Gross Margin
Revenue minus cost of goods sold, expressed as a percentage of revenue.
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Definition
Gross margin measures the profitability of a company's core product or service after subtracting direct costs (COGS). For SaaS companies, COGS includes hosting/infrastructure, customer support, third-party service costs, and payment processing fees.
SaaS gross margins are typically 70-85%, among the highest of any business model. This is because software has near-zero marginal cost per additional user. However, AI-heavy products may have lower margins (55-70%) due to compute costs for model inference.
Gross margin is a key valuation driver. High-margin companies are valued at premium multiples because more revenue flows to the bottom line. A company with 85% margins at $10M ARR generates $8.5M in gross profit; one with 60% margins generates only $6M.
Why It Matters for Founders
Gross margin determines how much revenue is available to fund growth, R&D, and path to profitability. SaaS companies with 80%+ margins have more flexibility to invest in sales, marketing, and engineering than those with 60% margins.
For AI startups, margin management is particularly important. Inference costs for large language models can significantly reduce gross margins. Companies that optimize their AI infrastructure, implement caching, and design efficient architectures maintain higher margins and more attractive unit economics.
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Formula
Gross Margin = (Revenue - COGS) / Revenue × 100%Real-World Example
A SaaS company earns $500K/month in revenue. Infrastructure costs $50K, support costs $75K. COGS = $125K. Gross Margin = ($500K - $125K) / $500K = 75%.
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Frequently Asked Questions
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