Why Do Gross Margin Matter?

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Mela wao: What really matters is the return on invested capital that business generates for practical purposes. It's often easier to build a higher return on capital if you have a higher gross margin, because ive more a points to re invest ad back in your business. But there're a lot of low gross margin businesses with a deep moat that can generate very high returns on invested capital.

Gross margins–which are essentially a company’s revenue from products and services minus the costs to deliver those products and services to customers–are one of the most important financial metrics for any startup and growing business. And yet, figuring out what goes into the “cost” for delivering products and services is not as simple as it may sound, particularly for high-growth software businesses that might use emerging business models or be leveraging new technology.

In this episode from June 2020, a16z general partners Martin Casado, David George, and Sarah Wang talk all things gross margins, from early to late stage. Why do gross margins matter? When do they matter during a company’s growth? And how do you use them to plan for the future? The conversation ranges from the nuances of and strategy for calculating margins with things like cloud costs, freemium users, or implementation costs, to the impact margins can have on valuations.