The more ARR, the better
Roger Hurwitz is a founding partner of Volition Capital. He primarily focuses on investing in software and technology-based business services.
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The global software The SaaS (as a service) industry continues to grow rapidly, but developing and pricing professional services is often a difficult task for SaaS companies.
Gartner recently forecast that global SaaS sales could exceed $ 140 billion by 2022, a 40% increase from around $ 100 billion in 2019. These are heady numbers for an industry that only took off 20 years ago.
As someone who has made a lot of investments in SaaS companies, there is a clear consensus in the boardroom assuming compelling sales efficiency metrics: the more ARR, the better. It is also clear that across the SaaS industry, gross margins across software are highly consistent and generally in the 60% to 80% range.
There is a clear consensus in boardrooms, assuming strong sales efficiency metrics: the more ARR, the better.
Much less obvious is how customers are charged for professional services, be it for implementations, consulting work or training.
In the past, in the days of perpetual software, such offers were billed on a time and material basis or for a fixed fee with a targeted gross margin of, for example, 10% to 30%, but they also lead to large losses as the Company fees for these services vary widely.
If you look at SaaS companies, you see a margin fluctuation of 50 points or more in service revenue of -30% to 20%. Why do we see such margin differences in professional services and what impact do these different approaches have on the strategy of a SaaS company?
Are professional services a profit center or a loss leader?
We can first ask why a company would accept a single digit or even negative margin for its professional services. For some, a strategy is to speed up ARR by covering some of these costs, for example by waiving an implementation fee for a higher annual subscription amount. The aim here is to eliminate friction losses in the sales process by lowering service fees. This will accelerate the pace of the new logo, resulting in a higher ARR and therefore stronger growth, which should lead to a higher appreciation in the share price.
To implement this strategy, a SaaS company can increase its subscription price, albeit not significantly. This enables the provider to offer such services without specifying the costs in a separate position. However, is this really the correct answer? As with so many questions, the answer depends on many variables, such as: B: Does it accelerate the sales cycle? Would the charges for such services make customers more responsive and lead to faster implementations? How much does it cost to cover such services? What impact does this have on the company's liquidity, profitability and financing needs?
Two pricing strategies for professional services
Let's compare the three-year effects of two pricing strategies for professional services and the resulting effects on funding needs:
Company A: Provides professional services with an annual value of $ 10M and a gross margin of -20% resulting in an annual loss of $ 2M. The total losses over the three year period are $ 6 million.