Gross Margin

Gross margin is revenue minus cost of goods sold (COGS), divided by revenue, expressed as a percentage. For software companies, COGS typically includes hosting costs, third-party API fees, payment processing fees, and customer support costs directly tied to service delivery. High gross margins mean more of each revenue dollar is available for growth, R&D, and profit.

Software businesses are valued highly partly because of their gross margins. Typical SaaS gross margins range from 70-85%, compared to 30-50% for traditional businesses. Investors scrutinize gross margin because it indicates the scalability of the business model: a company with 80% gross margin can invest $0.80 of every dollar earned back into growth, while a 40% margin business can only invest $0.40.

Gross margin can be misleading if not calculated consistently. Some companies exclude certain costs from COGS to inflate their margin, while others include too much. The key is to include all costs that scale directly with revenue: if you add one more customer, what additional costs do you incur? Those costs belong in COGS. R&D salaries, marketing, and G&A are not COGS; they are operating expenses.