September 30, 2023
Software development engineers are simultaneously the greatest asset and the biggest expense for SaaS companies. With a shortage of software engineering talent in U.S. markets, even junior developers are earning nearly six figures, making building a highly skilled team costly. The profit margins with software development companies can be beneficial for businesses but difficult for consumers.
So, what happens when the workload fluctuates? Once you’ve acquired your crack team of software unicorns, you won’t want to let them go because finding and onboarding them was difficult. Personnel costs get bloated. Flexibility and scalability are sacrificed.
What’s a software development leader to do when you need quick access to talented coders for the next vision and version you’re asked to deliver at the speed of sound itself? Not to mention doing so on a budget that never seems quite adequate.
"Lowering the costs associated with SaaS product development can be a surprising lever for increased profitability while simultaneously gaining speed, innovation, technology and best practices."
To explain how, let’s start with the metrics that investors, stakeholders, and stockholders care about gross margin and cash flow. Think of it as a quick primer on SaaS metrics for software engineers.
Gross Margin
Gross margin is the number most investors care about. To gain valuation, SaaS companies not only need a solid business plan in place but also a gross margin that attracts investors.
Gross Margin is expressed as a percentage:
Cash Flow
In addition to having a solid gross margin, you need positive cash flow to meet expenses. While a business plan and gross margin are important, they won’t sway an investor if the software company can’t meet its monthly expenses.
Investors also weigh a company’s earnings before interest, or EBITDA. This number gives firms a good proxy for cash flow. EBITDA calculates earnings before interest, taxes, depreciation and amortization. It can be expressed as:
Software Development Costs and Cash Flow
As a SaaS company, you have two ways to improve cash flow and margin. First, you can increase revenue per unit. Think about the monthly subscription price for end users. Second, you can reduce expenses or operational costs.
By moving either lever or a combination of the two, many software development companies can achieve a target gross margin and EBITDA within today’s range of typical averages.
However, not every SaaS company will be able to increase revenue, especially when market factors are at play. Instead, they focus on decreasing costs.
To get the most impact and see more movement in both areas, most companies use a dual-pronged approach. By simultaneously decreasing costs and increasing revenue, either through pricing or new products, you gain steadily improving margins.
Now, we’re at the part where you can be a profitability hero.
Fanfare, please...
Calculating SaaS Development Personnel Costs
One tried-and-true way to decrease business costs is to take a closer look at those associated with personnel. Compensation is one of the largest overhead expenses for a company, so outsourcing software development can improve your gross and EBITDA margins in that regard.
An outsourced team of 100 software engineers, and by that we mean a team that has been successfully onboarded and is familiar with internal policies, practices, and processes, would save the company $4.0 MM - 6.0 MM per year (the lower end of the range assumes higher ongoing management costs).
Outsourcing is Your Corporate Money Tree
Well, maybe not quite. Money doesn't magically start dropping from trees once software engineering has been outsourced. The following four selection factors are critical to gaining profitability through software outsourcing.
Team Selection
You’ll want to take a close look at the capabilities of your outsourced vendor, including their culture and the size of your engagement relative to their entire customer base. Learn where they are willing to grow with your company to learn new skillsets like waterfall methodology or agile.
Onboarding
The onboarding process can determine the success of many - if not most - outsourcing projects. Working with an external partner takes time, particularly at the outset. The outsourced team needs to ramp up to produce the work expected of them. It’s unfair to expect them to hit the ground running, the same as it is to expect it from a new hire.
Set Your Goals
It’s essential to understand what your development needs are and match them accordingly. You might place a premium on keeping costs low, for example, while others want to get their hands on highly skilled R&D talent who know the latest augmented reality technology. If you’re looking to increase margins, you’ll want to plan for that from the beginning.
Relationship
The most successful outsourced engagements are those in which the client and the outsourcing firm are true partners. While it takes time to build a relationship, it’s worth it in the long run. Having a partner who understands, cares about, and is loyal to you is good for not only your margins but also your reputation. Service providers, like employees, enjoy working with companies that treat them well.
Outsourcing for Profitability
Outsourcing, when done well, can improve margins and cash flow for SaaS development companies. Spend the time to set your goals, select the right outsourced development provider, and build a true partnership. These efforts will reap exponential benefits, and you’ll be known as the genius who k produced great software with cost-saving partnerships around the world.
Trust your software to Accelerance.
Accelerance is your global software outsourcing authority. We connect Western companies with the world’s most talented software development and engineering teams. Talk with an Accelerance software outsourcing advisor representative about your no-risk consultation.