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The right contribution margin in software

Contribution margin is one of the most important metrics in SaaS. It’s revenue from a certain set of customers (a cohort) less the cost of acquiring and servicing the customers over time.   Customers are generally grouped into annual cohorts – in other words, customers acquired in 2011 are the 2011 cohort, those acquired in 2012 are the 2012 cohort, etc. ZScaler provides a nice chart of the performance of the 2015 cohort in their S1.

We found only 9 publicly traded SaaS companies that mention contribution margin in their public filings.  The quality of disclosure was also varied and limited. For instance, Box disclosed the least about their contribution margin while Coupa Software disclosed the most.  The data was still quite valuable and below is a summary as well as some observations.

You will lose money on the customer in the first year.  The cost of a customer in the first year is especially high because it includes not only the cost of customer success/customer service, but also the marketing and sales expense to acquire the customer. As a result, no SaaS company in the data set makes money on the customer in the first year. Contribution margins in the first year for Z-Scaler, MobileIron, Mind Body, Coupa Software, Okta, Workiva, and Mongo DB were -87%, -28%, -254%, -249%, -93%, -81%, and -111%. As you can see some SaaS businesses like Mind Body and Coupa Software lost a lot of money in the first year of acquiring the customer, so it’s critical they not lose the customer in subsequent years in order to earn a profit.

By the 3rd year, the customer is thoroughly profitable. In the third year of owing the customer, Mobile Iron generated $4.70 in in contribution margin, Mind Body did $5.83, Coupa did $7.50, Okta did $22.10, Workiva did $13.40, ZScaler did $18.80, and Mongo did $11.70. This is the beauty of SaaS: so long as you keep the customer, you’ll make a lot of money from them.

After the first year, contribution margin is consistent. In the first year, contribution margin is negative because it includes the cost of acquiring the customer. But after the first year, all that is left is servicing the customer, so contribution margins tend to show great consistency. Only Mobile Iron shows volatile margins after the first year. Excluding Mobile Iron and Box, we see contribution margin after the first year falling somewhere between 60% and 75% for the companies above. This is a typical fully baked SaaS margin when including the cost of customer service/customer success.

Contribution margin is difficult to measure, but an imperative metric for understanding the health of your SaaS business. Make sure you monitor it for each customer cohort annually.

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