What Is Gross Margin? Definition, Formula, and Industry Benchmarks

Gross margin is the percentage of revenue a company retains after subtracting the direct costs of producing its goods or services. It's calculated as [(Revenue – Cost of Goods Sold) / Revenue × 100], and SaaS companies typically target 70-85%, while the cross-industry average sits at 36.56%. Unlike net margin, it excludes operating expenses, taxes, and interest.

Understanding gross margin tells you how efficiently your business converts revenue into profit before overhead. For SaaS founders especially, it's the single metric investors scrutinize most before writing a check or making an offer.

In this guide, you'll learn what gross margin is, how to calculate it, what counts as a good benchmark in your industry, and how to improve it.

Key Takeaways

• Gross margin equals gross profit divided by revenue, expressed as a percentage
• SaaS companies with gross margins above 75% are considered attractive to investors and acquirers
• The average gross margin across industries is 36.56%, but benchmarks vary widely by sector
• Gross margin only captures direct costs; you need net margin for full-picture profitability

What Is Gross Margin?

Gross margin is a profitability ratio that measures how much of each revenue dollar a company keeps after paying for the direct costs of delivering its product or service. Those direct costs are called the cost of goods sold (COGS).

The higher your gross margin, the more revenue remains to cover operating expenses like sales, marketing, R&D, and rent. A low gross margin leaves little room to invest in growth or absorb cost increases.

Gross margin is sometimes called gross profit margin. The two terms are interchangeable, though "gross margin" is more common in SaaS and tech circles while "gross profit margin" appears more often in manufacturing and retail.

How Gross Margin Works

The Gross Margin Formula

Wall Street Prep's formula is straightforward:

Gross Margin (%) = (Revenue – COGS) / Revenue × 100

Or expressed as dollar profit first:

1. Calculate gross profit: Revenue – COGS
2. Divide by revenue
3. Multiply by 100 to get a percentage

What Counts as COGS?

COGS includes only the direct costs tied to producing and delivering your product. What qualifies depends on your business model.

For a physical product company, COGS typically includes raw materials, direct labor, and manufacturing overhead.

For a SaaS company, COGS typically includes:

• Cloud infrastructure costs (compute, storage, bandwidth)
• Customer support directly tied to service delivery
• Third-party APIs and databases required to run the product
• DevOps and SRE costs tied to uptime
• Software licensing fees for product delivery

SaaS COGS excludes sales salaries, marketing spend, and general R&D, which appear lower in the income statement.

Gross Margin Calculation Example

Say your SaaS product earns $500,000 in annual revenue. Your cloud hosting, support team, and third-party API costs total $100,000.

• Gross profit: $500,000 – $100,000 = $400,000
• Gross margin: $400,000 / $500,000 × 100 = 80%

That 80% means you keep $0.80 of every revenue dollar before paying for sales, marketing, and other overhead. For SaaS, that's a healthy result.

Types of Profit Margins

Gross margin is one of three core margin metrics. Understanding the difference helps you avoid misreading your financial statements.

Gross margin answers: "How efficient is production and delivery?"

Operating margin answers: "How efficient is the business including overhead?"

Net margin answers: "How profitable is the entire company after all costs?"

Investopedia notes that a company can have a high gross margin and a low or negative net margin if sales and marketing costs are extremely high, which is common in early-stage SaaS companies.

Gross Margin Benchmarks by Industry

What counts as a "good" gross margin depends entirely on your industry. Comparing a software company's 80% margin to a car manufacturer's 12% tells you nothing without that context.

Data from NYU Stern via Vena shows average gross margins vary widely:

SaaS Gross Margin Benchmarks

For SaaS founders, the numbers to know are:

• Median total gross margin: 77% (Benchmarkit 2025, across SaaS companies)
• Subscription revenue median: 81% (Benchmarkit 2025)
• Professional services revenue median: 30% (Benchmarkit 2025)
• Attractive to investors: above 75% (Software Equity Group)
• Raises buyer concerns: below 70%

Stripe's analysis confirms that a gross margin above 75% signals scalability: each new customer costs significantly less than the revenue they bring in. Below 70%, investors and acquirers start questioning the unit economics.

Growth Unhinged's 2025 benchmarks show early-stage SaaS gross margins fell nearly 10 percentage points year-over-year, driven largely by AI workload costs and unpredictable cloud infrastructure spend.

Benefits of Tracking Gross Margin

It Reveals Pricing Power

Gross margin tells you whether your pricing covers the cost of delivery with room to spare. If your margin is shrinking, your prices may not be keeping pace with rising COGS, whether that's infrastructure costs, third-party API fees, or support overhead.

It Signals Scalability

Stripe notes that high gross margin suggests you can scale operations without proportionately increasing direct costs. This is the defining advantage of software: one codebase serves 10 customers or 10,000, and COGS barely moves.

It Attracts Investors

Private equity firms and strategic buyers scrutinize gross margin before valuation. Software Equity Group puts it plainly: companies above 75% gross margin signal operating leverage and earn better multiples at exit.

It Catches Supply Chain Problems Early

For product businesses, a small gross margin decline often flags a supplier price increase or manufacturing inefficiency before it becomes a P&L crisis. Monthly tracking lets you act while the problem is still manageable.

It Guides Product Mix Decisions

If you sell multiple products or tiers, gross margin by SKU or plan tier shows which offerings generate the most profit per dollar sold. You can then shift focus to high-margin products or reprice underperforming ones.

Challenges and Limitations

It Doesn't Show Full Profitability

A 75% gross margin sounds impressive, but if your sales and marketing spend is 80% of revenue, you're losing money. In SaaS, there is often a wide gap between gross and operating margins because sales, marketing, and R&D sit below the gross profit line and can dwarf it. Stripe notes that these costs are separate from COGS. Use gross margin alongside operating margin and net margin for the full picture.

AI and Cloud Costs Are Compressing SaaS Margins

As AI features become table stakes, the underlying compute costs are significant and often unpredictable. Growth Unhinged's 2025 data shows early-stage SaaS gross margins fell nearly 10 points year-over-year. If you're building AI-native features, model inference costs belong in COGS and will drag your margin lower than pre-AI benchmarks suggest.

COGS Misclassification Distorts Results

A common problem in SaaS: shared services, DevOps salaries, and customer success costs get misattributed, leading to overstated gross margins. If you're not careful about what you classify as COGS versus operating expenses, your gross margin becomes an unreliable signal. Stripe's COGS guidelines are a useful reference for what belongs in cost of revenue.

Industry Context Is Required

A 40% gross margin is strong for a brick-and-mortar retailer but alarming for a SaaS company. Never benchmark gross margin across industries. Compare within your sector and stage.

How to Improve Gross Margin

Raise Prices Strategically

Software Equity Group identifies pricing as the most powerful lever for expanding gross margin. A well-designed tiered model lets you capture more revenue from customers who get the most value, without increasing delivery costs. Value-based pricing, aligning your price to usage volume, seat count, or API calls, tends to preserve margin better than flat-fee models as you scale.

Reduce Infrastructure Costs

Pre-purchasing reserved cloud instances, right-sizing compute resources, and auditing third-party API usage are among the fastest ways to cut COGS. Stripe recommends improving development efficiency and minimizing maintenance costs as a route to higher gross margin.

Prioritize High-Margin Revenue Streams

Benchmarkit's 2025 data shows subscription revenue delivers an 81% median gross margin, while professional services deliver 30%. If you're spending significant resources on implementation and customization, those hours are dragging your blended margin down. Productizing services or shifting toward self-serve can recover meaningful margin points.

Improve Customer Mix

If some customer segments require disproportionate support or infrastructure, they may generate lower-than-average margin. Identifying and de-prioritizing unprofitable customer types, or re-pricing them, protects your overall gross margin without requiring a price increase across the board.

Gross Margin vs. Markup

A common point of confusion is the difference between gross margin and markup. Both describe the relationship between cost and selling price, but they use different denominators.

• Gross margin is calculated as a percentage of revenue
• Markup is calculated as a percentage of COGS

If you price a product at $100 and COGS is $70, your gross margin is 30% and your markup is 42.9%. Always clarify which metric you're using when discussing pricing with your finance team.

Conclusion

Gross margin is the foundation of SaaS unit economics. It tells you whether your product is fundamentally profitable to deliver before a single sales or marketing dollar is spent. A margin above 75% signals the operating leverage that investors and acquirers look for; below 70%, every new customer you add puts more pressure on a model that isn't yet efficient enough to scale.

Tracking gross margin monthly, by customer segment and revenue stream, gives you the visibility to act before small cost creep becomes a structural problem. Start with your COGS classification, make sure every direct cost is in and every operating expense is out, then benchmark against your stage and sector.