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gross margin

Also called: gross profit margin

The share of revenue left after the direct costs of delivering the product (for SaaS: hosting, third-party services used per customer, payment fees and customer support): (revenue − cost of revenue) ÷ revenue.

Gross margin is the percentage of revenue a business keeps after paying the direct costs of delivering its product: gross margin = (revenue − cost of revenue) ÷ revenue. For a SaaS company the cost of revenue usually includes hosting, services paid per use (such as SMS or email sending), payment processing fees and customer support. Product development, marketing and the founders' salaries are not part of it; they come out of what the gross margin leaves.

Software typically has high gross margins, often 70–90%, because serving one more customer costs little. That's a large part of why software businesses are valued the way they are. A low gross margin is a warning that the "software" is really a service in disguise: lots of manual work, expensive third-party costs or heavy support per customer.

Gross margin also matters for unit economics. LTV should be calculated from gross profit, not revenue, and CAC payback depends on it too. When a cost grows with every customer, such as messages sent on their behalf, it pays to watch that line closely and to set prices so that heavy users don't eat the margin.

Example

In October of year 2 GarageDesk's MRR is 165,000 UAH. Direct monthly costs: tools and SMS 12,000 UAH and part-time support 16,000 UAH, 28,000 UAH in total.

Gross margin = (165,000 − 28,000) / 165,000 = 137,000 / 165,000 ≈ 83%. Without support it would be (165,000 − 12,000) / 165,000 ≈ 92.7%. The contract developer, the accountant and the founders are paid from the remaining 137,000 UAH.

Common mistakes

  • Leaving support out of the cost of revenue. It's a direct cost of serving customers.
  • Putting development or marketing in. Those are operating expenses, below gross margin.
  • Ignoring per-use costs. SMS, messages or AI calls per customer can shrink margin as usage grows.
  • Comparing with non-software businesses. A 40% gross margin is great for a shop and poor for SaaS.