Gross Margin
The percentage of revenue remaining after subtracting the direct costs of delivering a product or service.
Gross margin measures how much revenue a company keeps after paying the direct costs of production or delivery (cost of goods sold, or COGS) — hosting and infrastructure costs for software, cloud compute for AI products, materials and fulfillment for physical goods. It's foundational to unit economics, since it determines how much revenue growth actually translates into gross profit that can fund the rest of the business.
SaaS companies typically target gross margins of 70-85%, since software has relatively low marginal delivery costs; AI-native companies with heavy inference and compute costs often run meaningfully lower gross margins (sometimes 40-60%) that investors now scrutinize closely, since compute costs don't naturally decline the way traditional SaaS hosting costs have over time.
Gross margin % = (revenue - cost of goods sold) / revenueA company generates $5M in quarterly revenue and spends $1.25M on cloud infrastructure and support costs directly tied to delivering the product. Gross margin = ($5M - $1.25M) / $5M = 75%.
Track gross margin trends closely for any AI-native product — falling gross margin as usage scales (rather than the traditional software pattern of margin improving with scale) is one of the biggest structural risks investors are now underwriting in AI company diligence.
Why do AI companies often have lower gross margins than traditional SaaS?
Because inference and compute costs scale roughly linearly with usage, unlike traditional software hosting costs that tend to decline as a percentage of revenue with scale — this is a key structural difference investors weigh in AI company valuations.
Related terms
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