Overview
Software became the most profitable business model in history for one reason: once built, serving each additional user cost almost nothing. Gross margins of 80–90% were normal. AI quietly breaks this — and that has big consequences for software economics.
The old magic: near-zero marginal cost
Classic SaaS spends a lot to build the product, then serves millions of users at trivial incremental cost (a bit of storage and bandwidth). That's why software margins dwarfed physical businesses — revenue scaled while cost of goods barely moved. It was, effectively, infinite leverage.
What AI changes
Every AI-powered action — a generation, a summary, an agent run — consumes real compute that costs real money, every single time. AI features carry a recurring cost of goods sold that scales with usage. A heavily-used AI feature can quietly turn a high-margin product into a low-margin one. The more successful the feature, the bigger the bill.
The flat-fee trap
Many products still charge a flat monthly fee while their AI usage costs vary wildly per customer. Power users can consume far more compute than they pay for, making your best-engaged accounts your least profitable. This mismatch is a quiet margin killer.
How software adapts
Survivors do two things: re-architect pricing toward usage-based or tiered models that tie revenue to AI cost, and engineer inference costs down (caching, smaller/routed models, prompt efficiency). The discipline that hardware and services businesses always had — watching cost of goods — is returning to software.
What this means for you
If you build software: track gross margin per feature and per customer, align pricing to AI cost, and optimize inference. Don't assume software's traditional 80%+ margins still hold once AI is in the loop. If you invest: scrutinize AI-era gross margins, not just revenue growth.
Honest limits
Falling model prices partly offset this, and not all software is AI-heavy. But the structural point stands: AI reintroduces meaningful marginal cost to software, ending the era when margins could be ignored.
