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Before we dig in on Gross Margin, make sure to check out this week’s Run the Number’s Podcast with Brandon Deer, the Chief Strategy Officer at UiPath.
We talk about the perils of speed at all costs, how B and C players can kill companies, and a funny Jim Kramer story.
I’ll admit it - I probably talked about Gross Margin in hand wavy, theoretical BS kinda way for the first five years of my career (OK, first six). I kinda sorta understood what was shoved up there from an academic angle (not to toot my own horn, but I did pass level 1 of the CFA (on the second try)). But the emperor truly had no clothes when I was asked to apply it to a real company in real life.
The emperor had bad gross margin.
As any good financial analyst will recite:
Gross profit is Revenue less Cost of Service.
And Gross Margin is Gross Profit as a percentage of Revenue.
And conceptually speaking, the higher your gross margin, the more money you have to run the rest of the business.
A gross margin of 74% (the median for software companies) means that for every $1 the biz brings in, 74 cents is left over for salaries, rent, and those uncomfortable Gildan tee shirts you got at the last company All Hands.
Said another way - a high gross margin “frees” up money for investment in other areas.
So the Revenue piece of the equation is easy to understand…. But what Expenses are tagged up above?
That would be your cost to maintain a successful customer. Some companies call this Cost of Service, some call it Cost of Revenue, and some call it Cost of Goods Sold if they actually sell a “thing” (like a Peloton bike).
Generally speaking, for software companies, Cost of Revenue includes:
Customer support (headcount): Help when something breaks
Customer success (headcount): Enhance the customer’s experience and get them to use more features and modules
Hosting (compute): Cloud costs (AWS, Azure, or GCP or the dusty ass servers in your basement)
Royalties / Licensing (subscriptions): Data you buy or license from others that is embedded into the delivery of your product
Data Communication (infrastructure): The plumbing that links all your stuff together so the users can use your stuff.
Today I want to peel out some real life examples that I’ve collected from company 10K’s to “bring gross margin to life”. This is how I finally got the concept to click.
Let’s look at a few.
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