Is There an Enterprise Margin Crisis?

0/ Is there an Enterprise Margin Crisis? It’s not uncommon to see software startups with surprisingly low margins (30-40%). I believe there is a broader trend going on here, which I explore in this thread.

1/ While not all of these are new, there are a number of macro trends that have downward pressure on margins: the move to cloud, AI/ML, bottom-up GTM (go-to-market), etc. Below I outline the most common contributors I see across the industry.

2/ AI can be expensive: Many AI/ML companies will have unique data sets and unique models per customers. This can add a nontrivial compute and data management component per customer dollar spent.

3/ Lack of central buyer: Software continues to penetrate non-traditional verticals (forestry, mining, construction, agriculture, etc.). However, in some verticals, there is no central software buyer and LTV/CAC (lifetime value/cost to acquire a customer) is well off traditional IT.

4/ Data costs suck: The economics of data do not necessarily get better over time. Data is expensive to collect, store, maintain, move, process, label and keep fresh. In many domains, data unit contribution costs grow over time.

5/ Automation isn’t magic: Many companies start with humans doing a process and then hope to improve margins through automation. This can be technically very challenging, and the drive for growth makes prioritization difficult.

6/ Unoptimized cloud: Private markets push for growth, and so cloud implementations can be horribly inefficient (by orders of magnitude). Correcting that, once growth slows and margins are more important, is rarely trivial.

7/ Reselling cloud: A number of *aaS companies have non-trivial back end cloud costs per $ of their product they sell. If they don’t structure sales comp right, they incentivize their reps to resell cloud while not having direct discounting authority over it.

8/ Dropping ACVs (annual contract values): Lower price points on bottom-up products create a cost anchor against similar enterprise-grade products with top down sales. And not all products or buyers can drive the net dollar retention needed for attractive LTV/CAC.

9/ Two GTM motions: The move to bottom-up adoption favors products that are pushed initially via product / marketing. However, over time larger dollar pools are reached via enterprise sales. Doing both can be expensive if not done right.

10/ Services: Customer dollars on the high end continue to shift from product to services. Startups smartly chase these to get initial traction and maintain strong account control. But relying on them does mean a lower margin business on the book.

11/ This isn’t to say that enterprise startups should sacrifice the right GTM motion or product trade-offs to protect margins. Rather, the first generation of SaaS may no longer be the right point of comparison for an attractive margin profile. And that’s perfectly fine.