No matter whether you are developing a digital business model for your company from scratch or whether you consider acquiring digital expertise with Transformative M&A: It is helpful to understand (and can be motivating) what the profitability of business models in the Digital Industry look like. For sure, taking a look at company valuation would also be an exciting exercise, however, it’s only a small step from the operating profit to a company valuation by applying the multiples common in the M&A market.
In the following, we look at some selected companies to get a “feel” for the profitability and robustness of business models in the Digital Economy. I have clustered the companies for the order of structuring this article. We will start with companies whose business model can be dubbed “classical”: Delivering Software – on-premise or in the cloud (a SaaS business model).
What’s the profitability of Digital Business Models: Software Companies
The Microsoft group, which celebrated its 40th anniversary in 2018 and thus belongs to the “old economy of the digitalization industry”, generated revenues of 125 billion US dollars in the 2019 financial year. At the beginning of the 5-year period 2014-2019, Satya Nadella takes over the helm and consistently orients Microsoft towards the cloud business. With success: Revenues have grown by 45% since Nadella took the helm at the company, operating profitability averaged almost 30% over the 5-year period, in fiscal year 2019 it was 34%. (Note: The source for key financial figures is in this blog article – unless otherwise stated: finanzen.net) For the purpose of a differentiated assessment of this financial KPI, it should be noted that Microsoft is no longer a “pure” software provider (operating systems, office software, databases): Revenues comprise business areas such as Bing, X-Box, the Public Cloud Azure.
Oracle, also part of the “Old Economy in the digital industry” (founded in 1977), stagnates in terms of sales development over the same 5-year period (approx. 40 billion US dollars sales in 2019), but impresses with a profitability of 36 percent on average. Let us take a look at Germany. SAP, founded in 1972; the growth of 57% in the 5-year period is impressive (approx. 28 million EURO turnover in 2019), but obviously at the cost of crumbling profitability, which in 2019 was at 20 percent (5-year average: 23%).
Companies of more recent foundation date of this category of “software producers”: SalesForce (established in 1999) in turn shows a dynamic sales growth over 5 years of 220% percent, reaching 17 billion US dollars in the financial year 2019/20. In 2016, EBIT is in the black for the first time (17 years after the company was founded!), and in the last financial year 2019/20, operating profitability is 3 percent.
SalesForce is a good example of the fact that investors definitely need more patience before reaching break-even. Another example is the company Splunk (founded in 2003), most easily described as “Google for Big Data”. The software is enjoying a popularity boom, with sales growing by 425% (!) between 2014 and 2019. However, the company is still far from being in the black, with a 5-year average operating loss of about 30 percent and a minus 11 percent in the last available financial year.
A similar pattern can be seen in ServiceNow (established in 2004). Revenue growth of 410% between 2014 and 2019, most recently to USD 3.5 billion. 2019 was the first year with operating profit in the black (15 years after foundation!), however, just approx. 1 percent.
Let me drop a remark on late break-even points: This is of course related in parts to the strategy of “Blitzscaling”. This means that these tech companies are investing massively in marketing and the establishment of a global sales organization. It’s all about establishing a leadership position in global markets due to an (assumed) “the-winner-takes-it-all” logic. Profitability ranked only second on the company strategy. However, it can be observed that a shift in the mindset is taking place, which has come about as early as 2019. Investors have re-prioritized profitability and re-align company development towards entering a path to profitability – the corona crisis has accelerated this process even further.
What’s the profitability of Digital Business Models: Platform Economy
Let us take a look at business models that are designed on the logic of the “platform economy”, let’s start with Facebook (founded in 2004). It is a company where you rub your eyes in amazement when you look at the key figures: In the 5-year period 2014-2019, sales figures will explode from USD 12.5 billion to USD 71 billion (+470%), while operating profitability over the same period averaged just under 43 percent. Dip in growth due to Cambridge Analytica scandal? – Nope.
Another classic example of platform-based business models: AirBnB. The company was founded in 2008 and, according to its own statements, has been in the black for the first time since the second half of 2016 (8 years after its foundation). Revenue growth in the 5-year period from 2013 to 2018 is enormous, with sales exploding from USD 250 million to USD 3.6 billion, which corresponds to a growth rate of 1,340% (data source: craft.co). Revenue in 2019 is likely to be in the order of more than USD 4 billion. The EBIT margin is in the lower single-digit range, for 2017 it is given as 4 percent, for 2018 as 1 percent, in the first 9 months of 2019 it was reported to have made a loss.
Let’s take a look at another player in the “platform economy” category: the Ride-Hailing Company UBER, founded in 2009. The company is still showing high growth rates: In the period from 2016 to 2019, the turnover goes from 3.8 billion US dollars to 14.1 billion US dollars. However, the company (as well as competitor LYFT) is known to have a very high cash burn rate, the operating loss margin was 54 percent on average over the 4-year period 2016 to 2019, and in 2019 it was even minus 60 percent.
What’s the profitability of Digital Business Models: Google, Amazon, Apple
The Google search engine exists since 1997, in 2000 the Google Ads were launched: In the following year (2001) the company was in the black for the first time. In the 2019 financial year, the company’s turnover was around 160 billion US dollars, and in the 5-year period 2014-2919, the group thus achieved an increase in turnover of 145%. The operating profit (EBIT) for this period fluctuates around 25 percent – for the entire Group (Alphabet)! However, you need to consider a diverse portfolio of business models: The core business (search engine) is highly profitable, but Alphabet runs a couple of not-so-profitable businesses, pixel smartphones, networked loudspeakers, robot carts and delivery drones – to name but a few. Some business areas are recording operating losses.
The cult company Apple achieves higher revenues compared to Google, namely USD 260 billion in the financial year 2019 – the revenue growth in the 5-year period 2014-2019 is about 40 percent (i.e.: lower than with Google). The profitability (EBIT margin) in the period under review is 27 percent. The iPhone is (despite falling revenues) still the most important product in the Apple Group, and still accounts for about 50% of revenues.
Amazon (The company of the richest man in the world): In the 5-year period 2014-2019, sales revenues grew by 215 percent to 280 billion US dollars – but with significantly lower profitability compared to the other big players in the GAFA group of companies: In the financial year 2019, the EBIT margin was 5 percent – on average during the 5-year period under review it was 3 percent. This is hardly surprising, since Amazon’s core business is retail, and a comparison with a player like WalMart gets things in perspective: the latter has annual sales of around USD 515 billion, with profitability of just under 5 percent (in the period 2014 to 2019). To conclude: The (booming business) with the public cloud provider AWS (Amazon Web Services) is again a real earnings pearl within the group: Revenue in Q4/2019 was around USD 10 billion, the operating profit margin was 26 percent (!).
“A man is a success if he gets up in the morning and gets to bed at night, and in between he does what he wants to do.”