Why High Gross Margin Software Companies Matter?

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As a company gets big, we look for companies that can generate a lot of cash flow. If you have high gross margins, that gives you more of your cost structure than you can spend on things like sales and marketing. We typically see softwhare companies that have gross margins of 70 to 80 per cent in the public markets.

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.