One of my Digital Health clients faced challenges determining their Unit Economics during a “Fundability” evaluation. The company relied on data-driven solutions and focused on a vast target market with millions of potential users. Our primary focus was analyzing hosting expenses and other associated Cost of Revenues, such as device connectivity and support. Chart I shows the initial calculation. It revealed a monthly hosting cost of $874 per user, which accounted for 17% of their $5,128 MRR. Consequently, the Gross Margin was $3,413, translating to 66% per Unit Economics, which appeared low for a SaaS company, possibly affecting their valuation.
Given the significant impact of hosting costs, we were motivated to explore the "black box" and address our concerns. Our first meeting focused on raising awareness among all executives by highlighting the critical role of hosting costs. Our subsequent 3-week process involved a speedy analysis across several domains, as depicted in Picture I:
- Hosting Analysis (led by the Platform Architect) - we analyzed the main building blocks of hosting, including data centers, hardware, storage devices, and operational staff. We quantified their impact on the total hosting cost, compared each cost driver and product impact, and mapped them using tagging capabilities and automated simulations.
- Efficiencies (led by the VP of Product and VP of R&D) - we employed targeted software practices to lower hosting costs, such as data prioritization and compression. As a result, we managed to reduce hosting costs by $269 or 31% of the hosting cost per Unit Economics.
- Pricing (led by the VP of Business Development) - we identified several unprofitable deals that required different pricing updates through our deals classification process. We also removed several auto-scaling services from the price list, resulting in an additional hosting cost-savings of $70 or 8% of the hosting costs.
- Monitoring (led by the Controller) - we initiated hosting activity tracking, which became a part of our routine process, including cost benchmarks vis-à-vis competitors to ensure cost minimization.
The company significantly reduced hosting costs, resulting in a 39% decrease from $874 to $535 per Unit Economics (in bold). This led to an improvement in the Gross Profit for every $5,192 of MRR, rising from 66% or $3,413 per Unit Economics (see Chart I) to 73% or $3,752 per Unit Economics (see Chart II).
Regular evaluation of hosting and infrastructure costs is crucial for startups to optimize their investment and avoid overspending on underutilized resources. Hosting costs are particularly important for SaaS companies, as they validate Unit Economics and support the overall valuation.
