Gross margin done right: capitalized costs, hosting, and support allocation

Why gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → is the SaaS scoreboard

Gross marginGross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → equals revenue minus COGS, divided by revenue. For software companies, it signals how efficiently the core product delivers value, before sales, marketing, and R&D (research and development) enter the picture.

Public SaaS benchmarks (2025 estimates, based on aggregated data from sources like Bessemer's State of the Cloud reports) cluster as follows:

• Best-in-class: 78 to 85% gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition →
• Healthy median: 70 to 75%
• Below-average: under 65%, often flagging a services-heavy or infrastructure-heavy business

European SaaS companies often report slightly lower gross margins than US peers, commonly cited as 3 to 7 percentage points lower on average, partly due to smaller scale (less negotiating leverage on cloud contracts) and higher relative support staffing costs in some markets. Treat this gap as directional, not precise.

What actually belongs in SaaS COGS

COGS for a SaaS business typically includes:

1. Hosting and infrastructure: AWS, Azure, or Google Cloud bills tied directly to running the product

2. Customer support: salaries for support staff resolving product issues (not sales-related contact)

3. Third-party licensing fees: costs for embedded software or data feeds required to deliver the service

4. Customer success, partially: only the portion tied to onboarding and technical enablement, not upsell activity

5. Amortization of capitalized software: more on this below

The judgment calls live in items 3 through 5. That's where Company A and Company B diverge.

The capitalized R&D trick

Under US GAAP (Generally Accepted Accounting Principles, the standard rules for financial reporting in the US) via ASC 350-40, and under IFRS (International Financial Reporting Standards, used across most of Europe) via IAS 38, companies can capitalize certain software development costs rather than expensing them immediately.

Capitalizing means the cost moves onto the balance sheet as an asset, then gets amortized (spread out) over future years, instead of hitting the income statement in full today.

Here's the mechanic that moves gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition →:

• If a company expenses engineering costs for maintaining the live product as R&D (an operating expense, below the gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → line), those costs never touch COGS.
• If a company instead classifies platform engineering as part of "cost to deliver the service" and capitalizes then amortizes it into COGS, gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → looks different depending on aggressiveness of capitalization and amortization schedule length.

Worked example:

Company A expenses $8 million of engineering costs supporting live infrastructure as R&D. That $8 million never appears in COGS.

Company B capitalizes $8 million of similar work, then amortizes it over 4 years, so only $2 million hits COGS this year through amortization.

Same $50 million revenue, same underlying $8 million spend.

• Company A: COGS includes the full impact of running infrastructure support elsewhere, pushing reported COGS higher (say $17.5 million total), giving gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → of (50, 17.5) / 50 = 65%
• Company B: only $2 million of that cost hits COGS this year, keeping total COGS around $9 million, giving gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → of (50, 9) / 50 = 82%

Neither company is lying. Both follow accounting rules. But Company B's margin looks better today at the cost of future amortization drag, and it depends heavily on capitalization policy aggressiveness, which varies company to company and is disclosed (if at all) in footnotes.

Support cost allocation: the other lever

Customer support classification also swings margin meaningfully.

Some companies bucket all support headcount, including senior technical account managers who also do renewal-influencing work, into sales and marketing instead of COGS. This inflates gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → because support costs, which are genuinely part of delivering the service, get moved below the line.

A rough rule used by sector analysts: if support cost as a percentage of revenue looks unusually low (under 5%) while gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → looks unusually high (above 85%), check whether support headcount got reclassified elsewhere.

Where to actually look

For public companies, the 10-KKThe average number of new users each existing user generates through referrals. Above 1.0, growth compounds on itself and becomes exponential.View full definition → (annual report filed with the US Securities and Exchange Commission, or SEC) or 20-F/annual report for European issuers under IFRS will have a "Cost of Revenue" note, sometimes broken into subcategories. Not all companies disclose this granularly, but when they do, compare:

• Hosting cost as % of revenue (typically 5 to 15% for efficient SaaS models, per industry estimates)
• Capitalized software additions each year (found in the cash flow statement, investing activities)
• Amortization period disclosed in accounting policy footnotes (commonly 2 to 5 years for capitalized software)

The SEC's EDGAR database is free and lets you pull 10-Ks directly to check these footnotes yourself.

A quick sanity-check ratio

When comparing two SaaS companies, a useful cross-check is:

Adjusted gross margin = (Revenue, Hosting, Support, Cash R&D spent maintaining the live product) / Revenue

This forces capitalized amounts back into the calculation as if they were expensed immediately, neutralizing the accounting choice. It's a rough normalization, not a GAAP or IFRS metric, but it's what serious analysts do informally when comparing companies with different capitalization policies.

Applying this to the earlier example: Company B's adjusted margin would drop back toward 65%, matching Company A, once you add back the full $8 million instead of just the $2 million amortized slice.

US versus Europe, briefly

IFRS (used in Europe) has historically been viewed as somewhat more permissive about capitalizing development costs once technical feasibility is established, compared to US GAAP's stricter thresholds for internal-use software. This is a generalization; actual practice depends heavily on company-specific judgment and auditor scrutiny. The practical effect: don't assume a European SaaS company's higher or lower margin versus a US peer reflects operational reality without checking capitalization policy first.

🎬 [VIDEO: "SaaS Metrics that Matter" - youtube.com/@saastr - SaaStr's channel regularly covers gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → and COGS breakdowns with real operator perspectives, useful for seeing how practitioners discuss these tradeoffs]

Key Takeaways

• Gross marginGross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition → differences between SaaS companies often reflect accounting classification choices (what goes into COGS versus opex), not just operational efficiency.
• Capitalizing software development costs under ASC 350-40 (US) or IAS 38 (Europe) delays cost recognition, inflating current-year gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.View full definition →; amortization timing and duration matter enormously.
• Customer support classification is a second common lever: support costs shifted to sales and marketing artificially boost reported margin.
• Best-in-class SaaS gross margin sits around 78 to 85% (2025 estimate); treat anything above that with skepticism until you've checked the COGS footnote.