Gross Margin

Also known as: Gross Profit MarginGPMGross Margin PercentageContribution MarginProduct Margin

Gross Margin (%) = (Revenue − COGS) ÷ Revenue × 100

💡The Concept

Gross margin is the percentage of revenue left after subtracting the direct costs of delivering your product (Cost of Goods Sold / COGS). For SaaS, COGS includes hosting, customer support, and payment processing — typically leaving 70-85% gross margins. For e-commerce, COGS includes product costs, shipping, and packaging — typically 30-50% margins. Gross margin determines how much money you have to invest in growth (sales, marketing, R&D). A SaaS company with 80% gross margins has $0.80 per revenue dollar for growth; a hardware company with 30% margins has only $0.30.

⚠️The Trap

The trap is miscategorizing expenses to inflate gross margin. Some companies exclude customer success, onboarding, or infrastructure costs from COGS to make gross margins look SaaS-like (75%+) when they're really services businesses (50-60%). VCs see through this immediately. If your 'SaaS' has 55% gross margins, you're not a SaaS company — you're a services company with a software wrapper. The valuation difference is 3-5x.

🎯The Action

Calculate gross margin honestly: include ALL costs directly related to delivering your product to one more customer. For SaaS: hosting/infrastructure, payment processing, customer support, DevOps. Formula: Gross Margin = (Revenue − COGS) ÷ Revenue × 100. Target: 70%+ for SaaS, 50%+ for marketplace, 30%+ for e-commerce. Track monthly and investigate any decline — it usually means infrastructure costs are scaling faster than revenue.

⚡Pro Tips

SaaS gross margins should INCREASE with scale because infrastructure costs have economies of scale — hosting 1,000 users doesn't cost 10x hosting 100 users. If your margins are flat or declining as you grow, investigate your infrastructure cost structure.

Gross margin is the single best predictor of a SaaS company's valuation multiple. Companies with 80%+ margins trade at 15-20x revenue; companies with 60% margins trade at 6-8x. Each percentage point matters.

Customer support is a hidden margin killer. If support costs scale linearly with customers (1 ticket per customer per month), you have a gross margin problem. Invest in self-serve support, documentation, and in-app help to bend the cost curve.

🚫Common Myths

✗Myth: “High gross margins mean the company is profitable”

✓Reality: Gross margin only covers direct costs. A SaaS company with 85% gross margins but spending 120% of revenue on sales and marketing is still losing money. Gross margin is a necessary but not sufficient condition for profitability.

✗Myth: “All SaaS companies should have 80%+ gross margins”

✓Reality: Infrastructure-heavy SaaS (video streaming, cloud storage, AI/ML) can have 50-65% margins and still be excellent businesses. Snowflake's gross margins are ~67% because compute costs are real. Context matters — compare within your category.