What VCs Should Invest In: The Future, Business Metrics, and High Gross Margins

The Investments VCs Should Favor A VC should invest in the “next big thing” and “next-generation products”: projects and products for the future, with the potential to create a monopoly. Only by investing early in the future and next-generation products can you have a chance to achieve monopoly or a relatively high market share and uniqueness. Positioning ahead of the future makes the company more unique than others, enabling it to grow larger and generate better VC returns. A business that is profitable now and simply pays regular annual dividends is not particularly suited to the VC investment mindset. ---- Business-to-business (B2B) differs somewhat from business-to-consumer (B2C). Consumer models are often simpler, allowing a rapid shift from loss to profit. A consumer business may spend heavily on marketing, but once it attracts traffic, monetization through advertising or other means can generate strong cash flow and profitability. B2B is different because the process is complex. Selling a B2B product involves sales, presales, after-sales support, consulting and implementation, and various other expenses. If a B2B business starts with a low gross margin, improving its eventual profit margin is quite difficult. Even intense optimization may not be enough; improving each stage by a few percent is hard. Consumer advertising, by contrast, can have almost zero marginal cost. In B2B, every stage has marginal costs, and each dollar of revenue carries meaningful incremental expense. When investing in B2B, investors examine business metrics such as net dollar retention (NDR) and marketing efficiency, including customer acquisition cost. Another difference is that many consumer businesses naturally have high margins, especially online. B2B margins vary widely: the weaker ones are in the teens, some are 30–40%, and better ones reach 70–80%. Why do people like investing in SaaS and enterprise services—SaaS products or product-oriented companies? Because they have 70–80% gross margins. What do those margins often represent? Customer switching costs. If you add an 80% gross margin on top of your operating costs and customers still buy, it shows your product is very unique. Why do some customization-oriented companies have margins of only 20–30% and still face fierce competition? Because customers permit only that level. If margins go higher, customers may find another provider of similar services. Buffett says you need three elements: a good business, a good team, and a good price. He puts the business first. This is also a strong VC consideration: should you invest in product businesses and high-margin companies? Even if revenue or gross profit looks similar, customer switching costs may differ enormously. High switching costs represent substantial competitiveness with target customers. --- Robin: 1. VCs invest in the future, the next big thing, and next-generation products. Early positioning can lead to high future market share or even monopoly. 2. VCs examine business metrics such as NDR, customer acquisition cost, and customer lifetime value. 3. VCs want product businesses with high gross margins, because those represent strong competitiveness and customer switching costs.