Gross Margin

Definition

Gross Margin is the percentage of revenue remaining after subtracting the direct costs of delivering your product or service (Cost of Goods Sold / Cost of Revenue). For software businesses, this is primarily hosting, infrastructure, support, and customer success costs.

Formula

Gross Margin % = (Revenue - Cost of Revenue) / Revenue × 100%

Gross Profit = Revenue - Cost of Revenue

Cost of Revenue typically includes:
  - Hosting/Infrastructure (AWS, Azure, GCP)
  - Customer support team salaries
  - Customer success team salaries
  - Payment processing fees
  - Third-party API/data costs
  - DevOps/Site reliability team (portion)

Worked Example

Monthly P&L for a SaaS company:
- Revenue: $850,000
- Hosting & infrastructure: $51,000
- Customer support team (8 people): $64,000
- Customer success team (4 people): $48,000
- Payment processing (2.9%): $24,650
- Third-party data feeds: $12,000
- DevOps team (2 people, allocated to COGS): $28,000
- Total Cost of Revenue: $227,650

Gross Margin = ($850,000 - $227,650) / $850,000 × 100% = 73.2%

For every dollar of revenue, $0.73 is available to cover operating expenses (R&D, S&M, G&A) and generate profit.

Benchmarks

Business Type	Typical Gross Margin
Pure SaaS (software only)	75–85%
SaaS + Services (blended)	60–75%
Marketplace	60–80%
E-commerce (own inventory)	30–50%
E-commerce (dropship)	15–25%
Hardware + Software	45–60%
Professional services	50–70%
Infrastructure/Cloud	55–70%

For SaaS specifically:
- Best-in-class: 80%+
- Healthy: 70–80%
- Acceptable: 60–70%
- Concerning: <60%

Common Pitfalls

Classifying all engineering as R&D. If engineers are doing customer-specific implementation or maintaining infrastructure, some of that cost should be in COGS, not R&D. Under-allocating to COGS inflates gross margin.
Excluding hosting cost increases. As you grow, hosting costs should scale sub-linearly. If they scale linearly or super-linearly, gross margin will erode at scale.

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