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I’ve argued that Gross Margin Dollars is more important than Gross Margin percent. Most business school grads are focused on the percent because it’s good for t

• aqme28 7y ago
  Why would you ever axe a product that generated $25M, "no effort" or not?
  • csa 7y ago
    Cynical reply... sloppy MBA thinking. Slightly less cynical reply... it will lead to someone’s promotion by writing something like “doubled gross margin percentage by streamlining product lines to focus on core competencies” in an annual review. Sad to say that this happens all the time.
    • jmpman 7y ago
      I agree. My theory is that it was partially our MBAs and partially the stock analysts MBAs. In our industry, normal margins were 60 points, so when our company was generating 36 points, it looked wrong to the analysts, so it needed to be fixed....
      • formercoder 7y ago
        Nothing in my MBA curriculum has taught me that low margins are bad, just that low margins with high capital intensity is bad. At the same time, absolute numbers are critical and should be analyzed independently from margin.
        • paggle 7y ago
          You’re talking like a rational actor. However there is a lot of irrational behavior caused by principal agent problems in investing. If a trade goes belly up the boss or client is going to ask why you bought a company doing 36 points of gross margin in an industry where the average is 60. In many cases, to preserve competitive advantage, the company doesn’t want to disclose the mix of revenue and profit margins of its business units, so investors don’t even have any way to evaluate why the company is doing only 36 points. So in many cases it can be “rational” to shut down a business unit making $25 million of gross profit.
        • aflag 7y ago
          I think I don't understand what capital intensity means here. If the margin is low, doesn't it mean that it's capital intensive? In the example, $75M is required to get $25M. Isn't that intensive?
          • formercoder 7y ago
            Capital intensity has to do with net operating assets (PP&E, working capital). It’s capital intensive if you have to build a $1B plant in order to make a 1% margin.
            • arethuza 7y ago
              ROCE (Return On Capital Employed) is a common measure in capital intensive businesses.
        • thawaway1837 7y ago
          You’re absolutely right. Unfortunately a lot of people forget that caveat. They also forget that in an environment where capital is fairly cheap (which hasn’t been the case in human history until extremely recently) the margins shouldn’t be compared against other industry players, etc, but rather against the overall cost of capital on the market. Comparing margins across industry is useful because if your margins are lower than your competitors then it could indicate inefficiencies or mistakes you might be making. But one needs to understand why those margins are lower. Apple, for example, can enjoy much higher margins than Dell, because although they are in the same industry, the brand and value proposition Apple brings is very different from Dell’s. Dell could try and chase the margins Apple has, but it would have to then become a very different company from what it currently is.
  • nostrademons 7y ago
    I worked on a project that made over $100M for my employer and then got axed. (Or technically, it got axed by my department after 2 years and then was picked up by another department because it was still making money, and then got axed again 2 years later in some priorities reshuffle.) The real answer has to do with org charts and executive attention. If your VP is told that anything less than a billion dollars doesn't matter, he's not going to want to be distracted by anything that you know is going to be worth less than a billion dollars, and is going to want to focus 100% on those opportunities that could be worth more than a billion dollars (even if they have a low chance of success and an expected value much less than $100M). It's possible that some other VP might be interested in it - for example, if you have a product that's made $100M and has a decent chance of growing 2x and another department has a mandate to make $100M this year, it could be an easy win to adopt the $100M project off the $1B department and take credit for its continued growth. But then next year your growth target is $200M and the project may only have $50M worth of growth left in it, so your incentive is to axe it and concentrate on newer initiatives. Same reason that VCs only fund companies that have a potential to single-handedly return the fund, or that hedge funds & private equity will drive well-known brands like Sears into the ground so they can strip the assets and sell them off to more productive companies. Manager attention is worth something, usually in proportion to the amount of capital they're already managing, and so it may not be worth spending the attention needed to make $25M when the resources you have at your disposal are expected to make $250M. That same opportunity could be very attractive to a team of 3 with no outside funding, though, and that's why we have the full-employment theorem for entrepreneurs.
    • edoceo 7y ago
      Basically: HIPPO (Highest Paid Person's Opinion)
  • AmericanChopper 7y ago
    The only sensible answer is opportunity cost. I’ve worked with a few startups that have axed entirely profitable products because they could get a better ROI by defunding those products, and directing that investment into their core competency. In the cases of this that I’ve been involved with, it’s always turned out to be a very good decision.
    • taneq 7y ago
      Why would you not spin off the product as a separate company? I can't think of a single situation where "having X" is better than "having X and also $25mil/year".
      • zapita 7y ago
        If your all-star engineering team is tied up by the 25mil/year business, you may need their attention urgently refocused on the core product. In theory they could recruit a replacement team and hand off the business, but that also takes time and attention.
        • inerte 7y ago
          Agreed, and just to expand, not only the engineers, but ops, infrastructure maintenance, customer support, sales, rent, HR, legal, recruiters, translators, the IT guy that keeps the TVs with Zoom working, and the list goes on and on and on. Some of these people are full time on the project, some are part-time, some are shared costs, some are not, but sometimes it's totally worth to shed the $25mil/year and re-focus on something else.
      • AmericanChopper 7y ago
        Because opportunity cost means you don’t get to “and also”. In the cases that I’ve been involved with personally, spinning off another company hasn’t been feasible. To put it a bit more explicitly, say you have a product that generates $25mil/year, and runs about $10mil/year expenses. But, you also have a different product that for every $10mil that you invest into it generates $50mil/year in revenue. The opportunity cost isn’t that you’re spending $10mil to generate $15mil in profit, it’s that you’re spending $10mil to lose $25mil in profit. In reality everything will be a lot more complex than this. But having the discipline to focus on your core competency, especially in situations like this, is a common trait I’ve seen in many successful start-ups.
  • gpresot 7y ago
    You axe it if you can use the same resources (people, capital, time) to produce something with a higher absolute margin (or better, future cash stream, which is the real measure of value for a company). So you don't axe it but keep the costs in, idle. You could even discontinue the product, restructure the company to fit, and give back the cash to shareholders if the contribution that product was giving is less that they can make elsewhere (on a risk adjested basis). At least in theory... in practice cutting the costs to fit is very difficult...
• rileymat2 7y ago
  I am not sure that the article argues against that, but it does explain why your revenue multiple based valuation will end up being lower than if you had not taken on that additional business, even if the valuation is ultimately higher.
• tiffanyh 7y ago
  What you’re describing is called the Contribution Margin. https://www.investopedia.com/terms/c/contributionmargin.asp https://www.investopedia.com/terms/c/contributionmargin.asp Essentially, how much did that add-on ($100m) service “contribute” to the companies overall margin ... which obviously factors in absolute dollars Edit: fixed typo
• chrisdhoover 7y ago
  Understanding percentage of GM allows you to set the allowable percentage of all the overhead expenses below the GM line. It matters not of you have high gross margin dollars but spend it it all and your net is zero.
• thawaway1837 7y ago
  The argument would be that the $75mm deployed towards creating the $100mm could probably be better used elsewhere. If deployed towards something that would have a 33% margin, you would be making about $38mm instead of $25mm. Of course, the argument sucks because it ignores the fact that there are massive risks and therefore discounting associated with an unproven revenue stream. And if it is proven, then there should be absolutely no difficulty in getting financing for it with a 33% margin, and that financing would be much cheaper than the cost of shifting the money used to drive the 25% margin earner. Shifting this money means you’re basically paying for the new 33% margin product with money that has been borrowed at a cost of 33% itself...25mm profit on 75mm investment. You can get money from the market at a small fraction of that cost. Borrowing 75mm in the US should not cost more than 7-8mm per Anjum if you have such an obvious opportunity that you were willing to forsake 25mm of earnings for it. And if you’re unable to borrow at a reasonable cost for that project maybe it indicates that the project isn’t as much of a sureshot as you think it is and therefore the 33% margin that is being projected needs to be steeply discounted due to the risk factor. Unfortunately I’ve seen a lot of people learn the metrics, and the ratios but never really understand what they mean and what information they provide, and therefore, what they are useful for.
  • jmpman 7y ago
    We would have the product in inventory for about 5 days before it was sold. What’s the interest on $100M for 5 days? From that, we then made $25M.