Gross Margin
The percentage of revenue remaining after subtracting the direct cost of goods sold, measuring production profitability.
Gross margin is the percentage of revenue remaining after deducting the cost of goods sold (COGS) — the direct costs of producing or delivering the goods or services sold. It measures how efficiently a company produces its products relative to the price it charges and is the first profitability metric on the income statement.
Gross Margin % = (Revenue − COGS) ÷ Revenue × 100
For a company generating $10M in revenue with $3M in COGS, Gross Margin = ($10M − $3M) ÷ $10M = 70%.
What's included in COGS varies by industry: for manufacturers, COGS includes raw materials, direct labor, and manufacturing overhead; for retailers, it's the wholesale cost of merchandise; for SaaS companies, it includes hosting/infrastructure costs, customer support, and implementation costs (but NOT R&D, sales, or marketing).
Gross margin benchmarks vary dramatically by industry and business model. SaaS companies typically achieve 70–80%+ gross margins (low incremental cost to serve additional customers). Software companies can reach 90%+. Professional services firms range from 30–50%. Manufacturers 25–45%. Grocery retailers 20–30%. These differences reflect underlying business model economics, not operational efficiency.
For investors and analysts, gross margin is a critical quality indicator: it sets the ceiling for all other profitability (operating margin and net margin can't exceed gross margin). Gross margin expansion over time indicates improving pricing power or cost efficiency; gross margin compression signals competitive pressure, rising input costs, or product mix shifts.
For SaaS companies specifically, gross margin is the starting point for LTV calculations — it determines how much of each dollar of revenue is available to cover customer acquisition costs and overhead. A SaaS company with 80% gross margins can sustain a much higher CAC than one with 50% gross margins.
FAQs
What is the difference between gross margin and gross profit?
Gross profit is the dollar amount: Revenue − COGS = Gross Profit ($). Gross margin is the percentage: Gross Profit ÷ Revenue = Gross Margin (%). Both measure the same profitability at the gross level. Gross profit is used in absolute dollar comparisons; gross margin percentage is used for trend analysis and benchmarking across different-sized companies.
What gross margin should a SaaS company target?
Best-in-class SaaS companies target 75–85% gross margins. Below 60% is concerning — it suggests high customer support costs, heavy implementation requirements, or infrastructure inefficiency. Investors typically use 70% as a minimum threshold for 'software-like' margins. Companies with gross margins below 60% are often categorized as 'services businesses' rather than pure software, which commands lower valuation multiples.
Can gross margin be negative?
Yes, though it's unsustainable for established businesses. A negative gross margin means COGS exceeds revenue — the company loses money on every unit sold before any operating expenses. This can occur during product launch ramp (fixed costs not yet covered by volume), with loss-leader pricing strategies, or in severe distress situations. Early-stage companies sometimes accept negative gross margins temporarily while scaling.
Related Terms
Operating Margin
The percentage of revenue remaining after all operating expenses including COGS and overhead, excluding interest and taxes.
Net Margin
The percentage of revenue remaining as net income after all expenses including interest, taxes, and non-operating items.
EBITDA
Earnings Before Interest, Taxes, Depreciation, and Amortization — a proxy for operating cash generation used in valuation and financial analysis.
