One Overlooked Metric That Could Transform Your Company Value

Apr 20, 2023

As a business owner, you may already know that your gross margin affects your profit. But have you considered how it impacts your company’s overall value? When potential investors and acquirers assess your company’s value, they often scrutinize your gross margin. Simply put, gross margin is the percentage difference between your company’s revenue and its cost of goods sold. It’s the profit your company earns from each unit of product or service sold, after accounting for the cost of production or delivery but before operating expenses are deducted.

High Gross Margin

A high gross margin is a crucial factor for investors and potential acquirers, as it suggests that your company has pricing power through marketing differentiation and possesses a competitive advantage. Having a strong competitive moat is an indicator of your company’s long-term sustainability, making it more attractive to potential investors.

On the other hand, if your company’s gross margin shrinks, it may indicate that your company is competing on price. This is typically a sign that your business lacks a unique value proposition or marketing differentiation, and competing on price is the only way to attract customers. A shallow moat leaves your company vulnerable to competitive threats and makes it less appealing to potential acquirers.

To illustrate the impact of gross margin on your company’s value, let’s compare two fictional companies: Company A and Company B. Company A has a strong competitive advantage and a healthy gross margin, whereas Company B’s competitive moat is weaker, and its gross margin is lower.

Company A has a highly differentiated brand and controls the buying experience through its retail stores. Additionally, Company A has invested in a range of high-margin subscription offerings, such as streaming services. The market is willing to pay more than 24 times Company A’s forecasted earnings for the upcoming year, and the company has a market capitalization of over $2 trillion.

By contrast, Company B offers commoditized products, putting them in a weaker competitive position, requiring them to compete on price and resulting in a lower gross margin. The market is only paying around six times Company B’s earnings estimates, giving it a total market capitalization of around $30 billion.

Increasing your company’s value isn’t just about improving your gross margin. It’s also about investing in carving out a point of differentiation for your business in the minds of your customers. When your customers see your business as unique, you’re less likely to have to compete solely on price. Charging a premium for a differentiated product or service will improve your gross margin and the overall value of your company.

If you’re looking to increase your company’s value, consider investing in marketing differentiation and developing a strong competitive moat. This will not only help you stand out in a crowded market but also make your company more appealing to potential investors and acquirers.