Gross margin is a financial metric that gets a lot of attention from investors, analysts, and management teams — and for good reason. An expanding gross margin is a sign of a desirable product or service, strong pricing power, and an increasing economic moat. And if a company can grow revenue at the same time it is increasing its margin, all the better.
Often, a young company, especially in Silicon Valley, will sacrifice its margin and profitability to win market share. However, there is one software creator that has managed to expand its margin while maintaining strong growth. In fact, over five-plus years as a public company, Workday (NYSE:WDAY) has steadily increased gross profit from 51% in fiscal-year 2012 to about 71% in its most recent quarter.
Meanwhile, annual revenue has grown from just under $135 million to nearly $1.6 billion over that same period.
Decreasing dependence on professional services
Digging into the company’s financial statements, it becomes obvious that the main driver of higher profitability is the reduced size of the professional services segment relative to the software subscription business. Professional services fees are charged to customers for assistance with software deployment, optimization, and training. The work can be performed by the Workday staff, a third party, or a combination of the two. It’s an important service to provide, as a successful deployment leads to increased customer success and satisfaction. However, it’s also a very low-margin business. As shown in the chart below, professional services are almost sold at cost:
The professional services segment is still growing with the rest of the business. In the most recent fiscal quarter, it grew revenue 18.7% year over year. However, over 80% of the company’s top line comes from highly profitable software subscriptions, which were up…