Gross margin is the percentage of revenue remaining after subtracting the direct costs of delivering the product, known as cost of goods sold or COGS. For SaaS businesses, COGS typically includes hosting, infrastructure, third-party API costs, payment processing fees, and customer support directly tied to product delivery. High gross margins are a defining characteristic of software businesses and a key driver of valuation multiples.
Gross margin shows how much of each revenue dollar is available to cover operating expenses and fund growth. High gross margins are a large part of why investors favor software businesses over other business models.
It directly affects LTV calculations, payback periods, and how much you can afford to spend on customer acquisition. A business with low gross margin has to work much harder on every other metric to reach the same unit economics.
Gross margin equals (Revenue minus COGS) divided by Revenue, expressed as a percentage. COGS for a SaaS company should include hosting and infrastructure such as AWS or GCP, third-party API costs, payment processing fees, and customer support staff directly tied to product delivery.
It excludes sales and marketing, research and development, and general administrative costs. Those are operating expenses that sit below the gross margin line instead of forming part of the direct cost of delivering the product.
Revenue is $100,000 for the month. Hosting costs $8,000, API costs $5,000, payment processing fees $3,000, and support costs $4,000, for total COGS of $20,000. Gross margin equals ($100,000 minus $20,000) divided by $100,000, or 80 percent.
Pure SaaS businesses typically run 70 to 85 percent gross margin. SaaS with a meaningful services component runs 50 to 70 percent. Marketplaces typically run 60 to 75 percent. Businesses combining hardware and software often run 40 to 60 percent.
Investors generally expect SaaS gross margins above 70 percent. Below 60 percent raises questions about whether the business is truly software or carries significant service or infrastructure costs baked into delivery.
Burying costs below the COGS line to make margins look better than they are. Investors will reclassify these during due diligence, so it rarely helps to hide them.
Leaving out payment processing fees, which typically run around 2.9 percent plus a small fixed fee per transaction on platforms like Stripe.
Ignoring third-party API costs that scale with usage, which can quietly erode margin as you grow if you are not tracking them per customer.
On your financials slide, show gross margin percentage with a brief COGS breakdown, and highlight if it is improving over time as you gain scale on infrastructure and support costs.
Use gross profit rather than revenue for LTV and payback calculations.
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