How to Increase Profits with Business Software and Technology FAQ

Introduction

As a founder or CEO of a SaaS company, one of the metrics your investors and buyers will probably scrutinize most closely is your gross profit. Gross profit, or GP, is simply defined as your revenue minus your cost of goods sold. In this article, we will explore how you can improve your gross profit margin and increase your profits with business software and technology.

Understanding Gross Profit Margin

Gross profit matters because the higher it is, the more capital you have to invest in other operational areas of your business such as sales and marketing, research and development, and general administrative purposes. Higher gross profit also reduces your reliance on external equity or debt capital.

For example, a business that generates $100 in revenue and has a cost of goods sold (COGS) in delivering the product to customers of $15 has a GP of $85. Its gross profit margin is 85% — calculated as $100 minus $15, divided by $100.

The Importance of Gross Profit Margin

Gross profit margin is a key metric that investors and buyers look at when evaluating a SaaS company. It indicates the profitability of the business and its ability to generate capital for growth. Let’s consider an example to illustrate its significance.

Example:

Company A and Company B have similar revenues and operational expenses. However, Company A has a higher gross profit margin than Company B.

• Company A generates $100 in revenue with a COGS of $15, resulting in a GP of $85 and a gross profit margin of 85%.
• Company B generates the same $100 in revenue but has a COGS of $35, resulting in a GP of $65 and a gross profit margin of 65%.

In this scenario, Company A is 2.5x more profitable than Company B due to its higher gross profit margin. This allows Company A to invest significantly more in other areas of the business, giving it a competitive edge over Company B.

Factors Influencing Gross Profit Margin

There are two main factors that can help improve your gross profit margin: increasing revenue and lowering COGS.

Increasing Revenue

To increase revenue and improve your gross profit margin, consider the following strategies:

1. Pricing Discipline: Price your products in a disciplined manner that aligns with the value provided to your customers. Benchmark your pricing against competitors’ pricing to ensure competitiveness in the market.

2. Automatic Price Increases: Implement automatic price increases annually to ensure that your gross profit margins improve over time.

3. Product-led Growth Strategy: Explore a product-led growth strategy that allows customers to implement and integrate your software themselves, reducing the need for significant professional services and improving gross profit margins.

Lowering COGS

To lower your cost of goods sold (COGS) and improve your gross profit margin, consider the following strategies:

1. Cloud Hosting Costs: Negotiate the best pricing for your cloud spend and compare pricing options across different vendors. Take advantage of substantial discounts offered by cloud vendors for multiyear contracts.

2. Infrastructure Optimization: Optimize your infrastructure engineering practices to reduce cloud spend. Monitor and eliminate unused cloud resources using various cloud cost-monitoring tools.

3. Remote Resources: Consider using resources in less expensive locations for product implementation, DevOps, and customer success teams. Remote work can help reduce costs and improve your gross profit margin.

4. Product Complexity: Design your products in a way that allows customers to implement and integrate them themselves, reducing the need for expensive professional services that can decrease gross profit margins. Provide accessible digital resources for customer support.

It’s important to note that COGS should only include direct costs of revenue, such as cloud costs, customer support, engineering salaries directly supporting product delivery, and costs of third-party software used in your product. Indirect costs such as R&D, G&A, and other expenses should not be included in COGS.

The Relationship Between Gross Margin and Valuation

Higher gross margins are attractive to investors and buyers. In our analysis of 146 public SaaS companies, we found that companies with higher gross margins trade at better multiples. This correlation holds true in both bull markets and periods of muted valuations.

High-quality SaaS businesses typically have gross margins between 75% and 90%, with an ideal range above 80%. If a software company’s gross margin is below 70%, it may raise concerns for investors and strategic buyers who prioritize capital-efficient businesses and acquisitions that are accretive to their own gross margin.

Conclusion

Having a high gross profit margin is crucial for the success and growth of a SaaS company. It provides the capital needed to invest in other operational areas and reduces reliance on external capital. By implementing strategies to increase revenue and lower COGS, you can improve your gross profit margin and increase your profits with business software and technology.

Remember to price your products in a disciplined manner, benchmark against competitors’ pricing, and consider automatic price increases. Negotiate the best pricing for cloud hosting costs, optimize your infrastructure, and explore remote resources. Additionally, design your products for self-implementation and provide accessible digital resources for customer support.

By focusing on improving your gross profit margin, you can build a profitable and successful company that attracts investors and buyers.