Oracle, founder & CEO Larry Ellison believes SaaS is not profitable enough. Here’s some excerpts from an article I read:

“We continue to get better at it and grow the (on-demand) business,” he said in an earnings call yesterday. “[But] it’s not really growing any faster than our overall business.”

“If you look at the leader, Salesforce.com, they don’t make very much money and they’ve been at it for almost 10 years”

“It’s hard to point to any software-as-a-service provider that’s doing a good job of improving its profitability,”

“… the entire on-demand industry has to get better at making money in selling on-demand software.”

I decided to do a little digging to uncover the facts.

Here are the Gross Profit Margins comparing the top on-premise and on-demand software vendors. All figures were taken from Google Finance based on the 2007 numbers.

Gross Profit margin is the measure of profitability before fixed cost. From the looks of it, the SaaS companies are indeed trailing the Big 3 (Microsoft, SAP and Oracle). In fact, judging by this metric alone, it looks like Oracle and Salesforce are the same in terms of profitability. So what the hell Larry? If we look at Net Profit margin that might explain something.

When you look at it from a Net Profit margin point of view, you can see what Larry’s talking about. Net Profit is profitability AFTER fixed costs. Indeed the SaaS vendors are way behind. Take note, Larry Ellison’s NetSuite is still not making a profit each year! So what’s going on? Could we just be naive of the fact that the Big 3 are established money machines. It’s important to also understand that many of the SaaS companies are still quite young which require significant initial investments.

At the same time, what category does hosting and data center expense fall under? To some it may be a variable or fixed cost. I would presume that most SaaS companies would consider it a fixed cost. Because most of them are not adding to the infrastructure as they sign up new customers. Servers and data centers are usually built and provisioned in anticipation of signing new customers. Though the cost of hosting and infrastructure could be pulling down profit margins, Larry is also forgetting one thing. Cost is not the only thing that affects profitability, so does revenue. If the demand for SaaS keeps up at this pace, then by the law of economics, demand for on-premise software will drop. And you too will see your profitability dropping as well. Then again, I’m no software mogul.