it to be."

So much for the unassailable truth of whatever is reported as "profit." Calculating it and interpreting it can be much more elusive than the cold, hard numbers would suggest.

"Profit" isn't especially meaningful, in particular for SaaS companies

Interpreting "profit" is even more elusive when assessing software-as-a-service (SaaS) companies. The problem is timing. Profit is calculated by subtracting costs incurred during a given period from revenues generated during that same period.

For most SaaS companies, though, they incur expenses in the current period, but the revenues are realized over many periods in the future. Costs now yield revenues... but not until later. (See "SaaS market consolidation: Blame Wimpy.")

The largest of those costs tend to be for customer acquisition. Sales and marketing expenses in a given period can often exceed 50% of revenues during the same period. Adding in support, operations, development, general & administrative costs, and other expenses, there's not a lot left for profit. In fact, a reported loss is far more common.

If not "profit," what really matters?

So if profit isn't a useful measure of success for SaaS companies, what is?

Metrics like "cost of customer acquisition/customer lifetime revenues"(CAC/CLV) can give a much better picture of a SaaS company's performance. For every dollar that the company invests in sales and marketing, how many dollars in revenue are earned? And how long does it take to earn them? (See Joel York's "SaaS Metrics Guide for SaaS Financial Performance" or David Skok's "SaaS Metrics" for additional metrics appropriate for evaluating SaaS companies.)

To amend the story about the CEO and the accountants, the best answer to the question "What would you report for our company's profit" wouldn't be "revenues less costs," or even "whatever you want it to be."

For a SaaS company, the best answer might be, "Who cares?"

Creative Commons License

This work by Peter Cohen, SaaS Marketing Strategy Advisors is licensed under a Creative Commons Attribution 3.0 Unported License.