Because so many software companies are unprofitable, there are certain metrics investors use to predict how profitable a company may be in the future 👀

Gross Margin is one of them!

The formula for Gross Margin = (revenue - COGS) ➗ (revenue)

💡The first part of this formula, (revenue - COGS), is also known as Gross Profit

Gross Margin essentially calculates what % of a company's revenue is not going directly towards COGS 📊

The higher a business’ COGS are, the lower its gross margin, because they would need to use a bigger chunk of the revenue to pay for the COGS, leaving them with less money to “take home”.

Remember: COGS only includes direct costs associated with producing and delivering an additional unit of a product, not things like marketing, sales, or even product development.

Software companies often have high Gross Margins because they usually have low COGS.

Once a piece of software is developed, you can usually distribute it infinitely with relatively low cost 📈

But Gross Margins can vary quite a bit across different software companies.

For example, Dropbox gross margin is 87%, whereas Twilio gross margin is only 50%.

Lower Gross Margins are not inherently bad, but you should always try to understand WHY a company might have a lower gross margin.

Twilio is a platform that helps businesses send texts and calls, so for each text that a business sends on Twilio, Twilio needs to pay some other service provider to actually send that text, which is a high COGS.

Try to compare a company’s Gross Margin to other software companies to understand if they truly benefit from software’s efficiencies, or if they’re more similar to a traditional business 🤔