Understanding Gross Margins in the Age of AI

What every founder needs to know before the economics of their business quietly shift underneath them.

If you run a business between $2M and $20M in revenue, you probably have a decent feel for your margins. You know what it costs to deliver your product or service. You know roughly what's left over after you pay your people, your vendors, and your cost of goods sold. That margin intuition is one of the most valuable things a founder develops over time.

But AI is about to challenge that intuition — not because it makes your business worse, but because it changes how value gets delivered and what it costs to deliver it. And if you're not paying attention to how AI affects your gross margin structure, you might wake up one day and realize your P&L doesn't look the way you thought it did.

As a Fractional CFO, I've started having this conversation with nearly every client. It's one of the most important financial conversations founders need to have right now.

First, a Quick Refresher: What Is Gross Margin, Really?

Gross margin is your revenue minus the direct costs of delivering your product or service — what finance people call Cost of Goods Sold, or COGS. It's the money left over before you pay for sales, marketing, G&A, and everything else.

If you're a services business doing $5M in revenue, and it costs you $3M in labor and tools to deliver that work, your gross margin is 40%. If you're a SaaS company, your gross margin might be 75-85%, because once the software is built, serving one more customer costs almost nothing.

Gross margin matters because it tells you how much room you have to invest in growth, pay yourself, and build long-term value. When I sit down with a founder and their margins are thin, that limits everything: hiring, marketing, R&D, even the valuation multiple a buyer or investor would assign to the business.

Here's the thing: for the past 20 years, the margin playbook has been relatively stable. Services businesses operated at 30-50% gross margins. SaaS businesses aimed for 80%+. Everyone knew the benchmarks.

AI is rewriting those benchmarks.

How AI Changes the Gross Margin Equation

There are two sides to this, and most founders only see one of them.

Side 1: AI Can Dramatically Improve Your Margins

This is the part that gets all the attention, and for good reason. If you're running a services firm and AI helps your team complete work in half the time, your cost of delivery just dropped while your revenue stayed the same. That's a direct gross margin improvement.

I'm seeing this in real time with clients. Tasks that used to take a team member four hours now take 45 minutes with AI assistance. Reports that required a senior analyst can now be drafted by a junior person using AI, with the senior person reviewing. The labor content of delivery is compressing — fast.

For founders in services, consulting, accounting, marketing, or any business where people-hours are your primary COGS, this is a massive opportunity. If you can maintain your pricing while reducing delivery costs, your gross margin expands. That's real money that drops to the bottom line.

Side 2: AI Has Its Own Cost Structure — And It's Not Free

Here's where founders get caught off guard.

If you're building AI into your product — or if you're a software company adding AI features — you need to understand that AI isn't like traditional software. Every AI query, every interaction with a large language model, every automated task that runs through an AI system incurs real compute costs.

Traditional SaaS is beautiful from a margin perspective. Build it once, serve millions of customers at near-zero marginal cost. That's why SaaS gross margins sit at 80-90%.

AI-powered products are different. The leading venture capital firms are reporting that AI companies are seeing gross margins of 50-60%, not 80-90%. That's a fundamental shift. Every time a customer uses your AI feature, you're paying for compute. The more successful your product, the more it costs you to deliver.

If you're a founder thinking about adding AI capabilities to your product, you need to model this carefully. The question isn't just "can AI do this?" It's "what does it cost me every time AI does this, and does my pricing support that?"

The Three Margin Traps I'm Seeing

In my work with clients, three patterns keep coming up. If any of these sound familiar, it's worth a deeper look.

Trap 1: Your Pricing Hasn't Caught Up to Your New Cost Structure

You added AI features to your product because customers wanted them. Great. But you didn't adjust your pricing because you didn't want to rock the boat. Meanwhile, your COGS just went up by 15-20% because of inference costs you didn't have before.

I've seen founders absorb these costs for months without realizing how much it's eroding their margins. By the time they notice, the damage is already in the financials.

What to do: Track your AI-related costs separately from day one. Know exactly what you're spending on compute, API calls, and any AI infrastructure. Then ask yourself: does my current pricing cover this, and is there room to capture more value?

Trap 2: You're Saving on Labor but Not Tracking the Improvement

Your team is using AI tools and getting more productive. But because you haven't formalized the measurement, you can't actually see the margin improvement in your P&L. The savings are real, but they're invisible — scattered across time sheets and project budgets that look roughly the same as before.

What to do: Measure delivery time and cost per engagement, per project, per client — before and after AI adoption. If a project that used to take 40 hours now takes 25, that's a quantifiable gross margin improvement. Make it visible.

Trap 3: You're Thinking About AI as a Cost, Not a Margin Lever

Some founders tell me they're "investing in AI" as if it's a line item they'll evaluate later. But AI isn't just an expense. It's a lever that can fundamentally change the economics of your business — for better or worse — depending on how you deploy it and how you price around it.

What to do: Treat AI like any other strategic investment. Model the impact on COGS. Forecast the margin improvement. And if you're adding AI to your product, price for the value it delivers, not just the cost of the tool

What I Tell My Clients

When I sit with a founder and we're working through their financials, the AI conversation now comes up in almost every engagement. Here's the framework I use:

Understand your current gross margin deeply. Not just the top-line number — break it down by product, service line, and customer segment. Know where your margin is strong and where it's thin.

Map where AI touches your cost of delivery. Is AI reducing labor costs? Adding compute costs? Both? Get specific.

Model the net impact. AI might save you $200K in labor but cost you $80K in compute. That's still a $120K improvement — but only if you're tracking both sides.

Revisit your pricing. If AI is making your product or service meaningfully better or faster, you may have room to charge more. And if AI is adding to your COGS, you need to make sure your pricing covers it.

Watch the benchmarks. The old margin benchmarks are shifting. If you're comparing yourself to pre-AI industry norms, you might be using the wrong yardstick. Talk to your CFO, your advisors, or your peers about what "good" looks like now.

The Bigger Picture

We're still in the early innings of how AI reshapes business economics. The companies that will come out ahead aren't the ones that adopt AI the fastest — they're the ones that understand how AI changes their financial model and plan accordingly.

As a CFO, my job is to help founders see around corners. And right now, the corner I keep pointing to is gross margin. Not because it's glamorous, but because it's the foundation that everything else sits on: your ability to invest, your ability to hire, your ability to build an enduringly profitable business.

If you haven't looked at how AI is affecting your margins — or how it could — now is the time. Not next quarter. Now.

At Tee Up Advisors, we partner with founders to build enduringly profitable businesses. If you want to understand how AI is reshaping your financial model, let's talk.