Gross profit

Gross profit measures the fundamental profitability of a company's products or services before accounting for operating expenses like sales, marketing, R&D, and administration. It answers the most basic question about a business model: does each unit of product or service generate more revenue than it costs to deliver?

Gross profit is expressed as an absolute number (pounds), while gross margin expresses the same concept as a percentage of revenue. Both are essential. Gross profit in absolute terms matters because it determines how many pounds are available to fund the rest of the business. Gross margin matters because it indicates the efficiency of the production or delivery process and enables comparison across different-sized companies.

For SaaS companies, gross profit is particularly important because it determines the customer lifetime value of a customer. Lifetime value should be calculated on a gross profit basis, not a revenue basis, because COGS represents the minimum cost of serving each customer. A customer generating 1,000 pounds in revenue at 80% gross margin provides 800 pounds of gross profit to cover acquisition costs and contribute to profit.

The tree shows that gross profit is driven by two independent forces: revenue (volume times price) and COGS (the cost of serving that volume). Improving gross profit requires growing revenue, reducing COGS, or both. The tree helps identify which lever is more impactful: if COGS is already low as a percentage of revenue, further improvements yield diminishing returns and the focus should shift to revenue growth.

1. 1

   Increase revenue per customer

   Higher ARPU grows the revenue line without proportional COGS increases, especially in SaaS where marginal delivery costs are near zero.

2. 2

   Reduce infrastructure costs

   Optimise cloud spend through right-sizing, reserved instances, and architecture improvements.

3. 3

   Automate service delivery

   Self-serve onboarding, knowledge bases, and AI-assisted support reduce the human labour component of COGS.

4. 4

   Renegotiate vendor contracts

   As volume grows, negotiate volume discounts with hosting providers, API vendors, and payment processors.

1. 1

   Misclassifying operating expenses as COGS

   Including R&D or marketing costs in COGS artificially deflates gross margin. Only include costs directly tied to delivering the product or service.

2. 2

   Ignoring gross profit in growth planning

   Revenue growth without gross profit improvement does not create sustainable value. A company that grows revenue 50% but lets gross margin slip 10 points may not be better off. Track operating margin alongside to see the full profitability picture.