B2B Startup Metrics | Startup School

Summary

In this insightful discussion, Tom Blumfield, a group partner at Y Combinator, emphasizes the critical role of metrics in guiding startup success. He advises startups to integrate basic metrics before launching, highlighting the importance of making informed decisions with data rather than 'flying blind.' Blumfield outlines key metrics such as revenue, burn rate, and runway for investor updates, and stresses the significance of customer retention and net dollar retention, especially for B2B companies. He also addresses the concept of gross margin and warns against scaling businesses with negative margins. The talk concludes with the importance of a balanced approach, combining metrics with customer engagement and product intuition to effectively steer a startup's growth.

Takeaways

• 📈 **Metrics for Decision Making**: Better metrics lead to better decisions, akin to instruments in an aircraft for navigation and control.
• 🚀 **Pre-Launch Metrics**: Integrate basic metrics into your product before launching to avoid flying blind post-launch.
• 📊 **Avoiding Analysis Paralysis**: Too many metrics can be overwhelming for early-stage startups; focus on key metrics that matter.
• 🔍 **Customer Engagement**: Don't rely solely on metrics; maintain close contact with customers for a holistic understanding of your business.
• 🔑 **Key Metrics Identification**: Select four or five key metrics to track, and ensure they are accurately defined and consistently measured.
• 💰 **Revenue Focus**: For B2B companies, revenue is often the most crucial metric, reflecting the company's financial health.
• 📉 **Burn Rate and Runway**: Include burn rate and runway in investor updates to show financial discipline and transparency.
• 🔗 **Retention Importance**: High retention rates indicate customer satisfaction and loyalty, contributing to a sustainable revenue stream.
• 📊 **Net Dollar Retention**: For B2B SaaS companies, a net dollar retention above 100% is indicative of growth and customer value expansion.
• ⚖️ **Gross Margin Consideration**: Gross margin is critical for understanding the cost-effectiveness of a business, especially in operationally intensive industries.
• 🚫 **Negative Margin Scaling**: Avoid scaling businesses with negative gross margins without a clear plan to achieve profitability.
• 📝 **Clear and Centralized Metrics**: Establish a centralized system for metric definitions to prevent internal disagreements and misalignment.

Q & A

Why are metrics important for startups?

Metrics are crucial for startups because they enable better decision-making, similar to how instruments help a pilot fly an airplane. Without metrics, a startup is flying blind, unable to control or understand what's happening within the business.

What is the first step a startup should take after launching without metrics?

The first step is to go back and build basic metrics into the product. It's advised to include these metrics before launching to avoid the need for retroactive implementation.

What is the difference between vanity metrics and key metrics?

Vanity metrics are big numbers that may seem impressive but are not necessarily tied to the success of the company, like page views or unique visitors. Key metrics, on the other hand, are directly related to the company's success and are more meaningful for decision-making.

Why is it not advisable to have too many metrics on a dashboard for a startup?

Having too many metrics can be overwhelming and impractical for a startup, especially with a small user base. It's nearly impossible to make sensible decisions based on a large number of metrics without sufficient user volume or data.

What are the three key metrics that should be included in every investor update?

The three key metrics are Revenue, Burn Rate, and Runway. These metrics are crucial as they provide insight into the financial health and sustainability of the startup.

Why is retention an important metric for startups?

Retention is a measure of how many customers continue to use the product over time. High retention rates indicate that customers are satisfied and continue to engage with the product, which is vital for sustainable growth.

What does a 'layer cake' retention model look like and why is it significant?

A 'layer cake' retention model depicts cohorts of customers stacked on top of each other over time, with each cohort representing a month's worth of new customers. If retention is high, these cohorts remain 'fat' over time, contributing to a consistent and growing revenue stream, which is significant for the long-term success of the business.

What is net dollar retention and why is it important for B2B startups?

Net dollar retention is a metric that calculates the growth of revenue from a cohort of customers over time, accounting for both lost and gained revenue. It's important for B2B startups because it indicates whether the business is growing its revenue from existing customers, which is a sign of a healthy and sustainable business model.

Why is gross margin a critical metric for operational businesses?

Gross margin is the revenue minus the cost of goods sold. For operational businesses, which often have higher variable costs per customer, gross margin is critical because it determines the amount of revenue left to cover fixed costs and achieve profitability.

What is the significance of having a net dollar retention above 100% for early stage B2B SaaS companies?

A net dollar retention above 100% signifies that the company is not only retaining its customers but also increasing the revenue from them over time. This indicates a sticky business model and can lead to exponential growth as the company adds new customers and existing ones grow.

Why is it not recommended to scale a business with negative gross margins?

Scaling a business with negative gross margins means the company is losing money on every sale, which is not sustainable in the long term. It's important to have a plan to turn around negative unit economics before attempting to scale, to ensure the business can achieve profitability.

What are the final thoughts Tom Blumfield shares on running a startup with the right blend of metrics, customer interaction, and product intuition?

Tom Blumfield emphasizes the importance of tracking key metrics before launching, avoiding vanity metrics, having clear definitions for each metric, and not hiding behind metrics. He stresses the need to get out of the building and talk to customers, using product intuition in conjunction with metrics to guide the startup's direction.

Outlines

00:00

📈 The Importance of Metrics for Startups

Tom Blumfield, a group partner at Y Combinator, discusses the critical role of metrics in guiding startup decisions. He emphasizes that without metrics, startups are 'flying blind'. He advises founders to integrate basic metrics into their product before launching and to focus on four or five key metrics. Blumfield also warns against the extremes of either not having enough metrics or having too many, which can lead to analysis paralysis. He stresses the importance of not hiding behind metrics and the necessity of engaging directly with customers.

05:02

💰 Key Metrics for Early Stage Startups

The video script outlines that the key metrics a startup should focus on from the early stages include revenue, burn rate, and runway. It explains that vanity metrics, such as page views or gross merchandise value, may seem appealing due to their large numbers but do not necessarily reflect the company's success. For B2B companies, revenue is often the most important metric. The script also highlights the importance of internal consistency in defining metrics to prevent confusion and misaligned goals within the team.

10:02

🔄 The Power of Retention and Net Dollar Retention

Blumfield illustrates the significance of customer retention and introduces the concept of net dollar retention, which is a measure of revenue growth from existing customers. He uses the analogy of a 'layer cake' to describe how high retention rates can lead to a stable and growing revenue stream over time. Conversely, low retention rates result in a 'leaky bucket' scenario, where the company constantly needs to acquire new customers to replace those lost. The script suggests that net dollar retention above 100% is desirable for B2B SaaS companies as it indicates growth.

15:03

📊 Gross Margin and Its Impact on Business Scaling

The script delves into gross margin, which is calculated by subtracting the cost of goods sold from revenue. It points out the importance of understanding and managing gross margins, especially for operationally intensive businesses where margins can be much lower than in software-only companies. Blumfield discusses how companies that hide behind free credits or subsidies can face significant challenges when these benefits are no longer available. He also touches on the concept of 'Blitz scaling,' where companies expand rapidly despite negative gross margins, and warns against this approach in the current investment climate.

20:04

🛠️ Final Thoughts on Metrics and Scaling

In conclusion, Blumfield advises startups to track their key metrics diligently before launching. He cautions against relying on vanity metrics and stresses the importance of having a clear, centralized definition of metrics within the company. The script encourages startups not to hide behind their metrics but instead to complement them with direct customer engagement and product intuition. It also warns against scaling a business with negative unit economics without a clear plan to improve them, using Monzo as an example of a successful turnaround.

Keywords

💡Metrics

Metrics are quantitative measures used to track and assess the performance of a business or product. In the context of the video, metrics are crucial for making informed decisions, understanding user behavior, and steering the direction of a startup. They act as the 'instruments' for a startup, allowing founders to be in control and make necessary adjustments.

💡Key Metrics

Key metrics are the most important measurements that a company chooses to focus on. They are typically a small, manageable number (like four or five) that provide a clear insight into the company's health. The video emphasizes the importance of selecting and consistently tracking these metrics from early on to ensure a startup is on the right path.

💡Vanity Metrics

Vanity metrics are numbers that may seem impressive due to their large size but do not necessarily reflect the true success or progress of a company. The video mentions that while these metrics can look good on paper, they often mislead founders and investors about the actual performance and health of a business.

💡Revenue

Revenue refers to the income generated by a company from its business activities. It is highlighted in the video as the key metric for most B2B companies. It is a direct indicator of a company's financial success and is a focus area for growth and improvement.

💡Burn Rate

Burn rate is the rate at which a company is spending its available financial resources. It is a critical metric for startups, as it determines how long the company can sustain its operations before running out of funds. The video stresses the importance of monitoring burn rate to understand the financial runway of a startup.

💡Runway

Runway is the period of time a startup can continue its operations based on its current rate of spending and the funds it has on hand. It is calculated by dividing the amount of capital available by the burn rate. The video emphasizes that knowing the runway is essential for financial planning and survival.

💡Retention

Retention is the ability of a business to retain its customers over time. High retention rates indicate that customers are satisfied and continue to engage with the product or service. The video discusses how retention is a strong signal of a product's value and is vital for the sustainable growth of a startup.

💡Net Dollar Retention

Net dollar retention is a metric used by B2B SaaS companies to measure the growth of revenue from existing customers over time, accounting for both expansion and churn. A net dollar retention rate above 100% implies that the company is growing revenue from its existing customer base, which is a sign of a healthy and sticky business model.

💡Gross Margin

Gross margin is the profit a company makes after deducting the costs associated with making and selling its products, expressed as a percentage. The video explains that gross margin is important because it represents the amount left to cover fixed costs and generate profit after accounting for the direct costs of production.

💡Negative Margin Scaling

Negative margin scaling is a strategy where a company intentionally operates at a loss per unit sold with the aim of achieving economies of scale or market dominance. The video discusses how this approach was popular in certain sectors but is now less favored due to the high risk and the need for a clear path to profitability.

💡Product Intuition

Product intuition refers to the ability to make informed decisions about a product based on instinct and understanding of the market or user needs. The video stresses that while metrics are important, founders should also rely on their product intuition and customer feedback to guide product development and business strategy.

Highlights

Metrics are crucial for startups as they enable better decision-making, akin to instruments in an aircraft.

Founders often lack basic metrics post-launch, which is not advisable; metrics should be integrated before launching.

Investors can easily distinguish between founders who are in command of their metrics and those who are not.

Having too many metrics (e.g., 500) can be overwhelming and impractical for startups with few users.

It's important not to hide behind metrics; customer interaction is still vital for understanding needs.

When planning a product launch, identify four or five key metrics to track and use straightforward analytics.

Agree on definitions for key metrics within the team to prevent internal disagreements and misalignment.

Consistency in metric definitions over time is key to accurately measure improvement.

Vanity metrics, like page views or GMV, may look impressive but don't necessarily reflect company success.

For most B2B companies, revenue should be the key metric, not gross transaction value.

Include revenue, burn rate, and runway in investor updates; they are crucial for startup health.

Retention is a vital metric for startups, indicating customer satisfaction and product stickiness.

Net dollar retention, especially above 100%, is a strong indicator for B2B SaaS companies.

Gross margin is increasingly important as software companies expand into more industries.

Operationally intensive businesses need to pay close attention to gross margins, which are rarely as high as 95%.

Negative gross margin businesses are difficult to scale, especially in a higher interest rate environment.

Startups should not scale until they have fixed negative unit economics.

It's essential to track key metrics before launching, avoid vanity metrics, and maintain clear definitions for consistent measurement.

Product intuition and customer interaction are as important as metrics for running a successful startup.

Transcripts

[Music]

hi there my name is Tom blumfield I'm a

group partner at Y combinator and today

we're going to be talking about one of

my favorite topics metrics and why

they're so useful for startups so why

are metrics important first of all it's

pretty obvious that with better metrics

you'll make better decisions it's like

flying an airplane with no instrument

you're Flying Blind you don't know

what's happening to the aircraft and

you're not in control having great

metrics is like having great instruments

in an aircraft it lets you tweak and

iterate and make sure you're really in

control of your startup we often see and

I've seen in even in the last two or

three weeks Founders who've had these

great launches they've launched on

Hacker News on product hunt and they've

had hundreds of people come and use

their service day after day but they

have no idea how many of those news

users are new users or returning users

they don't know if they're daily active

or weekly active they could be churning

off all of their users instantly and

they don't know at all so the first

thing they do after launching blind is

to go back and build metrics in we would

advise you don't do that you should

build basic metrics into a product

before you launch and as an investor

it's really easy to tell Founders who

are in command of their metrics versus

Founders who aren't and it's really

impressive when founders can talk about

what percentage best signups are da or W

or what the annual revenue per user is

and we'll go into some of these in

detail but it's a big differentiator

when a Founder can talk so fluently

about these metrics before we dive in I

want to give a couple of warnings The

Other Extreme is also bad so it's a

Founder who even before they launched

has a dashboard with perhaps 500 metrics

maybe they've been a product manager at

a big tech company or they've just

watched too many YouTube videos but they

want to make every decision in their

startup with metrics and when you have

only have a few hundred or a few

thousand users that's basically

impossible you know they want to split

test everything should this button be

blue or green and frankly it doesn't

matter and you don't have the volume of

users or data to make those kind of

split tests sensibly so what you should

do is certainly split test the really

important decisions you know should the

cost per user be $80 per year or $200

per year that's a really good experiment

to split test but you know making

buttons red or green that's not really

something you have the scale to split

test until you're really at the the size

of Google or Facebook a final warning

don't hide behind your metrics you've

still got to get out of the building and

talk to customers Brian from Airbnb

still hosts Airbnb users in his home

it's an obsession with staying close to

customers so you can't let metrics get

in the way of that so let's get started

you're planning a product launch in

perhaps a week or two and maybe maybe

you've not got any metrics in place yet

what do you do the first thing is to

pick four or five key metrics to track

accurately not 30 or 50 four or five is

fine this number will grow over time

we'll talk about what those key metrics

should be in eight a little bit you

should pick the most straightforward

analytics solution you can operate it

might just be uh your SQL database

making simple SQL queries to count to

the number of signups post hog from

Winter 2020 has a great SQL Analytics

tool you can use on top of pretty much

any SQL database so you should check

that out you should also agree the

definitions of these four or five key

metrics and stick with them so it might

not be the absolute perfect definition

of an active user but constant arguments

about what your key metrics are are even

worse than having no metrics at all so

your whole team has to come together and

agree that an active user is someone who

uses the product every day or at least

once a week or at least five times a

week it honestly matters matters less

the precise definition than you actually

all agree with it I've remember so many

disagreements where the marketing team

said you know we've sent you 2,500 New

Leads this month and the sales team says

no no no they weren't qualified leads

they don't meet our definitions and this

disagreement internally just destroys

the productivity of meetings where

metrics are involved so you really have

to have centralized definitions of

metrics that are written down and

everyone agrees on so say you launched

and perhaps the metrics aren't quite

what you hoped the weekly active users

aren't quite as high as you you

originally wanted in that situation

Founders are often tempted to pick a

different metric or change the

definition of those metrics so instead

of a weekly active let's go for a

monthly active the number looks a bit

better honestly you're only fooling

yourself in this situation it's really

really important that you keep the

definition of your metric consistent

over time to see if you're improving or

not that's why it's so hard to compare

metrics between different companies

definition just vary so a weekly active

user at my company monzo was someone who

transacted who made a financial

transaction at least once a week an

active user at some of our competitors

used different definitions maybe it was

every two weeks or eight weeks and so

this active us account between companies

just became totally meaningless just

important that you keep it internally

consistent so you're keeping a good

track of it so now let's talk about what

those key metrics are those four or five

you should really start tracking from

early on it will vary from every company

back in the early days of the internet

companies like to use metrics like page

views or unique visitors or something

like that because they're really really

big numbers and startup Founders love to

report really big numbers you've

probably heard the term vanity metrics

these are numbers that seem really

really big and perhaps they keep

increasing they're not actually tied to

the success of your company more

recently common vanity metrics are

things like gmv or gross merchandise

value that's the total dollar value of

goods that are sold on eBay rather than

eBay's Revenue itself or gross

transaction value for a fintech like

monzo you could report we're transacting

$50 billion do a year it sounds like a

really really big number but the revenue

that the company makes can be very very

different and so almost always

especially for B2B companies your key

metric should be Revenue if you pick

another number take gross transaction

value you'll find that your employees

and eventually you might might start

optimizing for that number I worked with

a Neo Bank a couple of batches ago in

the Middle East and they were reporting

gross transaction value and they're very

very happy they came to every group

office hours and their gross transaction

value was growing 50% every two weeks it

looked really great and we scratched

beneath the surface a little bit and it

turned out that they were signing up

much much bigger customers who had

higher transaction value but giving them

massive cash back massive rebates to

transact on the platform so whilst gross

transaction value was Rising every two

week weeks Revenue actually was pretty

flat for about the last two months the

founders were tricking themselves they

were fooling themselves into thinking

their company was succeeding when in

fact it was pretty flat in Revenue terms

so revenue is the key metric I would

suggest for most B2B companies and don't

hide if your Revenue isn't good one of

the most impressive Founders I've ever

worked with sent 10 successive monthly

investor update emails with zero with a

big zero as the main metric at the top

of the emailed she kept herself honest

she was honest with investors and it

became clear what they needed to focus

on to fix the company so if you ashamed

of this number you hide it away it's

easy to kid yourself but I think if you

put it up front and Central and pay

attention to it it's the right thing to

focus on so two other key metrics

especially for investor updates

alongside your Revenue please include

burn rate that should be net what that

means is monthly costs minus your

revenues if you're loss making which

most early startups are it's the amount

by which your bank balance decreases

every month that is your burn rate and

your Runway is a function of that so say

you have a million dollar in the bank

and your burn rate is $100,000 a month

that means you have 10 months Runway

that means in 10 months you're going to

run out of money and the the startup

will be bankrupt those three numbers

Revenue burn rate and Runway are

absolutely crucial to include and if

they're not at the top of your investor

updates honestly I always uh assume this

founder has something to hide for

Consumer companies we have a separate

video diving deep into the metrics that

are important for those kind of startups

and often revenue is very important but

for the earliest days of consumer

companies often you're trying to get

some kind of critical mass or network

effect and so growing the active user

base in the early days for a consumer

company might in some cases be more

important than Revenue so we've talked

about the main three metrics that should

be at the top of every investor update

that's Revenue burn rate and Runway now

we're going to dive a little bit deeper

one of the most important metrics for

all startups really is retention this is

the idea that if you sign up a 100

paying customers say you sign them up in

January how many are still paying you in

February March and April two months 3

months four months later that's your

retention rate so it might be 80% or 70%

it's a sign that people love your

product they keep coming back and they

keep paying for it so you can measure it

for all customers who signed up in

January and the subsequent months and

that's your January cohort and then you

measure the same for all of the

customers who signed up in February

that's your February cohort and you can

stack these cohorts on top of each other

and there are a number of different ways

of graphing this you might have a heat

map and some analytics tools do this

really nicely you might have a curve

that sort of decays over time those are

two pretty common ways of graphing it

and we'll show some examples but I'd

like to suggest a third way this is is

when it really clicked for me I'd heard

everyone tell me that Revenue was really

really important but it only really

clicked for me after I worked at a

dating startup that actually had very

bad retention and ultimately failed

sadly but it clicked when I stacked

these cohorts on top of each other so

you see the January cohort at the bottom

and then the February cohort and then

the March cohort and the April cohort

and what happens if you have sticky

cohorts if your retention is really high

you know 80 90 100% is you cohorts stay

really fat over time and you build up

this layer cake so you can imagine what

happens two or three years later if you

have dozens of these monthly cohorts

stacked on top of each other they're all

paying you money they're all

contributing to your Revenue every

single month even three years later and

if you're in a low churn business it

adds up to a layer cake that looks

something like this so this is an

18month graph of monthly cohorts each

month you're adding a new layer on and

after 18 months you've got 18 cohorts

still paying you this was like my first

company go cardless it was a a recurring

payments company very similar to stripe

and with those kind of companies people

Implement a payment solution once they

don't really like to change it every

month there's a lot of effort so the

customers are very very sticky and you

can imagine the team at go cardless goes

on holiday you know for a month after 18

months and the revenue stays pretty

consistent the beauty is actually

expanding Revenue so if those customers

you signed up in January launch grow

with the company they're using goard or

stripe as a payment processor they're

transacting more volume in year two and

year three they're growing their

business the revenue for for strip or go

carders actually increases as well so

the team perhaps goes on holiday or

signs up no new customers the business

still grows Revenue that's the beauty of

this this High retention business it's

sort of growing constantly underneath

you you're adding these layers and

layers and layers of Revenue and

eventually become Unstoppable but that

only happens if your retention flattens

out at some point if these Decay curves

flatten at some point and it almost

matters that they flatten out at any

point as opposed to a high point you

know I I take a 20% retention that

flattens out over a higher retention

initially that goes to zero because if

you sign up 100 people in January and by

month three or month six they've all

churn off they've all stopped paying you

get a very different layer cake that

lovely flat layer cake that builds up

and up over time if your customers all

churn out looks like this so you can see

customers you sign up in month one by

month three have more or less gone and

let's fast forward to month six they've

all gone by month 9 or month 10 and so

rather than building up secure and

steadfast layers month after month

you're actually scrambling to fill up a

leaky bucket you're pouring water into

the top of the bucket and it's leaking

out of the bucket just as fast as you

can fill it up you can imagine this is

an impossible task and so if your

business has customers that that don't

retain where retention goes to zero

you'll reach some natural Plateau where

you're working as hard as you can to

fill up the customers who simply churned

out last month and it's very very hard

to build a big business like that it's a

futile Endeavor so we talked about

overall retention number of customers

for B2B startups people often talk about

net dollar retention this is just a

fancy way of calculating retention

mostly used in B2B SAS companies so

let's take an example we've started an

AI customer service chatbot very uh

invogue at the moment and say we we sign

up 10 paying customers in January in the

first month and they're each paying

$10,000 a month so 10K Mr each you're at

100K of monthly recurring Revenue feels

pretty good right let's fast forward a

year and in each of those subsequent

months you'll have signed up more

customers let's let's ignore them for

now focus on those 10 initial customers

you signed up in January but fast

forward 12 months perhaps two of those

customers have canceled their contracts

at some point in the year so we're down

to

$80,000 of monthly revenue from that

cohort but you've also upsold three

customers perhaps you've introduced some

new functionality or they've they're

using it more and instead of paying

10,000 they're each paying 20,000

perhaps you do phone chat as well as

text chat so that's $30,000 of

additional Revenue so we've lost 20 but

gained 30 so that's net 10K plus so

$110,000 of monthly revenue from that

January cohort that's why it's called

net dollar retention it's the amount

you've gained that's netted off against

the amount you've lost so that cohort

that was making $100,000 at the start in

January of year one a year later January

of year two is making a

$110,000 that's equivalent to 110% net

dollar retention so a net dollar

retention above 100% means your cohorts

are growing over time if your net dollar

attention is below 100% they're

shrinking over time youve got to pour

more water into the funnel to fill up

the the Leaky buckets we talked about

and that's what gives very sticky

businesses like stripe like go carders

like PayPal this exponential growth it's

adding new customers every month but

having existing customers grow

underneath them as well and that gives

you this exponential growth curve that's

very very impressive the final thing as

a benchmark any early stage B2B SAS

company should be looking at net dollar

retention well above 100% this is for

several reasons first of all you've

probably underpriced your product with

your first launch so you might charge

$10,000 a month for your initial

customers you realize pretty quickly uh

that the product could be sold for 20 or

$30,000 secondly you're adding features

the whole time presumably you're

improving your product and so that makes

it more appealing and customers are

willing to pay more money thirdly you

should be getting it better at sales and

upselling over time as well it' be weird

if you weren't getting better at that

and so those three reasons net dollar

retention for early stage B2B startup

should be 125% 150% would be great even

higher than that for mature companies uh

in the same range 110% 120% is pretty

good net dollar attention if your net

dollar attention is below 100%

especially for Enterprise B2B SAS

something is wrong you are churning off

customers they don't love the product

and I would invest in fixing that

talking to customers and figuring out

why they're turning off rather than

trying to to shove more customers in the

top of the funnel by investing in sales

and marketing for example net dollar

retention is absolutely crucial for B2B

SAS companies okay the second Deep dive

we're going to do on B2B metrics and

this is applicable to Consumer companies

as well is gross margin gross margin is

your Revenue the money you get from

customers minus the cost of goods sold

so you can imagine that if you're a

grocery store that's most obvious you're

selling you're selling sandwiches for

example the cost of good sold is the

cost of the bread and the cost of the

butter and the the filling that goes in

the sandwich that's cost of good sold

for a software company it's any cost

that varies per customer or for each

incremental customer you incur more cost

so let's go back to example we had

earlier we were running a an AI customer

service bot and you're probably using

something like open AI or anthropic to

power the core model behind that and so

the cost the credits that you pay to

open AI or anthropic or someone else is

your cost of goods sold we didn't used

to talk about this very much for B2B SAS

companies because the cost of goods was

very very minimal for Pure software it

might have been your AWS bill or your

bandwidth bill or something like that

it's minimal and so pure B2B SAS

companies in the past might have had

gross margins of 95% you know you sell

$100 worth of software and it's only $5

of cost and so people just assume it's

very very high margin but these days as

software sort of taking over more and

more Industries gross margin has become

more and more important so for AI

companies today the gross margin the

amount they pay to open AI or anthropic

or others for the foundation model is a

really important cost and by the way

just because you're getting free credits

doesn't mean that that's a cost that

doesn't exist it just means you're

hiding it for the moment so companies

that hide behind open AI credits and

claim that they've got these huge huge

gross margins have a nasty shock coming

when those credits run out it's also why

heavily operational businesses are so

tricky and when a company joins YC with

a with something like a grocery delivery

business or really any kind of business

where a lot of humans involved a lot of

operational processes going along you

maybe you paint houses or install heat

pumps or something you have to pay a lot

more attention to the gross margin

because it's very rare that it's as high

as 95% you might be down at 5 10 15%

gross margins which means you have to do

a lot more work you have to get a lot

more customers a lot more Revenue to

generate the same gross margin and that

gross margin is the thing that can then

pay your head office rent your

engineering salaries all of those

remaining costs that don't vary per

customer but still have to be deducted

before you get to profitability and so

for operationally intensive businesses

we often try to work with Founders to

see if there's a software only version

of their business that they can run at a

much higher margin so for example

instead of running a delivery company

where you have Vans and bikes and

and delivery people instead can you take

the software that powers all of that and

sell it to other delivery companies

you're going to have a probably a much

easier life certainly you're going to

have much higher gross margins if you do

that so in the zero interest rate

environment sort of 2010 to 2021 period

companies were scaling negative margin

businesses because Capital was so cheap

famously Uber did this they used capital

as a weapon so they took these

businesses that were initially negative

gross margin that means they're

effectively selling $10 worth of service

but only charging $9 so losing money on

every single order but trying to get to

a sort of a network effect or a Tipping

Point um for Uber famously it was a

certain number of drivers certain

density of drivers and riders in a

certain city that gets the flywheel

going but when they launched in a new

city they didn't have that density and

so they had to subsidize drivers and

subsidize Riders which made it a

negative gross margin business and so

they raised enormous amounts of capital

to expand across the globe before

competitors could catch up but burnt

tens of billions of dollars of invested

money in doing so and that Blitz scaling

approach that that scaling of negative

margin got popular with Founders and so

we saw it in ride sharing then we saw it

in 10-minute grocery delivery we saw it

with electric scooters and honestly

there's like a a whole Wasteland of

startups that tried to do that and then

realize they couldn't continue to raise

money as investors just didn't want to

keep subsidizing these businesses and

certainly now with much higher interest

rates Capital has become much more

expensive investors are really really

loed to invest in negative margin

businesses and it's much much harder to

scale those those negative margins we

did this at monzo so monzo was an online

bank in the UK and for our first half

million customers or so we were losing

money on every customer 30 or 40 per

customer customer we scale to more than

half a million of those customers it

costs a lot but we had a plan to turn it

around so we brought technology in house

we didn't rely so much on external

vendors we introduced charges for

certain things we introduced new

products that customers were happy to

pay for and over time we flipped those

negative unit economics so rather than

losing 30 or 40 pounds per customer we

ended up when I was there making 30 or

40 pound per customer and now three or

four years later monzo is profitable so

if if you start with negative unit

economics you really really have to have

a plan to fix them and I would really

advise you don't scale your customer

base you don't try and grow as quickly

as possible whilst you have negative

unit economics you fix them first and

then you scale pH we covered a lot of

stuff today so as a recap we talked

about revenue and why it's the best core

metric for most B2B companies then we

talked about retention and it's fancy

cousin net dollar retention and why

having a net dollar retention above 100%

is so important for B2B startups and we

finish with gross margin and why it's so

important not to scale businesses with

negative gross margins I wrap up with

some final thoughts make sure you're

tracking your four or five key metrics

before you launch don't launch without

metrics in place it's like Flying Blind

be rigorous in what you track track the

right metrics don't fall for vanity

metrics like gross merchandise value

your impressions or unique users have a

clear definition of each of your metrics

and a central way of measuring them in

your company to avoid those pointless

arguments that derails meetings don't

hide behind your metrics you can't split

everything especially as a small startup

so a lot of these decisions just have to

be made by talking to your users and

using your product intuition you still

have to get out of the building and talk

to customers that's so important so I

hope that helps run your startup with

the right blend of metrics talking to

customers and product intuition those

three are a vital blend thanks for

watching

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today