Mind Your Margins… Again!

I have no idea why it surprises everyone. Every time some technology goes through the “hype cycle”, or the sector as a whole goes through a “we’re not in a bubble” bubble, inevitably, when the hype dies down or the bubble bursts, people suddenly “discover” business fundamentals.

Often, it is not the people discussing it who discover it. Rather, they are the ones reminding everyone that the fundamentals count.

It really is simple: you must have positive gross margins. No matter how complex or simple your business model is, its sustainability depends more than anything else on positive gross margins. Whether you sell a hammer or cloud CRM software, you must, as in you have no choice, make more money on each sale than it costs you. If the hammer costs $3.59, do not sell it for $2.99. No matter how many you sell, you will lose ever more money. If the cloud CRM costs you $1,000 to acquire a customer who lasts 3 years, and $20/month to support it, for a fully loaded cost of $1,720, or an average of $48/month for each of those 36 months, do not charge $35/month.

In truth, you should make a lot more than it costs you for two reasons:

  1. You want to make a profit, not just break even, on a per-unit basis.
  2. You have fixed costs to cover: insurance, legal, rent, IT, some marketing, etc. The extra from each sale – the positive gross margin – “contributes” to paying for all of that.

Today, within 30 minutes of each other, two of the technology business leaders whose writings I enjoy brought it home again.

The first, Fred Wilson of Union Square Ventures, wrote about negative gross margins. Fred seemed surprised that so many people just didn’t get it. Having a “Unicorn” – a company with a valuation north of $1BN – is not the goal; the goal is building a sustainable business. That only can come from positive gross margins, making money on every sale you make.

I have no idea why it surprises people. I distinctly remember the “new economics” during the late 1990s bubble, when the “only financial metric that counts… is eyeballs.” Unless you are in the business of selling eyeballs (eyeBay?), then the real metric that counts is profit!

The second, Patrick Campbell of Price Intelligently, writes about the failure of Homejoy and how they ignored SaaS fundamentals. In truth, SaaS fundamentals are nothing more or less than the subscription method of getting to positive gross margin. Unlike with a hammer, with a subscription model (of which SaaS is just one example) you pay most of your costs upfront – with technology, where the variable costs per month are so low, it is almost entirely upfront as customer acquisition costs, or CAC – yet the revenues come over an extended period of time. In that case, calculating the necessary price to have positive gross margins is harder. Hence, the basic concepts of CLTV, CAC and CLTV:CAC ratio. If you are running a SaaS business and are not aware of the fundamentals, please be sure to read his post, then ask us to help you get real insight into your business.

Summary

However you look at it, your business must have positive gross margins to survive, let alone thrive. If it is true in a traditional product or service business, it is especially true in a subscription or SaaS business. It just is that much harder to figure out what the actual numbers are.

Do you know if your business is profitable on a gross basis? Are you heading towards sustainable growth or a 1,000 foot cliff? Do you know how to track these numbers, and which levers to pull to get to proper growth?

Ask us to help you. We love seeing success and growth.

About Avi Deitcher

Avi Deitcher is a technology business consultant who lives to dramatically improve fast-moving and fast-growing companies. He writes regularly on this blog, and can be reached via Facebook, Twitter and avi@atomicinc.com.
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