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Predicting Economies of Scale: Scale Required to Become Profitable SaaS.

Author

Chintankumar Maisuria
August 19, 2024

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Read time: 3 minutes.

Welcome to the 60th edition of The Growth Elements Newsletter. Every Monday, I write an essay on growth metrics & experiments and business case studies.

Today’s piece is for 5,100+ founders, operators, and leaders from businesses such as Shopify, Google, Sage, Hubspot, Zoho, RateGain, Zaggle, Servcorp, Apollo and more.

Happy Monday!

It is crucial to evaluate if the business has the potential to become profitable and when before pumping capital and scale.

One of the best ways to figure this out is using the Contribution Margin.

In SaaS, it represents the profitability of individual subscriptions after accounting for variable costs.

Contribution Margin = (Revenue - Variable Costs) / Revenue.

[1] 𝐏𝐫𝐞𝐝𝐒𝐜𝐭𝐒𝐧𝐠 π„πœπ¨π§π¨π¦π’πžπ¬ 𝐨𝐟 π’πœπšπ₯𝐞

  • As the number of subscriptions increases, fixed costs (e.g., software development, marketing) are spread across more accounts, reducing the average cost per subscription.

  • Higher contribution margins indicate more revenue available to cover fixed costs, leading to economies of scale.

[2] ππ«π¨πŸπ’π­πšπ›π’π₯𝐒𝐭𝐲 π“π‘π«πžπ¬π‘π¨π₯𝐝

  • Businesses become profitable when total revenue covers both variable and fixed costs.

  • Contribution margin helps determine the subscription volume needed to achieve this.

[3] π‡π²π©π¨π­π‘πžπ­π’πœπšπ₯ π„π±πšπ¦π©π₯𝐞

Suppose a SaaS business has the following numbers:

  • Subscription Price per customer: $100

  • Variable Cost per customer: $30

  • Contribution Margin = ($100 - $30) / $100 = 0.7 or 70%.

  • Now, if the Fixed Costs = $50,000

[4] 𝐁𝐫𝐞𝐚𝐀-𝐞𝐯𝐞𝐧 π€π§πšπ₯𝐲𝐬𝐒𝐬

  • To cover fixed costs: $50,000 / $70 (Contribution Margin per customer) = 715 subscriptions.

  • At 715 subscriptions, the revenue will be $71,500, variable costs $21,450, and the contribution margin will cover the fixed costs, leading to profitability.

π…π’π§πšπ₯ 𝐖𝐨𝐫𝐝𝐬

Understanding and maximising contribution margin helps SaaS businesses predict the scale required to become profitable.

This involves calculating the break-even point and leveraging economies of scale as subscriptions grow.

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That's it for today's article! I hope you found this essay insightful.

Wishing you a productive week ahead!

I always appreciate you reading.

Thanks,
Chintankumar Maisuria