Gross Margin and Cash Health

Gross margin by business type

SaaS businesses target 70-85% gross margin (cost of service is mostly hosting and support). Professional services (law, accounting, consulting) typically run 50-65% (cost of service is mostly billable labor). Agencies typically run 45-60%. Construction and contracting often run 25-35% (heavy materials and subcontractor cost).

The lower the gross margin, the more revenue you need to generate any given amount of cash. A 25% gross margin business needs 3× the revenue of a 75% gross margin business to fund the same overhead — and the working capital strain scales correspondingly.

The 50% rule for service businesses

Greg Crabtree's 'Simple Numbers' framework argues that healthy service businesses keep direct labor cost to about 35% of revenue, leaving roughly 65% gross margin (or close, depending on classification). Below this, the business is essentially renting itself out at cost without funding overhead and profit.

Practical diagnostic: if your gross margin is 10+ points below the industry norm, the cause is usually one of three things — pricing too low, utilization too low (paying for capacity you're not selling), or overstaffed at the senior level. Each has a different fix.

Gross margin's effect on every other ratio

Gross margin sets the ceiling on every operating decision. A 70%-margin SaaS business can spend 40% of revenue on go-to-market and still have 30 points of contribution to fund overhead and profit. A 30%-margin services business spending the same 40% on GTM is structurally unprofitable — there's nothing left to cover the rest of the cost base.

Gross margin is also the binding constraint on customer acquisition cost. The CAC payback formula is CAC ÷ (ARPU × gross margin %), so a 50% margin business needs to recover acquisition cost from twice as much ARPU as a 100%-margin business. Compressing gross margin by 10 points doesn't just reduce profit — it doubles the volume of paying customers needed to break even on each new acquisition.

Track gross margin by customer segment, channel, and product line, not just in aggregate. Aggregate gross margin masks where the cash is actually generated: many service businesses discover that 80% of their gross profit comes from 20% of their customers, and the rest of the work is breaking even or losing money. That insight tends to drive aggressive pricing and customer-mix changes within a few quarters.