Big Tech and the Hunt for the ‘Magic Number’

(Bloomberg Businessweek) -- Banish thoughts of Uber Technologies Inc., Airbnb Inc., or whatever other flashy startup comes to mind when you imagine Silicon Valley riches. In what's been a bumpy year for tech companies, the superdull are the few sure things.

These companies sell nuts-and-bolts software used by businesses or office workers and include Veeva Systems Inc., which makes programs that pharmaceutical reps use to keep track of their sales prospects, and Twilio Inc., which coders use to create automated smartphone notifications when, say, an Uber is arriving. Their sales tend to grow like weeds, making it easy for investors to fire up a spreadsheet and predict when the company might turn profitable. (It's 2019: Even the safe startups are unprofitable.)

But there's good growth, and there's unsustainable growth. If you pay $2 in sales and marketing for every $1 soda someone buys, that's a recipe for a run on fizzy drinks and a dead business. Young tech companies are particularly vulnerable to this pitfall. In the minds of investors, if they're not growing fast, they're irrelevant.

The question is whether companies are spending for ephemeral or lasting revenue. One way to figure that out is by calculating the so-called magic number. The basic idea is to look at how much additional revenue comes from sales and marketing spending, but there are different approaches to getting there.

So who's got a magical magic number? Workplace data analytics company Splunk Inc. does, as do Twilio and Veeva. Closer to danger are Cloudera Inc. and Box Inc., both of which are hugely unprofitable because of high sales costs. Investors are beginning to notice.

• Easy Come, Easy Go

What does all that marketing money buy? Mainly it goes to salaries and commissions for guys who play golf with the executives who control companies' technology budgets, free trial offers to get customers hooked on the software, and advertisements placed in magazines such as this one.

• Living the Dream

Blue Apron Holdings Inc.'s sales almost doubled over six months in 2014, around the time it was spending a quarter of its revenue on ads, free meal kits for new customers, and other enticements.

• A Cautionary Tale

When Blue Apron's marketing scaled back, growth evaporated. Shares are down 94% since its 2017 initial public offering.

 
This simplified tally of a few tech darlings' “magic numbers” was created by multiplying each of their latest change in quarterly revenue times 4, and dividing by sales and marketing expenses. Anything greater than 0.75 is considered solid.
 
Ovide is a tech columnist for Bloomberg Opinion

To contact the editor responsible for this story: Jillian Goodman at jgoodman74@bloomberg.net, Howard Chua-Eoan

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