Sunday, February 12, 2017

Gross margins for SaaS startups in India

Gross margin is a very important number for SaaS products as that gives an indication to how much money you will have left to innovate on hiring,discounts,marketing etc.

What is a good gross margin for a SaaS startup in India?

To get the answer to that,lets first see what is gross margin:
"Gross margin is defined as the percent of revenue left over after the cost of servicing that revenue is taken into account"

So it is not just the cost of goods, but also the cost involved in servicing and supporting your product.
For Saas products the highest cost comes from hosting services. But thanks to cloud providers like AWS and Google cloud, hosting service costs have been coming down. And this in turn increases your gross margins.

It is widely accepted that a gross margin above 80% indicates a good SaaS business. Such a business can command a valuation of 10x on revenue. But anything above 65% should be ok. You can then optimize and move the needle towards 80%.

For us at Ozonetel,since we are in the cloud telephony space, our hosting charges are a little high as we need to manage data centers in each location in India. Also last year, we experimented with outbound calls and SMS services. These do not have a lot of margin as you make only 1-3 paise per call/SMS. When we were doing that model our gross margin fell below 50%. Though our revenues increased a lot, since our gross margin was low, we did not have too much left out to invest in the growth of the company.
So we made a conscious decision to concentrate on selling only software as that has higher gross margins. Right now, we have 70% gross margins and with a few more optimizations we should be able to reach 80% this year.

As a Saas business, make it a priority to improve your gross margins. The higher gross margins you have, the better multiples on revenue you will get. That is why ecommerce and SMS/Outbound call providers dont get too much revenue multiple valuations.

In fact if you have less that 40% gross margins, I don't think you can be called as Saas company. You will be more of a service company with a Saas bent.