Investors in LinkedIn should be pleased with the performance of their company. Operating profits for 2011 were up by 21% on 2010 and in the latest quarter those profits were up a further 73% on the same period last year.
So why should Marketing Services Financial Intelligence persist in expressing concern about the disproportionate growth in sales and marketing expenses relative to revenues?
LinkedIn has always been up front about its intention to spend more money on building more future revenue:
“We plan to continue to invest heavily in sales and marketing to expand our global footprint, grow our current customer accounts and continue building brand awareness”, the company reiterated last month. “In the near term and consistent with our investment philosophy for 2012, we expect sales and marketing expenses to increase and be our largest expense on an absolute basis.”
But surely over time those costs should gradually represent a smaller – not bigger – proportion of total revenues? Surely the cost of winning business in new markets will have absorbed the highest percentage of revenues in the very early years, when cash was being invested in sales staff and marketing activities before any material revenue could be expected to have been generated? Indeed in LinkedIn’s first year, those costs absorbed 90% of revenues.
As each year passes and markets get more established, it would be normal to expect the spend on developing sales in new markets to become a gradually smaller proportion of total marketing and sales spend, while the payback on spend in established markets to be greater. In overall terms the marketing and sales cost per dollar of revenue should settle down at a fairly standard percentage notwithstanding the continuing need to expand into new markets.
To justify spending an increasing percentage of current revenue on sales and marketing, either (a) LinkedIn’s expansion into new markets would have to be growing at an ever increasing rate relative to the scale of its existing markets, or (b) each new market entrance, or expansion of an existing market, would have to be significantly more difficult and/or more expensive than was previously the case. That’s a little hard to believe and LinkedIn has not offered either of those explanations (or any other) to justify the situation.
Of course, another possible explanation might be that it is getting increasingly hard to maintain the revenue streams from existing markets. And that’s the nagging fear.
With an ever-increasing proportion of revenue being derived from recruitment business, rather than marketing and advertising sales, it may well be that there is very little client continuity and every new piece of business costs the same percentage to win before spending anything on gaining new business from new markets. That would certainly be the case if most of the expenditure was in effect a commission on each transaction. But this alone would not explain the ever-growing percentage of revenue being spent on winning it.
More worrying would be the possibility that LinkedIn is having to pay more per dollar of revenue - by way of sales personnel costs, commissions and other incentives – to win sales in its established markets. According to the company, the sales and marketing cost increase was “primarily attributable to an increase in headcount related expenses of $26.1 million as we expanded our field sales organization”. Unless the latest financial period experienced an exceptionally big boost in sales staff numbers, that explanation certainly suggests that it is costing more to generate revenue in existing markets as well as in new ones.