How do you find the SaaS gross margin?
The Software-as-a-Service (SaaS) gross margin shows how profitable a company is compared to its creation, maintenance, and support costs. It shows how much money is left over after the cost of goods sold (COGS) is subtracted from income. It does not include operating costs like sales, marketing, office space, research, and development.
You’ll need to look at two numbers to figure out your SaaS profit margin:
What is revenue? It’s the total money you make from selling your goods or services.
Cost of Goods Sold (COGS): These are the direct costs of making and providing your product or service. They include hosting fees, software licenses, cloud storage, customer service, and services provided by other companies.
The size of your SaaS gross margin shows how well your company controls its costs and how efficient your business plan is. This number tells you how much cash you have to pay your bills and put into growth.
A high gross margin percentage means that for every dollar of sales, your business makes more money. A low percentage, on the other hand, means that your costs are eating away at your earnings. But it doesn’t take into account running costs. So, keeping an eye on your SaaS running costs and net profit margins is also essential.
Like words
- Margin for SaaS
- Profit margin for SaaS
Why it’s Important to Check SaaS Gross Margin
The first thing you need to do to build a successful SaaS business is to figure out your gross margin. It helps you find waste in your cost structure that could hurt your bottom line and gives you ideas on improving things to make more money. You’re losing money at the running level if you barely break even at the gross level. There are tons of possibilities.
Look at how profitable it is.
To determine if the SaaS gross margin is profitable, you should first compare it to the averages for your business. If a SaaS company runs efficiently, its gross margin is usually between 70% and 85%. However, this can change based on the product type, growth stage, target market, and pricing strategy.
If your gross margin is smaller than average, it could mean that your product is too expensive or that the cost of goods sold is too high. On the other hand, a margin that is higher than usual could mean that you aren’t putting enough money into growth, which could hurt your long-term profits.
Find Growth Opportunities
The SaaS profit margin also shows how much room your business has for growth. If the number is high, you have more money to put back into your business and get more customers, add new features, or enter new markets. For SaaS companies with a solid gross margin, more sales and a more significant piece of the market usually come right after or along with it.
On the other hand, a low gross margin means you don’t have as much money to spend on growth and may not be able to grow as much. A low gross margin for your SaaS business indicates something is wrong with your internal processes or the product. This is because recurring revenue models are designed to be scalable.
Value of SaaS
Because the SaaS growth margin is an excellent way to determine your growth potential and total financial health, investors will do the same. Ultimately, they’ll look at other numbers, such as operating margins and net income retention. There are other things that investors, partners, and buyers will look at. Your gross margin is the only way to get them to do that.
CRM (Salesforce): Salesforce has a high-profit margin of 75.44% and was one of the first companies to offer SaaS. It spends a lot on marketing and sales to grow, but because of its low costs, it still makes a good profit.
Dropbox: In 2023, Dropbox said its profit margin was 80.7%. Its low cost of revenue comes from its simple and scalable software delivery plan, which is why it has such a high margin. As high as 17.7x EV/EBITDA has been reached in the past.
Zoom: In July 2023, Zoom said its profit margin was 76.59%. Even though this margin is excellent, it’s not as big as in 2020 (80%+).
It is important to remember that a software business does not have to make money to be valuable. Uber’s profit margin was only 40.25% on June 30, 2023, much less than the required level. It’s also well known that the company has never had a year when it made money.
Despite this, Uber is not the norm. Long-term investors believe Uber can make money from electric vehicles, which would benefit the ride-sharing business. Most SaaS companies, especially B2B ones that don’t offer a crazy, one-of-a-kind product like Uber, do, however, have a structure and cost plan that make it more likely that they will make money. So, buyers should look at that first.
Improve your pricing strategy.
Price optimization can help businesses make more money by increasing their gross margin. Most of the time, SaaS companies use a mix of
- Tiered pricing means giving different sets at different prices, like Basic, Pro, and Enterprise.
- A flat-rate price is the price you charge for each level of your product.
- Pricing is based on usage, like a price per person, storage space, etc.
- Value-based pricing means that the price of a thing is based on how much people think it is worth.
Because SaaS business models are already very good at what they do, making money (for example, through a cost-plus model) isn’t usually the goal.
However, because SaaS pricing strategies are so complex, small changes to even one part of the business can significantly affect gross margin. Your base-level prices, for example, might be acceptable. However, customers won’t keep buying your product if adding more seats to another product is cheaper.
How to Figure Out the SaaS Gross Margin
It’s pretty easy for SaaS companies to figure out their gross margin. There are, however, some things to think about before doing that.
Changing factors
Revenue: “Revenue” means all your ways of making money. Since most SaaS businesses use a subscription strategy, most of their income comes from monthly subscription fees. The measure assumes you have been paid for your work during a specific period.
You can look at the total amount of money your bills bring in (without any discounts or rebates). Another option is to get more specific by considering MRR loss and upsells.
How much does it cost to sell goods?
The cost of goods sold, or COGS, is the money you make from selling your product. It is also sometimes called “cost of revenue.” It’s the direct cost of making and sending your goods to customers.
For businesses that sell actual goods, these costs would include making, putting together, and shipping those goods. COGS changes more for SaaS companies, though.
For software companies, COGS can be web servers (AWS, Azure, or GCP).
- APIs from other companies
- The cost of hosting and equipment
- Service for helping customers, tools, and pay
Fees for using credit cards
- Licenses for software tools used to build and manage the product
- Development costs, such as pay for engineers and developers
- Services from professionals and travel costs linked to setting up and helping with
These costs are variable because they change based on your goods and customers. The computer will be under more stress if there are more users. And more advanced technologies will need more infrastructure, research, and upkeep resources. These do cost more, though.
Formula for SaaS Gross Margin
Here’s how to figure out the SaaS profit margin:
Gross Margin for SaaS = (Total Revenue minus Cost of Goods Sold) / Total Revenue
For every $100,000 in sales, an 80% gross margin means that $80,000 can be used to cover extra costs and make a profit.
What SaaS companies can do to raise their gross margin
Gross profit is just the amount of money made before all the costs of running the business. To improve that number, you must find ways to get that amount closer to 100%.
Here are a few ways to go about that:
Grow your markets and accounts
Getting more sales from people you know is the best way to make more money. You can make more money without paying more (i.e., COGS).
Plus, it works a lot better. Customers who already buy from you are 50% more likely to try your new goods or services. Most of the time, they pay 31% more.
You can get more customers by upselling, selling extra items, or upgrades.
Cross-selling means recommending related goods to customers who have already bought something (for example, “Customers who bought X also bought Y”).
Freemium to paid means giving people a free version of your product and turning them into paid users.
Many SaaS companies give microservices (like Billingb CPQ + DealRoom + Billing) to meet the needs of their current customers who want to add to what they already have.
Adding extra features: Offer useful features in certain situations, whether they’re a premium feature that everyone can use or a new paid feature. This will make some of your customers buy more.
“Land and expand” account management techniques are another name for these methods. Because they turn between 60% and 70%, they work well for B2B companies that use subscriptions.
Getting into new markets is another way to make more money. If your product speaks to a particular group, try to reach out to more people by expanding your target market.
Some of the product-led tactics we talked about above can be used. For example, microservices and feature add-ons are great ways to attract new customers. You can also run programs or change your sales and marketing plans to reach different groups.
Spend less.
You can raise your profit margins and sell more without having to pay more to get new customers. You can also do this by cutting costs within the company. You can’t just stop spending money on Google Ads because this figure doesn’t take into account costs for sales, marketing, or running the business. The direct costs of your goods are what you need to look at.
Some SaaS companies hire outside companies to do programming or customer service. One big problem with this is that you won’t be able to control how the goods or customer service turn out.
Outsourcing is usually fine for SaaS companies that are still working on their MVP and don’t have much money. But in the long run, it won’t be able to meet the needs of a growing customer base.
So, the only way for bigger businesses to cut costs is to: ₷check the efficiency of their processes
- Automate jobs that can be done in an agile way, such as with continuous integration or continuous delivery
adopt a DevOps mindset that encourages software engineers and IT teams to work together
Every business can also spend money to improve their goods. When it comes to costs, the fewer development resources it takes to run and manage, the better. This also lets you work on making new products instead of fixing old ones.
Improve pricing
As we already said, optimizing your prices is an excellent way to raise your gross margin because it makes your business more profitable. One benefit of having the right offer that is often ignored is that it makes sales go more smoothly. When people believe they’re getting what they pay for, it’s much easier to sell things.
Gross profit doesn’t include sales costs, but being efficient doesn’t just cut costs. Increasing the speed of leads leads to more sales and bigger deals on average. Your sales margin and top-line both go up.
It can be hard to set the right price. For example, don’t charge more than what people think it’s worth. This could turn people off. You don’t want to lose money on people willing to pay more.
A market study is the best way to figure out the best prices. Check out what your rivals charge for similar items and how well that works out for them. Also, poll your customers to determine how much they are ready to pay.
Use different prices if possible, but don’t change prices based on the wrong factors. Do not A/B test your prices either. Customers who could have paid less will be upset with you.
Look at the payment structure.
You can increase your margins without changing prices by changing how you set up payments. One great example is SaaS companies that give discounts to people who pay for their services simultaneously instead of weekly.
They might get a free month if they pay for the whole year at once, which is the most common discount. This is done to thank them for their loyalty. If you can promise to keep a customer for a year, that’s better than seeing it change.
Look into different ways to market.
Marketing costs won’t count toward your “gross margin,” but will still affect your overall profits. They also affect the success of new goods and updates over time and the data that helps them make decisions. So, suitable marketing materials and valuable data will speed up development and help you make more money from your product.
You can also raise your gross margin by trying out new marketing platforms. This might not be affected, but it can speed up revenue growth.
So, revenue growth is a popular way for SaaS businesses to reach customers.
Marketing with content
Using influencers for marketing
Using email to market
Programs that help people find jobs
Each marketing platform has its benefits and groups of people it wants to reach. Multiple sales platforms can help you reach more customers and increase sales.
Look at and lower the costs of getting new customers.
Depending on your business, the things you can do to lower your customer acquisition cost (CAC) will be different. However, there are some practical, all-around ways to lower this cost:
Marketing through word of mouth
SEO stands for “search engine optimization.”
Partnerships and channel sales
Your SaaS company can make more money if you lower the cost of getting new customers. This can positively affect your gross margin by lowering the direct costs of each Billing. Use a Revenue Tech Stack (CPQ, Billing, revenue analytics, and other tools can help you cut costs, boost speed, and make more money).
The following technologies should be part of your DevOps stack: CPQ (Configure, Price, Quote), Billing, and contract management.
Tools for revenue analysis and ideas
The more you can simplify and streamline the sales process, the less it will cost. This will help your SaaS business make more money in the long run.
