The Gross Margin Problem: Lessons for Tech-Enabled Startups

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The Gross Margin Problem: Lessons for Tech-Enabled Startups

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The topic du jour in tech right now is the sudden reappraisal of some high-flying startups based on unit economics / gross margins (e.g. WeWork, Uber, Lyft, DoorDash, Postmates, etc).
The truth is that software startups never had to worry about gross margins until software started eating the world.
Gross margins only became a concern once software blended with physical-world products and services to create new tech-enabled business models.
As a result, early-stage software startups never needed to have much proficiency in cost accounting.
Software might be the disruptive element but it wasn’t the source of unit economics.
The new tech-enabled startups had cost structures more similar to the companies they were disrupting (e.g. commercial landlords; the taxicab industry) but they still thought like software companies.
Although growth solves many problems at startups, unit economics is not one of them.
In fact, the more revenue that a businesses with negative unit economics generates, the more money it loses.
“Growth solves many problems at startups, unit economics is not one of them.”
Valuations are similarly being reappraised as investors see through top-line growth that was achieved at the expense of negative unit economics.
You’ll need to know your unit costs at a much more detailed level than a typical SaaS startup (which doesn’t have meaningful COGS).
As an investor, I like these businesses to prove from the outset that unit economics are positive, even if marginally so, and then show how they can improve contribution over time with greater scale and operational efficiency.
Losing money at the corporate level is ok (all startups do); losing money at the unit level is not.
Losing money at the corporate level is ok (all startups do); losing money at the unit level is not.”
3) Third, you should prioritize 0 to 1 problems like establishing positive unit economics and a culture valuing operational excellence before going from 1 to N

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