Gross Margin
Why it matters
A high margin means each new customer adds plenty to cover the rest of the business, so growth can fund itself. A thin one means each customer barely covers their own cost. A company can grow revenue steadily while its margin slips, and by the time that shows up in profit the cause is hard to trace.
It sets how much the company can spend on growth. If gross margin is 70 per cent, £0.70 of every £1 is available for sales, marketing, product and profit. At 40 per cent only £0.40 is, so the same acquisition cost takes longer to earn back. It is the base of CAC payback and unit economics.
It also affects how a company is valued. Investors and buyers look at it to judge whether the model scales, so a gap between a service-like margin and a software-like margin changes the conversation.
How to apply it
- List the direct costs of delivering one unit of the product, and update the list when the product changes.
- Track the margin by product line. A blended figure can hide a line that loses money.
- Watch the trend over several months, since one large customer can distort a single month.
- When the margin falls, look at delivery cost before assuming price is the only lever.
What it is
Gross margin shows how much of each pound of revenue is left to pay for everything else the business needs: sales, marketing, product development, management and finally profit. The formula is revenue minus direct costs, divided by revenue.
Say a business bills £50,000 in a month and spends £15,000 directly on delivering it. Gross profit is £35,000 and gross margin is 70 per cent.
Common mistakes
- Leaving support time or usage-based supplier costs out, which flatters the margin.
- Confusing margin with markup. An item that costs £70 and sells at £100 has a 30 per cent margin but a markup of about 43 per cent.
What counts as a direct cost
Direct costs rise when you serve more customers. For a software company they include hosting, payment processing fees, third-party licences, the cost of any AI model usage a feature relies on, and the support or onboarding staff who serve customers. For a services business they are mainly the pay of the people who deliver the work. Sales, marketing, product development and office costs are usually kept out, and sit under operating expenses.
