What’s Dropping? The Salary Component of SaaS Operating Expense

October 25, 2018

The OER (Operating Expense Ratio – ratio of operating expense to revenue) is a traditionally viewed as a measurement of efficiency. It can be translated to mean the dollars required to produce one dollar of revenue.  Typically, that dollar of operating expense was 90 percent payroll components.

For early stage companies, the OER may be 3X.  In other words, to produce $1M revenue, they spent $3M in operating expense, which is mostly salaries, or even more for well funded SaaS companies in high wage areas like the Bay area and Boston.  As companies grow, their OER should come down, but many SaaS companies at IPO still require more than $1 in operating expense to produce $1 in revenue.  That dynamic hasn’t changed much in the past five years.  We still see most SaaS companies being unprofitable at IPO.

The Salary Component of SaaS Operating Expense is Dropping

So, while the OER hasn’t changed much and mostly at the high end of companies as more SaaS companies are improving OER at scale, what has changed is that the salary component of operating expense is dropping as a percentage of total revenue.   Companies appear to be investing more in automation and applications to assist employee productivity.

The more technology a company can leverage means that they are less dependent on employees to scale.  This may become more important going into 2019 and beyond as skilled employees for SaaS companies become even more difficult to find and hire. Compensation expenses as a percent of total revenue for SaaS companies have dropped by almost 10 percent over the past five years due to greater investment in productivity tools and training and other systems to automate processes.

Compensation expenses alone represented over 70 percent of revenue for most companies in the 2018 OPEXEngine benchmark analysis, the single largest expense category.

SaaS Sales, Marketing and R&D Leveraging Technology to Drive Productivity

Different departments have invested at different rates, and can be seen in the spread between compensation expense and total expense in a department such as Sales, Marketing and R&D.

This spread has increased for every department over the past 5 years, but has increased the most for Marketing and R&D. Sales, however, is increasing as well, as more Sales productivity and automation tools are utilized, which is more evident in private companies with faster adoption rates.

Salary Component in total Department Expense:  2018 Comparison with 2013

Source:  OPEXEngine 2018 and 2013 benchmarking

SaaS Employee Productivity

Employee productivity or revenue per employee has become an increasingly important metric that public analysts use to establish strategic company value.  Technology companies tend to be highly competitive in this area and need to continually track against peers and market leaders in order to manage company valuations. Private investors are only starting to really track and benchmark employee productivity in private SaaS companies.SaaS employee productivity hasn’t changed much for private companies.  Private SaaS company employee productivity is about the same in 2018 as it was five years ago in 2013, based on our proprietary benchmarking of hundreds of private companies.  Public company employee productivity has increased on average from just over $200k/employee five years ago to $221k/employee in 2018, an increase of 10.5%.  By definition, companies taking the IPO route are typically more productive and continually innovating to stay competitive.

Companies are increasing employee productivity by investing in more productivity enhancements:

  • Training – both of individuals and managers,
  • Individual productivity tools like CRM and dozens of other applications and technologies
  • Automated processes which require fewer human interaction, from automated customer support to sophisticated analytical tools.

Investment in automation and productivity tools should be analyzed against productivity gains.   This analysis should be undertaken for the company as a whole, as well as for individual operating departments.  Companies should track employee productivity against automation and productivity tool investments for the total company and specifically for Sales, Marketing, R&D and possibly also Customer Service or Customer Success. Tracking these numbers and comparing to benchmarks for comparable peer companies helps SaaS companies stay competitive as they scale and grow.

Key Compensation and Employee Productivity Metrics to Track and Benchmark Against Peers

Operating Expense Ratio:

  • Operating Expense divided by Revenue

Employee Productivity:  

  • Total Revenue divided by total number of employees
  • Can also be calculated by dividing ARR by the total number of employees

Total Compensation & Benefits Component of Revenue and Expense

  • Total employee compensation & benefits divided by total revenue and expressed as a percentage
  • Total employee compensation & benefits divided by total operating expense and expressed as a percentage