Analyzing the Economies of Scale of Software as a Service Software Firms: A Stochastic Frontier Approach

Software as a Service (SaaS) has been one of the fastest-growing delivery models in the software industry. The industry's trade press often considers economies of scale as the main benefit of SaaS firms, because information technology management and the associated resources are centralized at the SaaS vendors. However, centralized information technology management also requires the associated cost of expanding the firm's IT infrastructure to serve more customers. Intuitively, it is not necessary that the former effect must dominate the latter. Using public firm-level data from Compustat, this study attempts to analyze the economies of scale of SaaS firms relative to their traditional counterparts by using the stochastic frontier analysis (SFA) approach. Our empirical findings suggest SaaS firms have smaller economies of scale than traditional software firms. By utilizing the technical efficiency score obtained from SFA, we further examine the effects of R&D expense and advertising expense on technical efficiency. The analysis suggests that R&D expense, not the advertising expense, could be the cause of smaller economies of scale at SaaS firms.