Understanding Gross Margin Quality: Why It Matters More Than Growth Alone
Revenue growth often gets the headline, but margins tell the deeper story of how sustainable that growth really is. Gross margin is not only a measure of efficiency, it is one of the clearest indicators of scalability and long term health. For founders, understanding both the level of gross margin and the quality behind it is critical to building credibility with boards and investors.
What Gross Margin Tells You
Gross margin measures the percentage of revenue left after direct costs of delivering your product or service, often called cost of goods sold (COGS). A SaaS company with $1 million in revenue and $200,000 in COGS has an 80 percent gross margin. That 80 percent represents dollars available to fund sales, marketing, product development, and overhead.
Margins vary by industry. A pure SaaS product with minimal support needs may achieve north of 80 percent, while a SaaS plus services model might be closer to 65 percent. Hardware enabled businesses may see margins between 40 and 60 percent. Knowing where your company falls relative to peers is essential.
Why Quality Matters
Two companies can both report an 80 percent margin and yet tell very different stories once quality is considered. Key questions include:
Are expenses properly classified between COGS and operating expenses, or are support, hosting, or implementation costs sitting in OpEx to artificially inflate margins?
Do margins improve as revenue scales, showing true economies of scale, or do they flatten because costs rise in parallel with growth?
Are margins consistent across customer cohorts, or is one segment profitable while another drags down performance?
How does contract structure affect margin? Long onboarding cycles or heavily customized implementations may compress early period margins even if lifetime averages look strong.
High quality margins are transparent, consistently reported, and clearly tied to the drivers of the business. Poor quality margins may be propped up by accounting choices, heavy reliance on professional services, or hidden subsidies between customer groups.
What Investors Look For
Investors focus on gross margin quality because it shows whether a business can scale without burning outsized amounts of capital. They want to see:
Consistent margin reporting that aligns with industry benchmarks
A clear path to margin expansion as the company grows
Understanding of which levers, such as pricing or automation, move margins
No over reliance on services revenue to make the numbers work
For SaaS, margins of 70 to 85 percent are common benchmarks, but the trajectory matters as much as the absolute number. Margins trending upward suggest efficiency gains and stronger unit economics, while flat or declining margins raise concerns.
How to Improve Gross Margin Quality
Founders can take several steps to strengthen both the level and quality of margins:
Classify costs correctly: Ensure hosting, customer support, and other direct delivery costs are in COGS
Disaggregate margins: Track by product line, customer segment, or geography to see where profit pools really lie
Invest in efficiency: Optimize infrastructure, automate support, and streamline onboarding to reduce delivery costs
Align pricing with value: Make sure pricing models support sustainable margins, especially when bundling services with software
Highlight scalability: Document and communicate how margins improve as volumes increase, showing leverage in the model
Final Thought
Revenue growth alone does not guarantee a sustainable business. Gross margin quality tells investors and boards whether that growth can scale efficiently and whether capital is being used wisely. For founders, building a clear narrative around margin levels, trends, and drivers is one of the strongest signals of operational maturity.
High quality margins demonstrate not just the ability to grow, but the ability to grow in a way that compounds value over time.
