What is Gross Margin?
Gross margin is the percentage of revenue remaining after subtracting the direct costs of delivering your product or service. It shows how efficiently you turn revenue into profit before operating expenses.
For SaaS companies, COGS typically includes hosting, third-party software costs, and customer support. Everything else (sales, marketing, R&D, G&A) comes after gross profit.
Why Gross Margin Matters
Gross margin determines how much money you have to run and grow the business. A company with 80% gross margin keeps $0.80 of every dollar for operations. A company with 50% gross margin only keeps $0.50.
High gross margins are a defining characteristic of great software businesses. They enable aggressive investment in growth while still generating profit. Low margins force difficult trade-offs.
Gross Margin Benchmarks
SaaS companies typically achieve 70-85% gross margins. Below 70% suggests infrastructure inefficiency or heavy services component. Above 85% is excellent. Ecommerce margins are much lower, typically 30-50%.
Gross Margin = (Revenue - Cost of Goods Sold) ÷ Revenue × 100
Or: Gross Margin = Gross Profit ÷ Revenue × 100
SaaS company financials:
- Revenue: $500,000
- Hosting costs: $25,000
- Third-party APIs: $15,000
- Customer support: $35,000
COGS = $75,000
Gross Profit = $500,000 - $75,000 = $425,000
Gross Margin = $425,000 ÷ $500,000 = 85%
Strong margin typical of well-run SaaS.