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“Application SaaS companies are making the exact same mistake that brick-and-mortar retailers did with e-commerce. […] They looked at Amazon and they said, ‘Oh, it’s losing money. E-commerce is going to be a low margin business. Right now, our customers pay to transport themselves to the store and then they pay to transport the goods home. How could it ever be more efficient if we’re sending shipments out to individual customers?’ […] So, they did not invest in e-commerce. They clearly saw customer demand for it, but they did not like the margin structure of e-commerce. […]

That’s exactly what the SaaS companies are doing. They have their 70-80-90% gross margins and they are reluctant to accept AI gross margins. The very nature of AI is [different. With] software, you write it once and it’s written very efficiently and then you can distribute it broadly at very low cost and that’s why it was a great business. AI is the exact opposite where you have to recompute the answer every time, so a good AI company might have gross margins of 40%. […]

The way that those companies could or should think about the way to use agents is just to ask: “What are the core functions we do for the customer now? How can we further automate that with agents effectively? [Because] if you’re in CRM, what would our customers do? Talk to their customers [because] we’re a customer relationship management software and we do some customer support, too. So, make an agent that can do that, right? And sell that and let that agent access all the data you have.

[Because] what’s happening right now is another agent made by someone else is accessing your systems to do this job, pulling the data into their system, and then you will eventually be turned off. All because “we want to preserve our 80% gross margins.” […] This is a life-or-death decision, and essentially everyone except Microsoft is failing it.

— GPUs, TPUs, & The Economics of AI Explained | Gavin Baker Interview, at 1:10:12

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Gavin Baker warns that “Application SaaS companies are making the exact same mistake that brick-and-mortar retailers did with e-commerce” by resisting the fundamental shift in economic models required by AI.

The parallels and implications:

• E-commerce Analogy: Retailers initially dismissed e-commerce due to its lower-margin structure, failing to invest early. They focused on preserving their traditional margins, only to be overtaken by agile e-commerce players like Amazon, who eventually achieved higher margins through efficiency.
• AI’s Cost Structure: Unlike traditional software (written once, distributed at low cost, high gross margins), AI requires constant re-computation for every query, leading to inherently lower gross margins (e.g., 40% for a good AI company vs. 70-90% for SaaS).
• The Gross Margin Trap: SaaS companies are “reluctant to accept AI gross margins,” prioritizing the preservation of their 80% margins over adopting a transformative technology customers demand. This “life-or-death decision” is being failed by “everyone except Microsoft.”
• Competitive Vulnerability: AI-native startups, despite lower gross margins, generate cash earlier due to having “very few human employees.” While SaaS companies have a cash-generative business and existing data, their reluctance to embrace lower-margin AI agent strategies leaves them vulnerable to disruption.
• Microsoft’s Example: Microsoft’s success with Copilot for coding (via GitHub) demonstrates how a major player can embrace lower AI margins while leveraging existing distribution and data to create a “giant business.”

SaaS companies will be at risk of being “turned off” when AI agents, potentially from competitors, access their data and perform their core functions more efficiently. Embracing lower gross margins for AI agents is critical for survival and long-term success.