What is SaaS Gross Margin?

The percentage of revenue left over after subtracting the cost of goods sold (COGS) is known as the SaaS gross margin. It covers expenses that are directly related to creating, providing, and maintaining the software services. Return on equity can fluctuate based on a variety of factors, so it’s important to consider it in conjunction with other financial metrics. With operating expenses excluded, it concentrates on profitability and core business operations. 

Determine the total revenue of your business, including all money from SaaS subscriptions and other pertinent sources. 

Calculate the Cost of Goods Sold (COGS), which includes expenditures like hosting fees, data storage, and some employee expenses that are directly related to providing your SaaS product. After deducting the COGS from your revenue, divide the whole amount by your revenue. To get the SaaS Gross Margin as a percentage, multiply this number by 100. 

SaaS Gross Margin Formula

SaaS Gross Margin = [(Revenue – COGS) / Revenue] x 100

For example, your SaaS gross margin would be 60% ([(100,000 – 40,000) / 100,000] x 100) if your company’s revenue was $100,000 and its COGS was $40,000. To track and assess the profitability of your SaaS company, you need to calculate your SaaS gross margin on a monthly, quarterly, or annual basis.

The SaaS Gross Margin is impacted by a number of things. These consist of business models, cost structures, pricing tactics, and general market dynamics.

Pricing strategy has a big influence on profit and immediately affects revenue. Gross margins can benefit from effective and scalable cost structures for the cost of goods sold (COGS). 

To properly examine and manage their business’s gross margins, SaaS companies and investors need to be aware of these elements. 

Three strategies are available to potentially impact your SaaS gross margin:

1. Trying out several pricing strategies is the first step to increasing your gross margin. Company success and longevity might be influenced by pricing models that include usage-based billing or subscription plans.
2. Next, try to make your cost structure more efficient. Examine service delivery costs, including hosting fees, software licenses, and customer support, to find areas where you can save without sacrificing quality.
3. Lastly, make use of technology to your benefit. While cloud-based tools and solutions may have an impact on the automation of operations, resulting in a potential reduction in the need for manual intervention and streamlining of processes, the extent of this impact may vary. This will help you save money overall. For instance, compared to on-premise solutions, moving your data warehouse to the cloud might result in significant cost savings. While open-source platforms may not be suitable for all features, they can serve as a cost-saving option for some in comparison to proprietary software. 

Key metrics include: 

1. 1. Gross Margin Percentage: The most widely used measure is determined as follows:

(Revenue – Cost of Goods Sold) / Revenue * 100 is the gross margin percentage.

It shows the proportion of income left over after direct expenses are paid. Greater profitability is indicated by a higher proportion.

2. Cost of Goods Sold (COGS): For software as a service (SaaS) businesses, COGS comprises costs that are directly associated with delivering the software service, like:

• Costs of servers and hosting
• Licenses for third-party software
• Customer service and success costs
• Engineering and development expenses (sometimes)

3. The cost of acquiring new customers (CAC): CAC has a major impact on total profitability even though it is not a direct component of the gross margin calculation. It stands for the price of bringing on a new client. Profitability increases with a smaller CAC. 
4. Customer Lifetime Value (CLTV): This indicator forecasts the net profit attributable to a customer’s entire future relationship. Long-term profitability is higher when the CLTV is higher.
5. Churn Rate: The frequency of subscription cancellations by customers. Lower churn rates, often related to recurring revenue and customer loyalty, could potentially affect profitability.
6. Average Revenue Per User (ARPU): The average revenue per user is determined by this measure. There may be a positive correlation between Average Revenue per User (ARPU) growth and profitability levels, although this relationship may be influenced by other variables.

The benchmarks include: 

• Generally speaking, a decent SaaS gross margin is greater than 70%.
• Top-tier SaaS firms frequently attain gross margins of more than 80%.
• Starting costs often impact gross margins for businesses in the early stages of development.