What is gross margin?

By Paulo de VriesLast verified 2026-05-294 sources~3 min readhigh consensus

Quick answer

Gross margin is revenue minus cost of goods sold (COGS), expressed as a percentage of revenue. It measures how much of each sales dollar survives the direct cost of producing or delivering the product. SaaS targets 70–85%; gross margin sets the ceiling on LTV, CAC payback, and the Rule of 40.

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The full answer

The formula

`` Gross profit = Revenue − COGS Gross margin % = (Revenue − COGS) / Revenue × 100 ``

Gross *profit* is a dollar amount; gross *margin* is that profit as a percentage of revenue. A company with $1M revenue and $200k COGS has $800k gross profit and an 80% gross margin.

What counts as COGS (the direct cost of delivery):

Business type	Typical COGS
SaaS	Hosting/cloud, customer support, payment-processing fees, third-party API costs, data
E-commerce	Product cost, inbound freight, packaging, fulfillment
Services	Salaries of people delivering the billable work

COGS is the cost to *deliver* what you sold — not sales, marketing, R&D, or overhead. Those sit below the line and shape operating (net) margin, not gross.

Benchmarks by business type:

Business	Healthy gross margin
Software / SaaS	70–85% (best-in-class 80%+)
Marketplaces	50–70%
Consumer packaged goods	30–50%
E-commerce / DTC	30–50%
Hardware	20–40%
Grocery / distribution	5–25%

Why gross margin is the metric that gates every other metric

Gross margin is the multiplier hiding inside the canonical SaaS formulas:

`` LTV = (ARPU × Gross Margin) / Churn rate CAC Payback = CAC / (ARPU × Gross Margin) ``

A company at 80% gross margin recovers acquisition cost far faster than one at 40% — same revenue, same CAC, half the payback. This is why investors treat 70%+ gross margin as the price of admission for a software valuation multiple: low gross margin caps how much you can spend to acquire and still be healthy.

Gross vs contribution vs net margin

Gross margin — after COGS only.
Contribution margin — after COGS *plus* other variable costs (e.g., variable sales commissions, shipping). Useful for per-unit decisions.
Net (operating) margin — after *all* costs including S&M, R&D, and G&A. This is profitability.

A company can post 80% gross margin and still lose money if it spends 120% of revenue on growth — gross margin is the ceiling, net margin is the floor.

The "Rule of 40" connection

Gross margin feeds the Rule of 40 (growth rate + profit margin ≥ 40%) because the profit-margin side is impossible to improve without healthy gross margin. Low-gross-margin businesses have to grow faster to clear the same bar.

Cross-reference: see /pages/what-is/customer-acquisition-cost + /pages/what-is/lifetime-value + /pages/what-is-the-difference-between/cac-and-ltv for how gross margin flows into unit economics.

Time ranges by condition

Condition	Duration	Note
SaaS / software	70–85% gross margin (80%+ best-in-class)	—
Marketplaces	50–70%	—
E-commerce / DTC / CPG	30–50%	—
Hardware	20–40%	—
Formula	Gross margin % = (Revenue − COGS) / Revenue × 100	—

What changes the time

COGS definition. Misclassifying S&M or R&D as COGS understates gross margin; only direct delivery cost belongs
Business type. Software runs 70–85%; physical-goods businesses run 20–50% structurally
Scale. SaaS gross margin usually improves with scale (fixed infra spread over more revenue); hardware often does not
Pricing power. Higher prices lift gross margin directly when COGS is fixed per unit

Common questions

What is the difference between gross profit and gross margin?

Gross profit is a dollar figure (Revenue − COGS); gross margin is that figure as a percentage of revenue. $800k gross profit on $1M revenue = 80% gross margin. Profit tells you the absolute amount; margin lets you compare efficiency across companies of different sizes.

What counts as COGS for a SaaS company?

Only the direct cost of delivering the software: cloud/hosting, customer support, payment-processing fees, third-party API and data costs, and sometimes the portion of DevOps that keeps the service running. Sales, marketing, R&D, and G&A are NOT COGS — they sit below gross margin and shape operating margin.

Why do investors care so much about gross margin?

Because it is the ceiling on every downstream metric. Gross margin multiplies into LTV and divides CAC payback, so a 40%-margin business must grow far faster than an 80%-margin business to be equally healthy. High gross margin (70%+) is the structural reason software earns higher valuation multiples than physical-goods businesses.

Can a company have high gross margin but still lose money?

Yes — routinely. Gross margin is only after COGS. A SaaS company at 80% gross margin can still post a net loss if it spends more than its gross profit on sales, marketing, and R&D to fuel growth. Gross margin is the ceiling on profitability; net (operating) margin is the actual bottom line.

Sources

We cite primary research, expert practice, and authoritative reference. Higher-tier sources weighted heavier. See methodology.

Tier 1 · peer-reviewed / governmentalTier 2 · editorial referenceTier 3 · named practitioner

T1Bessemer Venture Partners "State of the Cloud" — Public-SaaS gross-margin benchmarks (70–85% healthy) + valuation linkage
T2David Skok, "SaaS Metrics 2.0" — Gross margin inside LTV + CAC-payback formulas
T1Aswath Damodaran, NYU Stern — Margins by Sector — Canonical gross/operating/net margin data by industry
T2Andreessen Horowitz, "16 Startup Metrics" — Gross margin as a quality-of-revenue signal

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de Vries, P. (2026). What is gross margin?. AskedWell. Retrieved 2026-05-29, from https://askedwell.com/pages/what-is/gross-margin

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Last verified: 2026-05-29 · Published 2026-05-29

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