Gross Margin
What is Gross Margin?
Gross Margin measures the percentage of revenue left after the direct costs of delivering the product or service.
Gross margin measures what is left from revenue after the direct cost of delivering the service. It links product economics to acquisition decisions: two subscriptions with the same price can contribute very different amounts toward recovering CAC when hosting, inference, support, or delivery costs differ.
How to use it
- Choose a reporting period and use recognized revenue for that period.
- Identify cost of revenue using a consistent accounting policy. For software, review hosting, third-party service usage, and direct delivery or support allocations with the finance owner.
- Subtract cost of revenue to obtain gross profit, then divide by revenue. Separate product lines or customer segments when their delivery requirements differ materially.
Worked example
Hypothetical worked scenario
A fictional SaaS product earns $200,000 revenue in a month and records $50,000 in cost of revenue. One resource-intensive plan contributes $40,000 of revenue and $20,000 of that cost.
Company gross margin = ($200,000 − $50,000) ÷ $200,000 = 75%. The resource-intensive plan has ($40,000 − $20,000) ÷ $40,000 = 50% margin.
Using the company’s 75% margin to estimate the expensive plan’s CAC payback would overstate its monthly contribution. The segment-level calculation gives a better acquisition planning input.
What the result tells you
Investigate changes by price, usage, infrastructure rates, and allocation policy. A margin improvement after moving expenses to another accounting category does not show that delivery became cheaper. Preserve a comparable view when cost classifications change.
Assumptions and common mistakes
- Gross margin excludes many operating expenses; it does not measure total company profitability.
- Keep period and currency consistent between revenue and cost.
- Usage-heavy products can have different margins by customer. Review high-cost outliers before applying one average to every acquisition channel.
Frequently asked questions
Is gross margin the same as markup?
No. Margin divides gross profit by revenue; markup divides it by cost. At $100 revenue and $25 cost, margin is 75% while markup is 300%.
Which costs belong in cost of revenue?
That depends on the service and accounting policy. Make the scope explicit and consistent; a finance professional should determine formal accounting classification for your business.
Sources and methodology
The references below explain the underlying methods. Our worked scenarios use hypothetical figures; they are not company results or current market benchmarks.
- Bessemer: Scaling from $1 to $10 million ARR
Gross profit after the cost of delivering software.
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