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Is a higher gross margin better?

Is a higher gross margin better?

Business

We came across a brilliant post on LinkedIn from Kyle Harrison, a General Partner at Contrary. Kyle discusses the importance of maintaining strong operating margins:

“Twilio has ~$3.6B in revenue; they dropped from $70B in market cap at their peak to ~$8B. Here’s why gross margins can kill a business…

Across the board, low gross margins do you no favors. They eat away at your ability to ever generate profit. The more expensive it is to generate your revenue, the less wiggle room you have to fund the operational complexity behind growing that revenue.

In a time of endless cash, the common wisdom was to launch the product, scale, and get efficiency with scale. When cash is hard to come by you’re forced to look for efficiency. But it’s much harder to right the ship at scale.

In 2021, Twilio generated $2.8B in revenue, and $1.4B in gross profit (~49% margins). That margin has gone up and down, averaging ~54% for the last five years. Dramatically better than companies like Opendoor or Bird. But that didn’t stop Twilio’s stock from cratering by 45%+ last week.

So what’s going on?

Operating margins “went from around negative 15% to negative 31% over the last 12 months” In Twilio’s defense, the goal post got moved dramatically over the course of 2022. A market that rewarded explosive growth quickly started picking apart margins with a magnifying glass. When growth was the game, Twilio did pretty dang good, growing revenue 2,000% since IPO

So when companies like Datadog and Atlassian are trading at ~10-15x revenue, why is Twilio down at ~1.5x revenue?

In part? Gross margins.

Remember that Twilio has ~50% gross margins.

Datadog? 77%
Atlassian? 84%
Cloudflare? 78%

Right out of the gate, that $2.8B in revenue? Its costing Twilio ~2.5x more to get it.

“One thing that happens in Silicon Valley – and this has been highly cyclical – the more we get into peak-y [valuations] territory, the more optimistic we get about business models that are lower margin.” Bill Gurley

TLDR? Margins matter. Unit economics are tricky. And they usually don’t get much better with scale (usually).”

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Business

Is a higher gross margin better?