Why software gets funded and services usually do not, and why a low-margin business cannot grow its way out of trouble.
10 min read · Level 2
Gross margin is structural — it says whether the model works, not how well you executed this month — which is why a falling margin is more serious than a bigger loss. The loss is a choice about how fast to spend. The margin is a fact about what you have built, and no amount of scale fixes a bad one. Growing a twenty-five percent margin business just gets you a bigger twenty-five percent margin business.
Gross margin is gross profit as a percentage of revenue: (Revenue − COGS) ÷ Revenue.
It answers one question: of every dollar a customer pays you, how much is left after delivering what they bought?
Because gross margin determines what the business can afford to do.
At 80% margin, $100 of revenue leaves $80 to pay for sales, engineering and everything else. At 25%, the same $100 leaves $25 — so you need four times the revenue to fund the same team.
This is why investors treat margin as a structural fact about the business rather than a number to be improved later. It decides whether growth helps you or hurts you.
Two companies, both at $500,000 of revenue.
SaaS company: COGS $100,000 (hosting, payment fees, support). Gross profit $400,000. 80% margin.
Agency: COGS $375,000 (the salaries of the people delivering the work). Gross profit $125,000. 25% margin.
The agency must reach $1.6M of revenue to have the same gross profit the SaaS company has at $500k — and to get there it has to hire proportionally more delivery staff, which keeps the margin at 25%.
Neither is a bad business. But only one of them gets meaningfully better as it grows.
First-time founders often exclude their own or their team's delivery time from COGS because 'we would be paying ourselves anyway'. That makes a services business look like a software business on paper, right up until you try to hire someone to do the delivery and the margin collapses to its real value.
The honest test: if you doubled customers, which costs would automatically double? Those are COGS, whoever currently absorbs them.
Hosting, per-seat third-party APIs, payment processing, direct customer support, and any delivery labour.
If a human must do work for each customer, their time is COGS. This is the step most founders skip and it is the one that matters most.
(Revenue − COGS) ÷ Revenue. Write it down as a percentage, monthly.
Software typically 70–90%. Marketplaces vary hugely by take rate. Hardware and e-commerce 20–50%. Services 20–40%. Being far below your category's norm is a signal, not a detail.
Automating manual delivery, changing pricing, or moving upmarket can all raise margin. If none of them can, that is real information about what kind of company this is.
Whenever pricing, when choosing which customers to serve, and before any fundraise. Margin is one of the first things a serious investor checks.
Do not obsess over it in the first few months when volumes are tiny and every fixed cost distorts the percentage. Get it roughly right, then watch the trend.
The entire structural difference is here. Software delivers at eighty percent margin and improves with scale; services deliver at twenty-five and do not, because every new customer needs more people. Both can be excellent businesses. Only one of them is what venture capital is designed to fund.
Compute your honest margin before deciding whether to raise. The answer tells you which kind of company you have, regardless of what you call it.
Margins of eighty-five percent in very early companies are frequently an artefact of the founder personally doing onboarding, support and implementation without recording the cost. The first hire into that role reveals the real number, often ten to twenty points lower, in the same month payroll increased.
Cost your own per-customer time at what you would pay someone. You want that shock on a spreadsheet, not in the bank account.
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