Uber may deliver marijuana in the future. Update on Credit Karma and Square

Uber’s business reportedly hit a stride in March. CEO hinted at the prospect of delivering marijuana

In a filing today, Uber revealed that it had an astonishing month in March 2021, when its Gross Bookings hit the highest level in the company’s history. Uber said that its annualized bookings for Mobility and Delivery hit $30 and $52 billion, respectively, last month. I have mixed feelings about this. At the first glance, the filing seems like a trove of good news for Uber as the figures imply that its two main business segments are firing on all cylinders. Uber’s total bookings in 2018 and 2019 were $50 and $65 billion, respectively. If the annualized numbers above are realized in 10 months’ time, that will be an impressive achievement for a company of this size, given that our societies spent more than one year in a historic pandemic.

But IF is the important word here. To be honest, I don’t really know how the annualization is calculated. Did they multiply the bookings in March by 12? Or did they multiply the bookings in the best week in March by 52? I may be ignorant not to understand the nuances in these languages, but if you invest your hard-earned cash into a company, it’s healthy to be a bit paranoid.

Another news that came from Uber is that its CEO hinted at the prospect of delivering marijuana.

“When federal laws come into play, we’re absolutely going to take a look at it,” 

Source: The Verge

Two months ago, I wrote about Uber’s acquisition of Drizly, the market leader in liquor delivery in the US. Chief among the benefits of acquiring Drizly for Uber are the proprietary technology that can verify IDs and the team that knows how to navigate the complex legal systems at the state and county levels. These capabilities will be tremendously helpful to Uber if they decide to delivery marijuana. Even in the states that allow the cannabis delivery, consumers still have to show that they are old enough; which is the perfect use case scenario for what Uber gets from Drizly. Right now, marijuana for recreational purposes is only legalized in a handful of states and is still illegal at the federal level. Some Democrats are pushing to change that and I think that it’s just a matter of time before the change takes place. Even if marijuana for fun is legal on the federal level, there will still be a lot of work to be done on the local level as each state will have a different mandate. In that case, having a team that knows how to deal with regulations from county to county on liquor delivery like Drizly will come in handy. The recreational legal cannabis market in the US is estimated to reach $27 billion by 2024. Estimates like this are usually optimistic, but even if half of that estimate checks out, it will increase Uber’s Total Addressable Market significantly.

Update on Credit Karma and Square

Last month, I wrote about Square’s acquisition of Credit Karma’s tax unit and potential benefits that the former can take from the latter

In essence, it benefits Square when customers have balance in their Cash App. The more balance there is, the more useful Cash App is to customers and the more revenue & profit Square can potentially earn. I imagine that once Credit Karma’s tax tool is integrated into Cash App, there will be a function that directs tax returns to customers’ Cash App. When the tax returns are deposited into Cash App, customers can either spend them; which either increases the ecosystem’s value (P2P), or deposit the fund back to their bank accounts. But if customers already direct the tax returns to Cash App in the first place, it’s unlikely the money will be redirected again back to a checking account. As Cash App users become more engaged and active, Square will look more attractive to prospect sellers whose business yield Square a much much higher gross margin than the company’s famous Cash App. 

Today, a user on Twitter noticed the new integration between Credit Karma and Square that would enable users to direct tax refunds straight to their Cash App account. Even though this is a logical move, how it will actually benefit Cash App remains to be seen as there hasn’t been any reporting on the overlap between Cash App and Credit Karma’s tax unit in terms of active users. Nonetheless, I look forward to seeing what Square brings to the market that stems from this acquisition.

Weekly reading – 20th march 2021

What I wrote last week

The economics of a credit card

Business

Hy-vee CEO shared how Covid shaped the company’s operations moving forward

Why Amazon Fresh stores will likely rock a few boats. As its competitors do more shipping from their own stores, Amazon can get on level terms in that sense with having more stores of their own in strategic locations. Plus, if they can get these cashierless stores to run properly, they will be able to cut back a significant line item on the Income Statement, paid employees!

How Trader Joe’s $2 wine became a best-seller

Telegram App Is Booming but Needs Advertisers—and $700 Million Soon 

The new Google Pay repeats all the same mistakes of Google Allo

Apple brand loyalty hits all-time high as Samsung loyalty dives

Austin Rief: How Morning Brew went from college newsletter to $75 million in 5 years

She Came to the US to Study With Only $300 in Her Pocket — Now She’s a NASA Director For the Mars Rover

What I found interesting

Does Atlantic Canada have a blueprint for rural revival in the post-pandemic era?

Facebook’s GDPR bypass reaches Austrian Supreme Court

Stats you may find interesting

BNPL grew by 215% year over year in Jan and Feb 2021. Total eCommerce spending reached $121 billion so far

As of February 2021, 45% of Square sellers accept online payments, up from 30% a year ago

56% of the people surveyed by AirBnb preferred domestic travel post-pandemic

Weekly reading – 13th March 2021

What I wrote last week

My thoughts on Square’s acquisition of Credit Karma’s tax unit

My review of the book Think Again: The Power Of Knowing What You Don’t Know

Business

An interview with Elliot Turner on Twitter. Lots of good stuff in here.

Octahedron Capital publishes a super interesting presentation every quarter, compiling quotes from executives

A very interesting piece on how Jeff Bezos approached design. I love the anecdote on how Amazon’s logo came into beings.

How Salesforce became Silicon Valley’s best late-stage tech investor. Salesforce is a prime example that you should care more about Operating Income than Net Income if you want to evaluate a company’s operations

A great post on the importance of reinvesting in a business. As the saying goes, it’s one thing to get to the top of the mountain, it’s another to stay there.

A great conversation between The Verge and Twitter’s Head of Consumer Product. The company announced some very interesting product developments in the pipeline. As a fan of the platform, I can’t wait to see what unfolds next

Postmates added $70 million in revenue and saved $3 million in network fees with Stripe

Neil Cybart published a new article on the importance of Apple’s retail stores

A very telling piece on how Facebook’s internal effort to curb misinformation using AI was punted by Zuckerberg’s desire for growth

What I found interesting

Apple Gave Us an Exclusive Look Inside Its Next-Generation Fitness+ Studio

Tesla told California DMV that its future autonomous vehicles wouldn’t be fully autonomous. What else is new?

WSJ’s profile on Manchester United star forward, Marcus Rashford. If you are not familiar with football (yeah, the real football where the ball touches feet more than hands), Manchester United is one of the richest and biggest clubs in the world. It has a reputation of playing home-grown talent and actually has been fielding at least one academy player every game for the last few decades. Marcus Rashford is the latest biggest home-grown star that came out of the famed academy. Inspired by his difficult childhood, Rashford took on the British government last year, in a campaign aimed at providing school meals to children during Covid-19. The government listened and hundreds of kids were fed because Marcus Rashford had the will to do what his reputation enabled him to.

Corporate logos are changing with the time

A look into the cyber-surveillance world of Israel

Stats that you may find interesting

Costco edged by Amazon and Apple to lead all brands in customer satisfaction

India leads the world in IPv6 adoption rate at 63%

Disney+ has more than 100 million subscribers. Though the count is impressive, comparing it with Netflix’s subscriber base, either now or when it first started, may require a lot of unpacking. The consumer attitude towards streaming is different now than it was when Netflix began to stream its content online. The mix of subscriber base is also different. Disney+ has 30% of its subscribers. Nothing inherent bad about it, but to have an apple-to-apple comparison, one must figure out whether Netflix has the same composition. Plus, the streaming competition 10 years ago for Netflix might be much less fierce than the current landscape.

If you need more evidence as to how different a GOP government and a Democratic government are, here it is. One proposed a law that benefits low-income folks (Democrats) while the other passed a law that put more money in the pocket of the richest.

Source: TPC

Thinking about Square’s acquisition of Credit Karma’s tax unit

Back in November 2020, Square announced its agreement to buy the tax unit of Credit Karma for $50 million in cash. Unlike Turbo Tax, which is infamous for slyly inducing tax filers to pay for its services, Credit Karma doesn’t charge users fees. Here is from the press release

Consistent with Square’s purpose of economic empowerment, Cash App plans to offer the free tax filing service to millions of Americans. The acquisition provides an opportunity to further digitize and simplify the tax filing process in the United States, expanding access to the one in three households which are unbanked or underbanked. The tax product will expand Cash App’s diverse ecosystem of financial tools — which currently includes peer-to-peer payments, Cash Card, direct deposit, as well as fractional investing in traditional stocks and bitcoin — giving customers another way to manage their finances from their pocket.

“We created Cash App to provide more access to the masses of people left out of the financial system and are constantly looking for ways to redefine our customers’ relationship with money by making it more relatable, instantly available, and universally accessible,” said Brian Grassadonia, Cash App Lead. “That’s why we’re thrilled to bring this easy-to-use tax product to customers as we continue to build out the suite of tools Cash App offers. With this acquisition, we believe Cash App will be able to ease customers’ burden of preparing taxes every year

Source: Square

There are several reasons why I think Square made a big splash on Credit Karma’s tax business.

Customer acquisition

In the same press release, Square claimed that 80 million people in America file taxes online every year, yet Credit Karma’s customer base is only 2 million. As of Q4 2020, Square’s Cash App monthly active user count stood at 36 million. Even if all Credit Karma’s current users are on Cash App and all active Cash App users file taxes online, by offering a decent free tax-filing service, Square can appeal to 44 more million tax payers in America at the top of the sales funnel. In the latest earnings call, Square disclosed that its Cash App user acquisition cost is less than $5 per user. At that rate, Square only needs from the acquisition of Credit Karma’s tax tool 10 million new users to break even on the $50 million in cash paid, let alone other benefits discussed later in this entry. Obviously, the conversion rate from being a tax filer to a Cash App user won’t be 100%, but a relationship to some extent with customers is still much better than no relationship at all. As of now, Paypal is Square’s arguably biggest rival with very similar offerings. However, Paypal doesn’t have an offering equal to what Credit Karma can offer to Square, yet. Perhaps, it can be a useful differentiator.

Customer retention

Engaged customers are often the more profitable customers. Filing taxes is, in most cases, a once-a-year activity for individuals. Given that Credit Karma is a free service and that Square essentially declares its intention to keep the service free, it won’t be a revenue center. Nonetheless, it doesn’t mean the new acquisition can’t help Square grow the top line. Here is how Square currently makes money with Cash App:

  • Whenever customers use Cash Card with Cash App to pay businesses for purchases, Square makes a small interchange fee
  • If customers want to expedite deposits to their bank accounts, there is a fee. If they can wait 2-3 business days, the deposits will be free
  • Customers are charged a fee when they make a P2P transaction using a credit card
  • Square imposes a small mark-up on Bitcoin’s price before selling it to customers through Cash App

In essence, it benefits Square when customers have balance in their Cash App. The more balance there is, the more useful Cash App is to customers and the more revenue & profit Square can potentially earn. I imagine that once Credit Karma’s tax tool is integrated into Cash App, there will be a function that directs tax returns to customers’ Cash App. When the tax returns are deposited into Cash App, customers can either spend them; which either increases the ecosystem’s value (P2P), or deposit the fund back to their bank accounts. But if customers already direct the tax returns to Cash App in the first place, it’s unlikely the money will be redirected again back to a checking account. As Cash App users become more engaged and active, Square will look more attractive to prospect sellers whose business yield Square a much much higher gross margin than the company’s famous Cash App.

Additionally, there is nothing that stops Square from giving customers immediate access to tax returns in exchange for a small fee. Tax returns, after being approved, only hit bank accounts after a few days. Square can entice customers to pay a small fee to access the money immediately in Cash App which they can use to invest or make payments. It’s a win-win for everybody.

Figure 1 – The more engaged customers are, the more valuable they are to Square. Source: Square
Figure 2 – Seller offers a much higher gross margin to Square than Cash App. Source: Square

A great source of data

With Credit Karma’s tax tool, Square can have access to a reliable source of demographic data such as age, location, status, income, education, reasons for tax credits and investing behavior. Individual tax filers don’t often try to deceive Uncle Sam in their tax forms. Hence, any information derived from tax filings through Credit Karma is accurate and can be very useful to Square in designing and offering new products. Last year, Square got approval from FDIC to open a bank in Utah and a few days ago, it announced that its industrial bank named Square Financial Services already began its operations. According to the press release, the bank will first focus on underwriting and original loans to existing Square Capital customers and potentially all sellers in the future.

Nonetheless, it won’t surprise me at all if Square’s bank ventures into consumer banking products such as mortgage, credit cards, savings or checking accounts in the future. If they do, information derived from tax forms will be very valuable. I am working for a bank now. We are often frustrated by the lack of demographic information on customers. When they apply for a credit card, sometimes they disclose their annual income, along with other basic information like age or street address, but that’s about it. After they enter our system, it’s almost impossible to receive updated information in their income, their status or other information that a tax form can reveal such as security trading, cryptocurrency trading or donations. What could possibly give a financial institution that kind of information accurately, reliably and regularly on an annual basis than a tax form?

In summary, I do think this is a good strategic acquisition by Square. Personally, I can see some useful applications that Credit Karma can offer and really look forward to how it actually pans out in the near future.

Disclosure: I have a position on Paypal

Weekly readings – 22nd August 2020

What I wrote last week

I compared what is happening in Vietnam and New Zealand in the fight against Covid-19 and why it looks very bleak for America

I wrote a bit of analysis on Square, the owner of Cash App

Business

Instacart dominated the grocery delivery in the US

Second Measure on pandemic grocery spending
Source: Second Measure

A startup that promises to deliver groceries in less than 13 minutes in Turkey

An interview with the CEO of New York Times. He grew the subscriber base from the rock bottom of 22,000 in Q2 2013 to 6.5 million today

How Uber Turned a Promising Bikeshare Company Into Literal Garbage

Technology

Ben Evans on App Store and antitrust issues

A deep dive into iPhone 5C plastic cases

John Gruber on TikTok as a security threat

What I find interesting

The Canva Backlink Empire: How SEO, Outreach & Content Led To A $6B Valuation

To all Americans who are told all the nasty and misleading facts about Socialism & Communism whenever social benefits and safety nets are mentioned, please read this from your fellow American, who considers his move to Vietnam the best decision

Confessions of a Xinjiang Camp Teacher

A dazzling civilization flourished in Sudan nearly 5,000 years ago. Why was it forgotten?

Get to know Square, the owner of Cash App

How Square was founded and what it is today

Shortly before 2009, Jim McKelvey and Jack Dorsey were looking for a business idea to work on together. Jim was operating a glassblowing studio at the time. He had a customer come in ready to pay for an order. The customer had an American Express card, which the studio couldn’t accept. Jim lost the sale. He started to dig into the payment world and soon realized that there was a problem. The payment world is highly complicated with different credit card vendors and a myriad of rules and fees. To make its store accessible, a merchant had to work different credit card networks. Worse, in 2004, credit card vendors were making 45 times the amount of revenue on Small & Medium Sized merchants (SMB) as much as the revenue on large corporations.

Book Review: The Innovation Stack :: UXmatters
Figure 1 – Small and Medium Sized Merchants made up the majority of credit card vendors’ revenue in 2004. Source: uxmatters

The two co-founders of Square came up with an idea of a simple-to-use dongle that could read different credit cards, along with unprecedented transparency over fees to eliminate confusion for vendors. Their value proposition to customers was to simplify the process of working with different card vendors and to avoid the situation that some cards like Amex couldn’t be accepted. To lessen the fees for merchants, Square waived the per transaction fee and relied on the sale of their dongle, a small cut of interchange from transactions and likely a one-time fee to be able to use the dongle. That’s how the company started.

Fast forward to 2020, you can hardly recognize that Square company. It has grown leaps and bounds so that their offerings expanded to include a set of solutions for business and consumers. On the seller ecosystem side, Square offers software, hardware and financial services, namely:

  • Software: Online store, Square for different industries, Gift Card, Marketing, Dashboard
  • Hardware: different POS types
  • Financial services: managed payments, instant transfer, Square Card and Square Capital

On the Cash App side, the app can enable users to store & transfer funds to another person, spend via a debit card called Cash Card and invest in stocks, ETFs or Bitcoin.

Figure 2 – A simple way to look at Square business
Figure 3 – A more granular look at Square’s offerings. Source: Square

How does Square make money?

  • Transaction-based revenue: Square takes a small cut from every transaction from some services that they help facilitate through products and services
  • Subscriptions and fees: For some Square services, customers have to either subscribe or pay fees to be able to use them, including Square Capital, Instant Transfer, Cash Card, website & domain hosting and other
  • Hardware: Square also makes money from selling their hardware, including Stand, Register and Terminal, card swiping devices and chip readers
  • Bitcoine: allowing users to buy, sell and deposit Bitcoin, Square makes money in this segment by charging a fee for every transaction as well as raking in the difference in Bitcoin’s prices. For instance, the company might buy a Bitcoin at $9,950 and sell it at $10,000, netting $50 in revenue, on top of 1.7% in transaction fees
Figure 4 – Revenue breakdown from the Seller ecosystem. Source: Square
Figure 5 – Revenue breakdown from the Cash App ecosystem. Source: Square

Square has been growing very nicely in the last five years. The top line increased from $1.3 billion in 2015 to $4.7 billion in 2019, a CAGR of almost 38%. Meanwhile, the company went from losing money to the tune of $175 million in 2015 to making a modest operational income of $27 million in 2019.

In terms of segment revenue, transaction-based was the dominant source of revenue, making up 66% of Square’s revenue in 2019. On the other, Bitcoin was the fastest growing segment, growing at 211% YoY, followed by Subscription & Services.

Figure 6 – Square’s revenue by segment. Source: Square

Among Square’s segments, hardware is consistently the one that loses money. It’s the case of razor and blades. Square is willing to lose dozens of millions on hardware if that means they can make hundreds of millions of dollars in return from services. Meanwhile, Bitcoin’s gross margin is routinely at 2% while Square has made great improvements on the margin of Transaction-based and Subscriptions & Services.

Figure 7: Square’s Gross Margin. Source: Square

The growth of Cash App

Cash App has grown more important to Square over the years. The application was responsible for around 22-23% of the company’s revenue in Q2 2019, but the figure grew to 62% in Q2 2020, leaving the seller ecosystem only responsible for 38% of the total revenue. While the numbers for Cash App look impressive, most of the growth was attributed to the increase in Bitcoin revenue, even though Transaction-based and Subscription & Services also recorded nice growth. Additionally, Square increased the pile with a lower gross margin between Cash App and Seller ecosystems. If Cash App had 23% gross margin in Q2 2020, Seller notched 44%.

Figure 8 – Square’s Q2 2020 result. Source: Square

Over the years, Square has increased their marketing leverage. Sales & Marketing as % of revenue for Cash App decreased from 27% in Q2 2019 to 12% a year later. As a result, even though Cash App offers a lower gross margin than Seller, I suspect the increased marketing leverage enabled Square to turn a profit in Q2 2020. Whether this will persist as a routine in the future or whether it is mainly driven by Covid-19 remains to be seen.

Square defines “active transacting customers ” as those who have at least one cash inflow or outflow during a month. The base that had 1 million active transacting customers in Dec 2015 grew to 30 million in June 2020. Covid-19 helped accelerate the use of Cash App as these customers transacted 15 times per month or more on average every other day, up 50% from a year ago.

Figure 9 – Square’s Active Transacting Cash App Customers

At the end of FY 2019, over 50% of Cash App customers brought revenue to the company, a figure that was exceeded in Q2 2020 as the company reported an uplift. Revenue per customer, excluding bitcoin, was $45 on an annualized basis, compared to $30 in Q4 FY2019 and $15 in 2017.

Cause for concern

While Cash App seems to be going on the right track, Square does seem to have a problem at hand with the Seller ecosystem. In Q2 2020, Seller revenue decreased to $723 million from $870 million a year ago. In the meantime, Shopify’s revenue almost doubled in Q2 2020, compared to a year ago while offering essentially the same solutions and going after the same market as Square. Another competitor that had an impressive growth in the same quarter is Amazon. Their 3rd party segment’s revenue grew by 52% YoY. As I expect us to continue struggling with the pandemic in the months to come, what I have seen so far shows that Square may have a tough time competing to facilitate eCommerce with the likes of Amazon or Shopify. Other players include eBay, Google, Etsy, BigCommerce or Facebook.

It’s valuable indeed to help businesses manage their operations, but it’s not enough. The biggest worry of businesses is to generate revenue. As the pandemic fast-tracks eCommerce, revenue usually means website traffic. Amazon is the king of eCommerce in the US. Shopify partnered with Walmart, Facebook and Pinterest to bring traffic to their vendors. Meanwhile, I am not aware that Square has a similar capability to bring traffic to their customers. That’s a huge missing piece in their puzzle.

Another challenge that Square has to face for its Seller ecosystem is fulfillment. Walmart, Shopify and Amazon all have their fulfillment network. Even though Square already partnered with UPS, it’s not the same as owning that capability themselves, especially when the fulfillment demand scales up.

Cash App is also having to deal with a growing and fierce competition. Apple is pushing very hard to market Apple Pay, Apple Cash and Apple Card, whose basic utility is the same as that of Cash App and Cash Card. There is also Paypal/Venmo, Facebook with their own payment system and neobanks such as Point App. Although Cash App is in a pretty good shape, there is still a lot of work to do to stay competitive and fend off rivals. Having the ability to invest and trade Bitcoin is nice, but 1/ I don’t believe both features offer a high margin and 2/ they aren’t likely to keep consumers exclusive on Cash App. One can easily use Robinhood for trading and Apple services for other purposes.

Compared to their rival Shopify, Square has an advantage of having their feet in the consumer world as well. If they can manage to connect the consumer and seller side by offering consumer trend insights in real time to their sellers, that will be a great selling point to sellers. For Cash App customers, they need to find a way to keep customers active and use their services more. Recently, a new feature was added to let users access short-term loans of less than $200. However, the feature is a horizontal expansion and not everyone will be happy with a high interest loan. Cash App needs to get customers locked in by giving them more utility than the likes of Apple, Paypal and a host of other competitors.

In sum, Square is spinning a lot of disks at the same time. One can argue that catering to both the Seller and Cash App ecosystems spreads thin Square’s focus and resources, but to fend off fierce rivals on both sides, that is likely what Square has to do. As a fan of eCommerce and fintech, I am very interested in seeing what awaits Square in the future.

Disclaimer: I own Shopify and Amazon stocks in my personal portfolio.

Book review: The Innovation Stack

Similar to the most recent books, this one came to me by chance when somebody I follow retweeted someone else who read it. I gave it a chance and I am glad I did. The book is penned by Jim McKelvey, the cofounder of Square. The book should be recommended by business schools and read by anyone who wishes to improve their competitiveness as a business or a company. It is a straightforward, easy-to-read, genuine and informative book. What I like the most about the book is the author’s genuineness. He doesn’t seem to try to immortalize entrepreneurs or make wild exaggerations. For instance, one of his main points is to copy what worked in the past. In my personal experience at business schools, I often listened to professors talk about “blue ocean” or “doing something unique”. I always find it hard to come across something that has never been done before. Perhaps, I am not smart enough. That’s why it’s refreshing to listen to a billionaire who admitted that he copied everything he could at Square.

Jim’s Innovation Stack simply refers to the process of companies trying to solve a problem which leads to two more problems and so on. By tackling each problem, successful entities come up with a unique mix of elements that only they can possess, elements that make them competitive. Any competitor that wants to copy an Innovation Stack has to somehow copy every single element of the Stack, not just one or a few. That makes a solid Innovation Stack defensible and difficult to emulate.

The same concept can also apply to individuals. For instance, speaking English may not give anyone a competitive advantage. However, combining English with other skills such as fluency in Latin and professional training in archaeology makes a person “more unique” and harder to compete.

There are other gems in the book that I believe will be useful to readers. If you are looking for a short quality read over this weekend, give it a try. It’s worth it.

“BEFORE stalking got such a bad reputation, I was pretty good at it. My target was always the same: some famous businessperson. Entrepreneurship was not taught in school at the time,* so I had to invent a way to get instruction. My technique was simple: I would wait until some famous entrepreneur came to St. Louis to give a speech. After the speech I would catch the speaker as he or she left the stage and offer a ride to the airport.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“A couple of ratios help illuminate the crime scene. Credit card vendors were making 0.04¢ on every dollar ($0.3 billion / $788 billion) they processed from their large merchants. Now compare this to 1.8¢ on the dollar, the profit they were making on small merchants ($2.4 billion / $130 billion). Their profit margin from small businesses was forty-five times higher than from billion-dollar corporations. I rechecked my math three times before that number sunk in. Small businesses pay forty-five times more than the giants do. We had identified a big problem and a good reason to start a company.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

The problem with solving one problem is that it usually creates a new problem that requires a new solution with its own new problems. This problem-solution-problem chain continues until eventually one of two things happens: either you fail to solve a problem and die, or you succeed in solving all the problems with a collection of both interlocking and independent innovation. This successful collection is what I call an Innovation Stack

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“But this book’s subject is the exploration of the unknown; so, as a consolation prize for readers expecting between five and seven bulleted steps to success, I will now tell you the universal formula for success in any existing industry. This formula works from building bridges to selling soap. This formula has worked for millennia and it will give you the ability to succeed in any known field of endeavor. Even better, you have been practicing the fundamental skill it requires since before you were born, and are almost certainly a master.

Ready?

Copy what everyone else does.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“In 1973, Braniff cut its fare between Dallas and Houston to $13, half of what Southwest charged. The Dallas–Houston run was Southwest’s primary source of profit—competing at that rate, even with its Innovation Stack and greater cost efficiency, would be disastrous. Braniff’s pricing attack violated US antitrust law, but the executives hoped to drive Southwest out of business before Herb could take them to court. Winning in court wouldn’t matter if Southwest was dead, so Herb needed a fast solution. He and his team devised a plan by looking at their customers.

Southwest knew that most of the passengers on the Dallas–Houston route were businesspeople. These businesspeople flew Southwest primarily for the convenience of multiple flights, easy changes, open seating, and on-time performance. Braniff could set any price it wanted, but it could not replicate the other effects of Southwest’s Innovation Stack. These business fliers were not choosing Southwest simply because of the low price, a price their employers reimbursed them for anyway. So Southwest offered fliers the option of paying only $13, or they could pay the full fare of $26 and get a complimentary bottle of Chivas Regal scotch, Crown Royal whiskey, or Smirnoff vodka. Most of the passengers stayed with Southwest and chose to pay the full fare and get the booze. Southwest managed to outsell Braniff at twice the price, and for the length of that promotion became the largest liquor distributor in Texas.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“Disruption has become nearly as threadbare a concept as entrepreneurship. The two words could be roommates at rehab. When Clayton Christensen first popularized the disruption concept back in 1997, the idea was novel and interesting. But what Christensen originally called disruptive innovation has now been shortened to just disruption and the oversimplification is profound. Two decades later, disruption has become the high-fructose corn syrup of business, an overused ingredient sprayed on pitches and injected into keynotes in the hope of disguising the familiar taste of conformity.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

“IS DISRUPTION BAD? Not by itself. But disruption has also never been the focus of good entrepreneurs. The entrepreneurs profiled in this book set out to build and not to destroy. To focus on disruption is to look over one’s shoulder into the past. But if you are trying to solve a perfect problem or expand a market, shouldn’t you study that industry? No, you look at your customers, or I should say your potential customers, for they do not even know your product or service is possible.”

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

But now that you have read this book you have lost something as well. You can no longer look at a problem and say, “Nothing can be done.” You can’t even say, “I can’t do it because I am lacking (fill in your excuse du jour).” You can only say either, “I’m not going to do anything” or “I am going to solve this problem.” Because we have seen how world-changing entrepreneurs had few if any qualifications when they began their journeys. 

Excerpt From: Jim McKelvey. “The Innovation Stack.” Apple Books.

Comparing Enterprise SaaS Companies’ Metrics

Interested in how enterprise SaaS companies whose some or all of their revenue come from subscriptions, I set out to collect data from the companies that I know offer subscriptions to enterprise customers. Please be aware that this is my personal research stemming from intellectual curiosity only. They are not meant to be anything more than that.

  • Data is collected from the latest year in the companies’ latest annual reports to ensure that seasonality factor is removed
  • The metrics include subscription gross margin (subscription gross profit/subscription revenue), overall gross margin, Sales & Marketing expense as % of revenue, R&D as % of revenue, SG&A as % of revenue and net dollar expansion rate (or retention rate)
  • If there is a difference between subscription gross margin and overall gross margin, it’s because those companies also generate revenue from other sources such as hardware or professional services
  • Much as I tried to keep the figures accurate, do use them at your discretion

Subscription Gross Margin

Median: 82%/ Mean: 80%

Gross Margin

Median: 72%/ Mean: 71%

Sales & Marketing Expense as % of Revenue

Median: 44%/ Mean: 42%

R&D as % of Revenue

Median: 22% / Mean: 22%

SG&A as % of Revenue

Median: 15% / Mean: 15%

Operating Income (Loss) as % of Revenue

Median: -14%/ Mean: -10%

Dollar Expansion Rate

Median: 115% / Mean: 115%