Here’s a good piece from Simply Statistics on Palantir:
At first glance it seems their doing pretty well. Their gross profit (Revenue – Cost of Revenue) suggests about a 72% gross margin percentage for 2018 and 67% for 2019, which both seem high… But ultimately, Palantir has posted net losses every year, indicating there are significant indirect costs to generating that revenue. In particular, their Sales and marketing costs almost equal their entire gross profit. Reading through the S-1 this ultimately is not surprising. Palantir itself admits that: “Our sales efforts involve considerable time and expense and our sales cycle is often long and unpredictable.”
And here’s an excerpt from Palantir’s Form S-1 Registration Statement to the Securities and Exchange Commission ahead of their anticipated initial public offering:
If our customers are not able or willing to accept our product-based business model, instead of a labor-based business model, our business and results of operations could be negatively impacted. Our platforms are generally offered on a productized basis to minimize our customers’ overall cost of acquisition, maintenance, and deployment time of our platforms. Many of our customers and potential customers are instead generally familiar with the practice of purchasing or licensing software through labor contracts, where custom software is written for specific applications, the intellectual property in such software is often owned by the customer, and the software typically requires additional labor contracts for modifications, updates, and services during the life of that specific software. Customers may be unable or unwilling to accept our model of commercial software procurement. Should our customers be unable or unwilling to accept this model of commercial software procurement, our growth could be materially diminished, which could adversely impact our business, financial condition, results of operations, and growth prospects.
Palantir’s statements should be recognized as a significant critique of government pricing policies, which have major impacts on the way contracts are awarded. The government still demands pricing contracts by reference to input costs such as labor, materials, and indirect rates. While this is intended to limit sole-source pricing power, it is often expected in the proposals of even competitive awards. Yet competition regulates prices in the commercial sector — not competition between suppliers making the exact same physical commodity, but instead differentiated goods where a lot of value is from the ones and zeros.
Notice the crazy accounting differences between Palantir and a defense prime like Lockheed. Palantir makes huge gross profit margins, but then they have to sink those margins and more into indirect expenses. More than three-quarters of all revenues in 2018 went to sales and marketing. Another 50 percent of revenues went to R&D, and 50 percent more to general and administrative costs. The operating loss for 2019 was greater than the entirety of Palantir’s revenues! It needs a lot of private financing to break in.
Lockheed Martin, by comparison, doesn’t even show S&M, R&D, and G&A on their income statement. That’s because it is all charged back to government contracts as indirect rates and would be reflected in the cost of sales. All that, of course, is handled by DCMA in the forward pricing rate proposal/agreement process. As for Lockheed’s independent R&D, just read what they have to say:
Company-funded R&D costs charged to cost of sales totaled $1.3 billion in each of 2019 and 2018 [just 2.5%!].
Company IR&D is reimbursed through G&A rates, and thus becomes additional cost added to contracts which is now a higher base for profit considerations of 10 to 15 percent. In other words, IR&D is a profit-center for Lockheed Martin and a loss-leader for Palantir. That has everything to do with how contracts are priced and reimbursed.
Government is biased to requiring cost or pricing data backed by labor and material estimates. Often, comparable invoices from commercial sales do not quell the demands. Procurement officials revert to input costs because they can’t figure on their own what the value of the product or service they’re buying is. Usually, these signals are given by the availability of alternative offers that can be weighed against each other.
The funny thing is that government’s pricing policies are there to protect it from a company reaping large profits on contracts and subsidizing other work or going right back to the shareholders. But that’s not what tech companies are about. It’s all about growth. They reinvest their gross profits and more back into scale. And that’s reflected in Palantir’s Registration Statement, which looks a lot like what you’d expect from a 21st century tech company. Lockheed Martin, however, looks much different, with very high cost of sales — reminiscent of industrial era firms — and large profits from operation not reinvested back into intangible assets like R&D.
Of course, Lockheed is as about as big as the defense market will allow within its budget. Unfortunately for defense, the total market size is pretty much known and fixed, unlike other sectors where TAM is a more fluid concept. Palantir wants to eat into Lockheed’s share.
You’d think Lockheed would take on big IR&D and sales efforts if it felt it’s position threatened by innovative startups. But maximizing direct expenses on government-funded contracts is actually a defensible strategy. It has pricing history based on labor and material inputs, and it has access to shaping (even “spoon-feeding”) the government future contract requirements which competitors like Palantir will have to compete against. Palantir, by contrast, has about 1/100th the revenue of Lockheed, and is using company-funded products and sales pipelines that aren’t as integrated into current government programs.
I’ll leave you with another excerpt from Palantir’s Registration Statement. The fact that they had to say it at all is telling about how backwards the government’s concept of price and value really is:
Our pricing structures for our platforms and services may change from time to time. We expect that we may change our pricing model from time to time, including as a result of competition, global economic conditions, general reductions in our customers’ spending levels, pricing studies, or changes in how our platforms are broadly consumed. Similarly, as we introduce new products and services, or as a result of the evolution of our existing platforms and services, we may have difficulty determining the appropriate price structure for our products and services. In addition, as new and existing competitors introduce new products or services that compete with ours, or revise their pricing structures, we may be unable to attract new customers at the same price or based on the same pricing model as we have used historically. Moreover, as we continue to target selling our platforms and services to larger organizations, these larger organizations may demand substantial price concessions. In addition, we may need to change pricing policies to accommodate government pricing guidelines for our contracts with federal, state, local, and foreign governments and government agencies. If we are unable to modify or develop pricing models and strategies that are attractive to existing and prospective customers, while enabling us to significantly grow our sales and revenue relative to our associated costs and expenses in a reasonable period of time, our business, financial condition, and results of operations may be adversely impacted.
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