SaaS Gross Margin

gross margin % = (revenue − cost of revenue) / revenue × 100

gross profit per customer per month = ARPU × gross margin

Two decisions hide inside that first line: which period, and what counts as cost of revenue. The period barely matters as long as it is consistent. The classification does.

The test is causation, not department: if the cost would fall to zero when the customer disappeared, it is cost of revenue. Support is the contested line — most modern SaaS companies include it, and investors increasingly expect it, because a product that needs heavy human support is not really an 85% margin product.

A company with $1,200,000 of annual recurring revenue:

hosting + infrastructure      $150,000
third-party APIs               $60,000
payment processing             $36,000
support + customer success    $114,000
cost of revenue               $360,000

gross margin = (1,200,000 − 360,000) / 1,200,000 = 70%

If the same company reported hosting alone as cost of revenue, the margin would be 87% — a number that describes a different business. Both are arithmetically correct; only the first predicts what happens when revenue doubles.

These bands follow the ranges published by Bessemer, OpenView and KeyBanc's SaaS survey. Compare within segment: a data-heavy product at 72% is not failing the way a project-management tool at 72% would be.

Both metrics are supposed to measure money available to repay acquisition and contribute to overhead, so both are built on gross profit:

LTV (gross profit)   = ARPU × gross margin × (1 / monthly churn)
CAC payback (months) = CAC / (ARPU × gross margin)

The sensitivity is easy to underestimate. At $100 ARPU with a 3% monthly churn rate, moving from 80% to 60% margin cuts LTV from $2,667 to $2,000 and lengthens payback on a $1,500 CAC from 18.8 months to 25 months — the same business, described twice. This is why the LTV:CAC calculator asks for margin rather than revenue, and why the LTV:CAC guide treats a ratio computed on revenue as inflated.

• Excluding support and success salaries. The most common inflation. It moves a 70% margin to 85% without changing anything real.
• Including all engineering. R&D is an operating expense. Only capitalised software amortisation that directly serves customers belongs in cost of revenue.
• Leaving professional services in revenue at 100%. If services are billed, their delivery cost must sit in cost of revenue too, or the blended margin lies.
• One-off implementation costs. They belong in cost of revenue in the period delivered, which is exactly why first-year margins look worse than steady state.
• Quoting gross margin from a different definition than the one used in LTV. The two must match, or the ratio is built from two different businesses.

Gross margin improves through infrastructure efficiency, support deflection and pricing — in roughly that order of difficulty:

• Infrastructure. Reserved capacity, log retention, storage tiering and query cost usually take several points with no customer-visible change.
• Support deflection. Better onboarding and docs move ticket volume, which is the largest headcount line in cost of revenue.
• Pricing and packaging. Usage-based pricing aligns cost with revenue and is often the only durable fix for a data-heavy product.

Scale acquisition only after margin is understood: a negative-margin product loses more money with every customer acquired, and no CAC number makes that work. See the CAC formula for what belongs on the other side of the ledger.