Software Development: The Surprising Source of Profitability for SaaS Companies

August 2, 2016

By Steve Mezak

Software development engineers are simultaneously the greatest asset and the greatest 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.


So, what happens when 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 were so 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? (And, 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 most:gross margin and cash flow. Think of it as a quick primer on SaaS metrics for software engineers. Stay with us… your moment to shine is coming.

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:

Gross margin equation

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:

EBTIDA equation

Software Development Costs and Cash Flow

SaaS companies have two ways to improve cash flow and margin. First, you can increase revenue per unit. Think: 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. 

But is outsourcing software development truly beneficial to your bottom line? Twitter_logo_blue_32.png Rather than attempt to convince through words, check out the numbers. Let’s assume the following all-in costs for employing a mid-level software developer. These numbers are conservative, but they’ll give an adequate representation of the expense.

In House vs. Outsourcing

Salary
80%$55/hour
Benefits and taxes
75%$15/hour
Office space, networking, administration
25%$10/hour
Total Cost
100%$80/hour
Hiring, Benefits, Tax and Overhead
35%$35/hour
Accounts for lower productivity
30%$6/hour
Management and oversight
15%$4/hour
Total Cost
45%$45/hour

 

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

Ok. 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, 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

Onboarding 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 that 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 partners. While it takes time to build a relationship, it’s worth it. Having a partner who understands, cares about and is loyal to you is good for not only margins, but also 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. The efforts will reap exponential benefits and you’ll be known as the genius who knows how to produce 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.

Outsource or Else!

We wrote the book on software outsourcing.

Learn more about successful software outsourcing in the critically acclaimed business fable from Accelerance founders, Steve Mezak and Andy Hilliard.
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