Kaaryvik Enterprise reports a 62% gross margin, but a quarter of its revenue is low-margin implementation services. What is the subscription gross margin, and what does that change about the multiple you would pay?

The subscription business earns a 79% gross margin; the 62% is dragged down by services. Only the Rs 60 crore of subscription revenue deserves a software multiple. At an illustrative 8 times subscription and 1 times services, Kaaryvik is worth about Rs 500 crore, not the Rs 640 crore you get by applying 8 times to all Rs 80 crore. That is a blended 6.25 times revenue.

A restaurant that also runs a catering arm might report a 40% margin overall, while the dining room earns 65% and catering earns 10%. You would not value the dining room on the blend. Kaaryvik's 62% is the average of a subscription business and a services business, and the average describes neither. Gross profit is Rs 80 crore times 62%, Rs 49.6 crore. Services contribute Rs 20 crore times 10%, Rs 2 crore. So subscription contributes Rs 47.6 crore on Rs 60 crore of revenue: a 79.3% margin.

Investors pay a high multiple for subscription revenue because it recurs and carries a high margin; services revenue is closer to a consulting business. Applying 8 times to all Rs 80 crore gives Rs 640 crore, while valuing the parts separately, Rs 60 crore at 8 times plus Rs 20 crore at 1 times, gives Rs 500 crore. The difference, Rs 140 crore, is what a buyer overpays by treating services as software. Expressed on total revenue, the fair multiple is 6.25 times, which is the number to quote if someone asks for one multiple.

Not necessarily, and this is the follow-up interviewers like. Enterprise software often needs implementation to get customers live, so services can be a cost of selling subscription rather than a business of its own. The questions to ask are whether services revenue grows only with new customers, which is healthy, or keeps growing with existing ones, which suggests the product needs constant custom work. Watch the ratio too: services at a quarter of revenue is high for software; if it is falling as the product matures, the subscription margin will show through in the reported figure. The limitation of the split: some companies book part of the implementation cost in subscription, so ask how the cost lines are allocated before trusting either margin.