What is Gross Margin?
Revenue minus cost of goods sold, expressed as a percentage, measuring how much of each revenue dollar remains after direct costs of delivering the product or service.
Understanding the Details
Gross margin indicates business model efficiency. SaaS typically has 70-85% gross margin because software delivery costs are minimal after development. Services businesses have lower margins because delivery requires labor. Gross margin matters because it determines how much revenue is available for sales, marketing, R&D, and profit. High gross margin enables aggressive growth investment; low gross margin constrains options. Gross margin can be calculated at company level or per customer/segment for more granular analysis.
How It Works in Practice
SaaS gross margin
$100K revenue minus $20K hosting and support costs = $80K gross profit = 80% gross margin.
Services impact
Adding managed services with 50% margin dilutes overall margin from 80% to 70%.
Unit economics
LTV calculation uses gross margin, not revenue, because revenue below gross margin funds delivery, not profit.
Why It Matters
Gross margin determines how much revenue actually contributes to growth and profit. High gross margin is what makes SaaS economics attractive and enables investment in growth.
What People Often Get Wrong
Revenue equals gross profit. Actually, gross margin accounts for delivery costs that revenue ignores.
SaaS gross margin is always high. Actually, heavy support loads or infrastructure costs can significantly reduce margin.
Gross margin is fixed. Actually, gross margin can improve through operational efficiency and pricing changes.
How We Handle Gross Margin
We help companies understand gross margin by segment, identify opportunities to improve margin, and incorporate accurate margins into unit economics analysis.
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Common Questions
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