Earlier this week, we published a blog by Tomasz Tunguz, How the Economics of Professional Services Have Changed in Software. He demonstrates that professional services strategies and gross margins vary widely across public SaaS companies and have done for some time in the SaaS world.
Despite large variances in professional services metrics, public SaaS companies have all achieved a milestone of financial success in order to raise funds on the public markets. OPEXEngine’s benchmarking shows that a company’s professional services strategy is specific to their overall product and market strategy, which varies among companies. There are several models that we tend to see among private SaaS B-2-B vendors.
Companies selling products in the SMB market place follow different operating models than companies selling large, ie., expensive products in the enterprise marketplace. The dynamics and resource allocations at the operating level are different. Different operating models can achieve financial success depending on how margins and customer acquisition balance out.
We’ve observed 2 factors that tend to influence SaaS vendor’s professional services strategy and hence their metrics. They are:
- Revenue/ARR Growth Rate
- Product/Market Type
Professional Services as Customer Acquisition and Retention Strategy
Our data from hundreds of private SaaS companies shows that among vendors selling mid-priced SaaS applications (ACV of $10k – $50K) and especially fast growth companies (50% + growth) tend to have lower professional services margins. For these companies, customer acquisition trumps services margins, at least for a while.
Source: OPEXEngine BenchmarkEngine 2018
The fastest growth companies generally are venture-backed and can afford to give away professional services either below cost or for very low margins. We’ve even had discussions at our SaaS Finance Meet-Upsdiscussing whether professional service expenses below cost should be categorized as Customer Acquisition Cost (CAC) instead of COGs. For some companies, professional services investments are blatantly an investment in growth.
This strategy is based on the assumption that services margins can be improved over time, but the pressure to perform in terms of customer acquisition is immediate and ongoing. Also, there is an assumption that customer acquisition is expensive and where resources should be allocated, while customer retention is less costly.
The most heavily venture-backed SaaS companies get the most money because they are following a credible strategy to be the number one player in a market. It certainly isn’t unusual that sometimes products aren’t as easy to use or fully capable as they are marketed to be –a one-time charge, especially if offered at a below market rate, for implementation or customization or integration can help reduce customer friction because a product doesn’t fully meet expectations.
Professional Services Enabling MVP Strategy
An adjunct reason that some SaaS companies have higher or at times variable professional services portions of their revenue, especially in the mid-market, is the widely embraced agile product development strategy of Minimally Viable Product (MVP) which technically means that new products are sold with only a sufficient number of features or capabilities to win over early adopters, and then based on their input, features can be built out.
Using this “MVP” strategy beyond the very early stage can cause companies to go through variable professional services margins periods. They may have stabilized their core product and market and margins, then as they introduce a new product or module, which is marketed and sold before it is fully productized, margins go down. Often times, a new product for a specific vertical or type of implementation is sold as a new product, when it really is more of a template which requires custom implementation. Then as they gain market and customer experience, more product capability is built in and professional services percentages and margins improve. Then the cycle is repeated in another area in order to expand sales and increase average contract values again.
SaaS companies following a low-priced product/high volume customers strategy tend to either have no professional services or only a small portion of revenue from professional services- at most in the 6-7% of revenue range. These vendors tend to spend a relatively high percentage of revenue on R&D resulting in self-service products and support.
Growth SaaS companies with ARR in the $20M – $100M range selling in the mid-market with average contract values in the $10k-$50k range often have professional services revenue streams in the 12-18% of revenue. These companies are trying to
- Grow their average contract value (ACV), and
- Grow upstream into larger customers
Their products are not fully self-service and require some help with implementation and customization. Their customer base isn’t quite ready or willing to pay a large enough subscription to cover productizing all of the capabilities currently being delivered by professional services as in the full enterprise market, and the vendor hasn’t quite reached scale to complete productizing all the functionality required for higher value customers.
Key Take Aways
There’s no one size fits all model for B-2-B software/SaaS professional services margins or percentage of revenue. Different companies follow different models based on product, market and growth strategies and the requirements of a particular period of growth (new product introduction, fast customer acquisition, etc.).
Low professional services margins can be balanced against high product margins, especially if they contribute to fast customer acquisition. At the end of the day, the goal of the Rule of 40 does play a factor, both among private investors and public investors. When evaluating a company’s model, if low professional services margins are a tactic to get to improved performance and can be improved later, then the model is okay. But, if low professional services margins are a requirement of the business, and there’s no improvement in sight, then it isn’t sustainable.