Innovation or Distribution? | Analyzing R&D vs S&M Spend
What companies spend on S&M relative to R&D might surprise you.
Founders embark on a journey to change the world with their amazing new software tool only to eventually realize that more is spent creating a distribution engine through sales & marketing than the actual product.
One of the flaws of many technical founders is the belief that the product will sell itself and that everything can be solved if the product is improved. This unfortunately isn’t usually the case. Side note - technical founders’ obsession with the product is also one of their greatest strengths
The best product doesn’t always win.
Yes, the product needs to be good, but…that isn’t enough. There are LOTS of good software products out there. Revenue growth provides the fuel for more innovation through R&D spend. If you don’t grow you can’t increase spend on innovation and things will slow down.
If you can get to $10M in revenue with your existing product then you likely can get to $20M or $30M with the same product (same concept applies at larger scales). But if revenue growth slows then you can’t spend as much on R&D, which slows down innovation and ability to continue high revenue growth.
I really like Dave Kellogg’s setup on this topic with the below slide
Public Cloud Companies - S&M vs R&D
The average public cloud company is spending 1.6x more on S&M than R&D!
The top 10 fastest growing public companies spend 1.7x more on S&M than R&D, which is only slightly higher than the total population average of 1.6x. The increase comes entirely from their higher spend on S&M.
Similar with the top 10 revenue growth companies above, the companies that receive the highest valuation premium (measured by enterprise value / revenue) spend very close to the overall public company average for S&M and R&D.
The companies with the highest S&M spend relative to R&D have a much lower valuation multiple than the general average. Below are the top 10 highest S&M/R&D ratios. These 10 companies on average spend $2.80 on S&M for every $1 on R&D! These companies have an average 4.9x EV/Revenue multiple while the overall public cloud population has 7.2x — well below the average.
Only a handful of companies spend more on R&D than S&M. These companies have a significantly better EV/Revenue multiple than the other extreme with an average revenue multiple of 8.7x.
Between the two extremes, the companies that focus on R&D clearly receive a much higher valuation premium than those who spend much more on S&M. The average valuation multiple difference is nearly 2x for those companies on the extreme end of R&D spend.
One of the big differences between these two extremes is the total S&M and R&D spend. For those companies with the highest relative R&D spend, they spend a total of 58% of their revenue on both R&D and S&M (calculated at the 22% plus 36% in the chart above). The companies with the highest relative S&M spend however, spend nearly 72% of their revenue on both R&D and S&M.
On the S&M spend extreme, those companies are spending 14 percentage points more on S&M and R&D!! They are much less efficient so it makes sense they will receive a much lower valuation multiple.
Stage Matters in OpEx Spend
Typically you can’t sell without a somewhat good product…although I know some sales people who have sold products that don’t even exist🤣.
Early stage companies spend much more on R&D but as a percentage of revenue that declines over time until reaching around 20-30% of revenue, which is the public company average (although this is likely too high for a very mature company)
The best products don’t always win and they almost never sell themselves. Most cloud businesses win through a good product and a great go-to-market (GTM) machine. As a company’s revenue increases then it can justify more spend on R&D to continue its fast innovation and become the best product.
On the extremes though, companies with high S&M spend relative to R&D appear to not do great as evident by their significantly lower valuation multiples and higher inefficiency.
The fastest growing public companies and those with the highest valuation multiples spend ~1.6x on S&M compared to R&D. These ratios should change though as a company scales and revenue growth slows.
There is no one-size fits all in what this ratio should be, but the best companies balance the spend better.
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