Enterprise Software Unit Economics Are Worse Than You Think
When commissions scale with revenue...
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This week, we have Braden Dennis on the podcast. Braden is the co-founder of Finchat.io (disclaimer: sponsor of ours and Ryan’s boss) as well as the host of the Canadian Investor Podcast.
I learned a lot from this interview. We did the classic discussion on his portfolio, but my favorite part was diving into what he has learned building a software start-up.
And trust me, they are building a good one. We get notifications almost daily of listeners signing up for Finchat.io (which we thank you so much for).
You or I cannot invest in Finchat.io, and we are a public markets podcast. However, Braden can help us take what he has learned in building a software start-up and apply it to our research.
One lesson? Enterprise software sales may have lower gross margins than you think.
Why? Because of those pesky sales commissions. On an enterprise software deal, the sales team will get 10% - 15% of every deal value. However, this is considered an operating expense at most companies.
I don’t think it should be.
Sales commissions will mostly scale with revenue. The sales staff — and their large salaries and perks — will scale with revenue too. Large enterprise software businesses may have thousands of people on their sales teams.
Consumer and self-serve software (i.e. UN-enterprise software) do not have these expenses. That gives them better unit economics and therefore more operating leverage. Meta Platforms is a perfect example of this.
Enterprise software can be a great business. But it is not a perfect business, and we should not expect every single one of these companies to reach 40%+ operating margins (which is how they were priced in 2021).
-Brett
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