SaaS companies are all about fast revenue growth and great products. Most discussions about SaaS models focus on Sales and Marketing – in fact we wrote a post about it last week, but what about R&D (Research & Development)? You can’t have fast growth without great products, so how do you measure SaaS R&D performance?
Valuable tech companies get high multiples of new revenue for every R&D dollar spent. Take a look at SalesForce.com in the years around their IPO (2004):
Source: OPEXEngine EdgarEngine analysis
Not only was SalesForce’s R&D productivity measure extremely high, but it improved over the next several years – investors always like to see upward trends.
How to Calculate the R&D Performance
At the highest level, the best and clearest way to track R&D productivity is the R&D performance measure. This calculation tracks how much new revenue is associated with each R&D dollar. It is valuable to compare your organization’s R&D performance measure against competitors, peers and market leaders. Obviously, R&D alone doesn’t create new revenue, the rest of the organization has to perform effectively and fire on all cylinders as well. You can’t produce new revenue with even the greatest of products if you don’t effectively market and sell them.
The R&D performance measure is calculated by taking last year’s R&D expense against this year’s change in revenue – think the Magic Number for R&D.
SaaS R&D Productivity Benchmarks
R&D productivity can be managed and improved with disciplined new product planning for each new development the company undertakes. Mid-sized, private SaaS companies on a fast growth trajectory have an R&D productivity measure between 2 – 3. How can companies use the benchmark to achieve good or great R&D productivity?
A SaaS CFO looking to meet or beat the benchmark can require that all new product development should pass a test of producing 5x new revenue within 12-18 months of launch. For example, if the product team wants approval for a new product or development costing $1M in expense, approval is only granted if there is confidence that the new product will drive at least $5M (5X the R&D expense) in new revenue in the next year.
The revenue multiple can be gauged by how much a company spends on sales and marketing—if the company’s business model requires a high spend on sales and marketing to produce new revenue, then the development-to-new revenue multiple should be higher.
Another metric to track carefully is the percent of total R&D expense spent on new development versus the percent spent on tech debt or product maintenance (typically viewed as necessary to keep customers satisfied and maintain the technology base for products). Tech debt is also understood to be the implied cost for rework required because of choosing an easy development solution over a longer-term solution. High tech debt can indicate problems in your R&D organization and management.
Investment to reduce tech debt is necessary, but doesn’t contribute directly to revenue growth and every tech company has to balance their R&D spending between maintenance and driving new revenue. If there’s too little spending here, the effects will be felt at some point in the future—particularly with the existing customer base, which is critical for high renewal rates and recurring revenues. If there’s one assumption you can make in the tech industry, it is that technology will keep evolving and you’ll need to invest to keep your products current.
Managing Tech Debt
SaaS CFOs typically target an upper limit for tech debt spending—we’ve seen that in the range of 20%, ie., no more than 20% of total R&D spending can be spent on tech debt. With a minimum amount spent on tech debt ever year, R&D departments have to prioritize and carefully evaluate maintenance activities. Early stage companies have less tech debt—but a bigger risk of taking the easy route to bring new products to market fast while paying the piper later. Later stage companies, or companies navigating a product/technology transition, have more product maintenance to do, so a CFO has to manage this expense over time.
Managing the amount of tech debt a company incurs along with the associated rework expense is critical for SaaS companies. This will have a direct effect on revenue and the ability of an R&D organization to produce new products and enter new markets. It should be measured and tracked annually and longitudinally.
Peter Drucker wrote, “Measurements need to be measurements of performance rather than of efforts.” Too many SaaS companies only look at the total R&D expense and measure some R&D activity without measuring R&D productivity, and then work backwards to measure the drivers of that R&D performance.
By benchmarking your company’s R&D performance measure, you can compare yourself to peers and competitors in the market. OPEXEngine’s comprehensive SaaS benchmarking platform gives you the analysis and data to compare performance, as well as the key performance drivers, for R&D, Sales, Marketing, G&A, Professional Services, and Customer Success.