When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact. – Warren Buffet
As I age in the business world, I have internalized this buffet quote. I superficially understood it early on in my career, but now I understand it! With fintech as the backdrop, this post is a view of my mental model on business models and gross margins in general. What makes a good high gross margin business?
Let’s start with a 30,000 ft view of what forms a business. Businesses exist to provide value to a set of customers via the products they create. A firm solves a need and customers pay them to solve that need. At its core, a company is a machine that takes raw ingredients (physical widgets, human capital, and intellectual capital) and transforms them into products that customers pay for. Raw ingredients cost money (cost centers) and customers pay money (revenue centers) for the finished product. A good business, in the long run, generates a consistent profit i.e (revenue – cost) is a positive number. Profit takes various forms such as free cash flow, EBIT or EBITDA – but the simple model holds, value creation only happens when what you get for the product is higher than what it costs to make it.