The right level of dev spend
We looked at the R&D spend of tech companies at IPO and in prior years (usually Series B to D rounds) to answer the question ‘what is the right level of spend on R&D’. The data is below and varies by industry.
SaaS. Leading up to the IPO, SaaS companies spent on median 23% of revenue on R&D. As you can see there is almost no deviation between the financials reported at IPO and 2 years prior. (medians were 22% and 23% respectively) For many of these companies, they were in their Series B or Series C two years prior to IPO, so it’s safe to say that spending a quarter of revenue on R&D is the right level for a SaaS business even at earlier stages. No matter where your SaaS business is in its lifecycle, as one founder put it to me, “managing a large and growing stack for a cloud application is damn tough” so you’re going to be spending materially on the stack no matter how fast you’re growing or how mature you are. The median level of revenue at IPO for these SaaS businesses was $99mm so with 23% of revenue going to R&D, that means R&D spend was $20mm on median at the time of IPO. That’s a lot of dev talent.
Note that for SaaS companies, there is no correlation between R&D spend and growth (correlation is only 0.18). In other words, just spending more on R&D and new product doesn’t result in more growth. We believe growth comes from a strong sales and marketing function, not more or better product.
Social Media. On median, social media companies spent $151mm on R&D prior to IPO which was 32% of revenue. No industry spent as much on R&D in terms of absolute dollars or percent of revenue. Snapchat was especially high spending 45% of revenue prior to IPO and 140% of revenue the year prior.
Marketplaces. On median, marketplaces spent 14% of revenue on R&D prior to IPO, 14% the year before that, and 18% two years before. Spending was pretty consistent across all of the companies except for Expedia which spent 55% of revenue on R&D prior to IPO. On median, spend was $16mm to $24mm in the years leading up to IPO.
Subscription. Similar to marketplaces, the R&D spend was consistent, as subscription based businesses spend only 10% to 11% of revenue on R&D. Note the range of spend was wide (6% to 35%) although the median for the group was $15mm to $18mm in the years leading up to IPO.
Ad based and Gaming. Businesses which generate revenue primarily from selling ads or in the gaming space were all over the place, making the median or average a little misleading. The range was 5% to 65% for ad based and 4% to 64% for gaming. We need more data points for these businesses before making generalizations.
E-commerce. Ecommerce businesses on median spent 12% of revenue on R&D spend prior to IPO. Interestingly, most of the companies in this sector don’t break out R&D or tech spend. Note Shutterfly’s spend really stands out.
Hardware. Hardware also spent a consistent 12% to 13% of revenue on R&D spend. Surprisingly the spend as a percent of revenue hasn’t changed much over time, as Apple’s spend was in line with more recent peers like Sonos. That said, Apple spent $6.5mm on R&D prior to IPO whereas Sonos spent $124mm.
Similar to SaaS companies, there is no correlation between R&D spend and growth for these other tech companies (correlation is only 0.25). Again, just spending more on R&D and new product doesn’t result in more growth.
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