Tinker: Microsoft and Cisco may be two examples of very rare companies who might have done such growth when their businesses were at scale. But it is a very rare feat to pull off.
Saul: Hi Tinker, that’s an interesting observation. I’m just wondering whether the modern companies we are discussing may have a better chance of continuing their growth because of the business model. They are, most of them, selling software as a service (SaaS) on a subscription basis, so they have 90% or 95% of their revenue recurrent and guaranteed for next year. When Cisco sold something they had to go out next year and sell another one. And some good SaaS companies have a Dollar-based renewal rate of 125% or so, meaning that they actually get an actual 25% growth “almost” recurring, and thus they only need another 25% of new revenue to bring them to 50% growth. Of course, as they get bigger that 25% growth gets harder to get, and that dollar-based renewal rate may recede back towards maybe 105%, but still… What do you think? (Or anyone who wants to chime in).
As you might imagine, I very much agree with this. It’s a great summary of the advantages of a subscription business and I will refer back to it often.
Another way to put it is that the money they spend on Opex (S&M especially) is a one time expense for an indefinite amount of revenue not the same quarter, but for an indefinite amount of quarters into the future. Where as a non-subscription company has to spend more each quarter in hopes to have more revenue than the last quarter, a subscription company’s S&M spend is totally in pursuit of additional revenue. Basically they are starting at 100% of the previous quarter’s revenue (or possibly more if they have deferred revenue!) before they begin.
Here’s how I visualize what this does to the Income Statement. The gross margin is the mathematical limit of profitability. As in mathematics, you never reach the limit, you only approach it. The gross margin in these companies is usually anywhere from 60 - 80%, so we’re really talking huge potential. Because eventually OpEx eventually becomes a smaller and smaller percentage of revenue, operating profits grow toward the gross margin limit. Again, they never actually reach 60% or 80% operating margin, but they should continually increase toward that over time. That’s why I’m so excited about the business model.
Adobe is a good current example for a much larger company, and they’re “only” growing revenue about 25%. Check out the operating income growth, though!
2013: 413M (10% of revenue)
2016: 2168M (30% of revenue)
Now that’s just incredible improvement in 3 years. And that kind of blast of profit potential should be in the future for companies like Shopify. My case in the first post of this thread was intentionally understated, because I do think their operating margin might very easily be more like 30%+ in 5 years. So even if they average less that 45% revenue growth (even though I see that as achievable as well), they just have so many ways to win.
The interesting thing is that other companies have even higher gross margin than Shopify (Wix and Hubspot have gross margins over 80%). Think about the potential there!