Gross Margin for Startups: What's Good and How to Improve
Gross margin determines how much of every dollar you keep after delivering your product. Here's how to measure and optimize it.
Quick Definition
Gross margin is the percentage of revenue remaining after subtracting the direct costs of delivering your product or service (COGS). It shows how efficiently you deliver value.
If you make $1,000 in revenue but spend $400 to deliver that service, your gross margin is 60%. That's the money you have left to cover operating expenses, invest in growth, and eventually generate profit.
Gross margin is a fundamental health indicator. High-margin businesses can afford to invest more in growth, weather downturns more easily, and command higher valuations. Low-margin businesses must be perfect at everything else to survive.
What Is Gross Margin?
Gross margin (or gross profit margin) measures the profitability of your core business operation before operating expenses like sales, marketing, and G&A.
Gross Margin = (Revenue - COGS) ÷ Revenue × 100%
The key input is COGS (Cost of Goods Sold)—the direct costs of delivering your product or service. What counts as COGS varies significantly by business model.
COGS for Different Business Models
Understanding what to include in COGS is critical. Get it wrong and your gross margin will be misleading.
SaaS / Software
Typical COGS: 15-30% of revenue
Include in COGS:
- • Cloud hosting (AWS, GCP, Azure)
- • Third-party API/data costs
- • Customer support salaries
- • DevOps/Site reliability
- • Payment processing fees
Don't Include:
- • Product development (R&D)
- • Sales & marketing
- • General & administrative
- • Office rent
Marketplace
Typical COGS: 40-60% of revenue (take rate)
Include in COGS:
- • Payment processing fees
- • Trust & safety costs
- • Customer support
- • Infrastructure
- • Insurance/guarantees
Don't Include:
- • Product development
- • Sales & marketing
- • General & administrative
E-commerce / D2C
Typical COGS: 40-70% of revenue
Include in COGS:
- • Product/inventory cost
- • Packaging materials
- • Shipping costs
- • Payment processing
- • Returns/refunds
- • Warehouse labor (order fulfillment)
Don't Include:
- • Marketing & advertising
- • Website development
- • General & administrative
Professional Services
Typical COGS: 50-70% of revenue
Include in COGS:
- • Consultant/employee salaries (delivery)
- • Contractor costs
- • Direct project expenses
- • Software tools for delivery
Don't Include:
- • Sales team salaries
- • Marketing expenses
- • Administrative overhead
How to Calculate Gross Margin
SaaS Gross Margin Example
Gross Margin Benchmarks
Healthy gross margins vary significantly by industry. Here are typical ranges:
| Business Model | Typical Range | Best-in-Class |
|---|---|---|
| SaaS | 70-85% | 85%+ |
| Marketplace | 40-70% | 70%+ |
| E-commerce | 30-50% | 50%+ |
| Professional Services | 30-50% | 50%+ |
| Hardware | 20-40% | 40%+ |
Note: Investors heavily prefer high-margin businesses. A SaaS company with 80% gross margin can invest much more in growth than one with 60%. This is partly why SaaS commands higher valuation multiples.
Why Gross Margin Matters
Determines Growth Investment Capacity
High margin means more money available for sales, marketing, and R&D. An 80% margin company can afford 4x the S&M investment of a 20% margin company.
Affects Unit Economics
Gross margin directly impacts LTV calculations. Higher margin = higher LTV = more you can spend on acquisition.
Influences Valuation
Investors pay higher multiples for high-margin businesses. A 70% margin company might get 10x ARR while a 50% margin company gets 6x.
Indicates Scalability
Low margins often signal high variable costs that don't improve with scale. High margins suggest good leverage and improving economics at scale.
How to Improve Gross Margin
Reduce Cost of Delivery
Optimize Infrastructure
Right-size cloud instances, use reserved capacity, optimize database queries, and implement caching. Even 20% savings compounds significantly.
Renegotiate Vendor Contracts
As you scale, renegotiate hosting, API, and payment processing fees. Volume discounts can meaningfully improve margins.
Automate Support
Self-serve documentation, chatbots, and better UX reduce support tickets. Every support interaction has a cost.
Improve Product Quality
Bugs and issues drive support costs. Investment in quality reduces ongoing support burden.
Increase Revenue Per Customer
Raise Prices
If you have strong retention and product-market fit, price increases flow directly to margin. Most startups underprice.
Shift Customer Mix
Larger customers often have better unit economics. Focus acquisition on higher-value segments.
Common Gross Margin Mistakes
Excluding Real COGS
Some founders exclude customer support or hosting to make margins look better. This is misleading and will be caught in due diligence.
Including Operating Expenses in COGS
R&D, sales, and marketing are not COGS. Including them understates your gross margin and misrepresents your economics.
Not Tracking by Product/Segment
Blended margin can hide problems. Your enterprise product might have 85% margin while your SMB product has 60%. Track separately.
Ignoring Margin Trends
Margin should improve (or at least stay stable) as you scale. Declining margins suggest costs are growing faster than efficiencies.
Key Takeaways
- 1Gross margin = (Revenue - COGS) ÷ Revenue
- 2SaaS should target 70-85%+; marketplaces 40-70%; e-commerce 30-50%
- 3Include hosting, support, and payment processing in COGS; exclude R&D and S&M
- 4Improve margins through infrastructure optimization, automation, and pricing
- 5Track margin by segment and watch trends over time
Need Help Analyzing Your Margins?
Eagle Rock CFO helps seed and Series A startups understand their unit economics, build financial models, and present compelling metrics to investors.
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