पाठशाला Pathshala · हिसाब Hisāb, Unit economics · Lesson 09 · Start
Gross margin and why investors fixate on it
Gross margin decides how much of each rupee of sales becomes profit, how fast a company can afford to grow and what its revenue is worth. How to compute it, and what 20, 50 and 80 per cent allow.
Pathshala, The Founder Library · 11 October 2026 · 7 min read
An investor looking at a company for the first time reads revenue, growth and then gross margin, and the third number often decides whether the first two are interesting. It is not vanity. Gross margin is the share of every rupee of sales that is left after the product has been delivered, and every other good thing a company wants, a sales team, a brand, a profit, a valuation, has to be paid for out of that share.
This lesson computes the number correctly, explains in rupees what a 20, 50 and 80 per cent margin each make possible, sets out the published benchmarks by business model, and ends with a monthly check that catches a margin before it slips.
The number, computed correctly
Gross margin is revenue less cost of revenue, divided by revenue. Three things go wrong. The first is GST: both revenue and cost are ex-GST, because the tax collected is not revenue and the input tax claimed back is not cost. The second is the line under cost of revenue, which founders draw too low; every cost of delivering and supporting what the customer bought belongs above it, and the [lesson on COGS](/library/what-belongs-in-cogs) shows how an analyst redraws a flattering line. The third is confusing margin with markup, which is common in Indian trading and distribution businesses. A product bought for ₹80 and sold for ₹100 carries a 25 per cent markup on cost and a 20 per cent margin on price. Investors speak in margin. A founder who says twenty-five when the investor hears margin has overstated the business before the meeting begins.
Compute the number monthly and by product line or customer segment, not just for the company. A blended 55 per cent can hide a 75 per cent software line carrying a 25 per cent services line, and the two have different futures.
What 20, 50 and 80 per cent each let you do
Take a company with ₹30 lakh a month of fixed cost: the team, the office, the tools. At 20 per cent gross margin it needs ₹1.5 crore of monthly revenue to cover that fixed cost, five times the cost itself. At 50 per cent it needs ₹60 lakh. At 80 per cent it needs ₹37.5 lakh. The same team, the same rent, the same ambition, and a fourfold difference in the revenue required simply to stand still.
The same arithmetic sets how much the company can spend to win a customer. Suppose each customer pays ₹10,000 a month and the company holds itself to recovering acquisition cost within twelve months, the line David Skok drew in Startup Killer: aim to recover CAC in under twelve months, otherwise the business will require too much capital to grow. At 20 per cent margin each customer returns ₹2,000 of gross profit a month and the company can afford ₹24,000 to win one. At 50 per cent it can afford ₹60,000. At 80 per cent, ₹96,000, four times as much for the identical customer. That is the gap between a business that can hire a field sales team and one that must rely on word of mouth and channel partners.
The figure starts at 50 per cent with the company above. Click through 20 and 80 and read the curve: on the left the revenue needed rises steeply, which is why a few points of margin matter far more to a 20 per cent business than to an 80 per cent one. Then move revenue per customer and the payback ceiling, and see how margin decides the acquisition budget long before the marketing plan does.
Read the three margins as three kinds of company. Around 20 per cent is a volume business: retail, distribution, quick commerce, much of e-commerce. It can work, and some of the largest companies in the world are built this way, but only with relentless operational efficiency, low-cost acquisition and the scale to spread fixed cost thin. Around 50 per cent is a company that can buy growth with discipline: many marketplaces, branded consumer goods, tech-enabled services, software with heavy usage costs. Around 80 per cent is classic software, which can fund a sales team out of a single year of a customer’s gross profit and still keep most of the next year’s.
Why investors fixate
The fixation comes from valuation. Bill Gurley’s All Revenue is Not Created Equal put it in discounted-cash-flow terms: you cannot generate much cash from a revenue stream saddled with large variable costs, so lower-margin companies trade at heavily discounted multiples of revenue. His examples, on 2012 estimates, were Wal-Mart at a 25 per cent gross margin trading at 0.41 times revenue and Best Buy at 24 per cent trading at 0.22 times. A rupee of revenue at 80 per cent margin can become far more free cash than a rupee at 20, and investors pay for the cash.
The published benchmarks follow the models. Andreessen Horowitz’s 16 More Startup Metrics says software companies should have very high gross margins in the 80 to 90 per cent range, while e-commerce businesses typically have relatively low ones, citing Amazon’s 27 per cent. Bessemer’s Scaling to $100 Million puts the average cloud company at 65 to 70 per cent regardless of stage, with the middle half between roughly 60 and 80. And a16z’s The New Business of AI found AI companies often at 50 to 60 per cent, below the 60 to 80 per cent-plus of comparable SaaS, because inference and human review sit in cost of revenue. An investor compares your margin with the right row of this table, not with the best one.
Services sit lower again, and India publishes the clearest example. Infosys’s fact sheet for the quarter to 31 March 2026 shows revenue of ₹46,402 crore and cost of sales of ₹32,058 crore, a gross margin of 30.9 per cent, for one of the best-run services firms in the world. A tech-enabled services startup pitching itself at software margins will be compared with that number, not with the cloud benchmark, until the share of revenue that does not need a person to deliver it is large enough to show in the accounts. The [services economics](/library/services-and-agency-economics-utilisation) lesson shows how to move it.
Gross margin is the ceiling on everything a company wants to do with its revenue. Growth, overhead and profit all have to fit underneath it.
When a low margin is fine and when it is a warning
A low margin is a choice of business model, and investors fund low-margin models that have the scale advantages to match: purchasing power, density, logistics that get cheaper per order as volume grows. What they will not fund is a low margin presented as a high one, or a margin with no credible path. Two questions separate the cases. Is the margin rising as the company grows, cohort by cohort and city by city? And is the gap to the benchmark explained by something the company controls and is fixing, a supplier contract, a pricing tier, an inference bill that falls with a cheaper model, or by something structural that will never move?
The warning sign is a margin that falls as revenue rises. It usually means growth is being bought with discounts that were booked as cost, a mix shift toward a cheaper channel or a larger customer who negotiated a better price, or delivery costs that scale faster than expected. Each is fixable if seen early, and the way to see it early is to compute margin by cohort and by city as well as for the month: a new city or a new customer segment usually starts with a worse margin than the old one, and the blended number will hide the deterioration for two or three quarters while the mix shifts. Seen late, it shows up first in the [contribution margin](/library/contribution-margin-first-number-to-know) and then in the runway.
The monthly margin line
On the fifth working day of each month, after the books close, put one line on a page: gross margin for the month, the trailing three months and the same month last year, for the company and for each product line. Beside it write the three largest cost-of-revenue items as a share of revenue. Then ask whether margin moved by more than two points, and if so which item moved it. A rising hosting or inference share points to usage outgrowing price. A rising delivery or support share points to a team growing faster than the customer base. A falling revenue line with flat costs points to discounting.
Once a quarter, set a margin target for the next four quarters and the one lever that will move it: a price change, a supplier renegotiation, an automation, a shift in mix. Write the target where the founders and the finance lead see it every week. An investor will read the trend before the level, and the trend is the part a founder can still change.
Nothing here is legal, tax or investment advice. Benchmarks are stated as their authors stated them and come from portfolios and public markets, not random samples of Indian startups.
Sources
- Bill Gurley, All Revenue is Not Created Equal: The Keys to the 10X Revenue Club, Above the Crowd, May 2011 — Lower gross margin companies trade at discounted price-to-revenue multiples; Wal-Mart 25 per cent at 0.41×, Best Buy 24 per cent at 0.22×.
- Anu Hariharan, Frank Chen and Jeff Jordan, 16 More Startup Metrics, Andreessen Horowitz, September 2015 — Software gross margins should be 80–90 per cent; e-commerce typically low, Amazon at 27 per cent.
- Mary D’Onofrio, Ethan Ding and Atlas editors, Scaling to $100 Million, Bessemer Venture Partners, September 2021 — Average cloud gross margin 65–70 per cent; middle half roughly 60–80 per cent.
- Martin Casado and Matt Bornstein, The New Business of AI (and How It’s Different From Traditional Software), Andreessen Horowitz, February 2020 — AI company gross margins often 50–60 per cent against 60–80 per cent-plus for comparable SaaS.
- Infosys Limited, Fact Sheet, Q4 FY2026 (quarter ended 31 March 2026) — Revenue ₹46,402 crore, cost of sales ₹32,058 crore, gross profit ₹14,344 crore.
- David Skok, Startup Killer: the Cost of Customer Acquisition, forEntrepreneurs, December 2009 — Recover CAC in under twelve months; LTV about three times CAC.