What Goes Into COGS for a SaaS Company?
Explore the essential, scalable expenditures directly tied to delivering your SaaS product, distinct from operational overhead.
In the Software as a Service (SaaS) industry, understanding Cost of Goods Sold (COGS) is distinct from traditional manufacturing or retail models. Unlike physical products, SaaS COGS focuses on the direct expenses incurred to deliver a digital service to customers. This metric is crucial for gauging the efficiency of service delivery and its impact on profitability. Accurately identifying these costs helps a SaaS company understand the financial health of its core offering.
Core Service Delivery Costs
The primary direct costs for a SaaS company involve the infrastructure and technology necessary to make the software accessible and functional. These expenses are directly tied to the operation of the service itself. Cloud hosting expenses, such as compute power, storage, and bandwidth from providers like Amazon Web Services (AWS), Microsoft Azure, or Google Cloud, form a significant portion of these costs. These infrastructure costs typically scale with usage and customer growth, meaning that as more customers utilize the service, these expenses generally increase.
Beyond cloud services, other essential technology components contribute to COGS. Database costs and their ongoing management are included, as are Content Delivery Network (CDN) services that ensure quick and reliable access to the software globally. Software licenses for tools directly embedded within or essential for the core service delivery, such as specific operating systems or middleware, are also part of COGS. Additionally, the salaries of technical staff directly involved in maintaining and operating this core infrastructure and ensuring product uptime, like DevOps engineers and site reliability engineers, are considered COGS. These personnel costs are directly attributable to keeping the service operational for customers.
Customer Onboarding and Support Costs
Costs associated with customer onboarding and support are also part of COGS. These expenses are tied to the ongoing delivery and utilization of the service, aiming for customer retention and satisfaction. The salaries of customer success managers (CSMs) directly involved in onboarding, training, and helping customers derive value from the software are included in COGS. Similarly, the compensation for technical support staff who directly assist customers with product-related issues is a component of COGS.
These roles are distinct from sales or marketing functions because their focus is on supporting the existing customer base and the delivered service. Costs for customer support software and tools, such as helpdesk systems or specific CRM functionalities, also fall under this category. Any training materials or resources directly provided to customers to facilitate product usage are considered direct costs.
External Platform and Transaction Fees
Other variable costs directly linked to transactions or the integration of essential external services are also included in SaaS COGS. These fees typically increase with higher customer volume or transaction activity. Payment processing fees, such as those charged by platforms like Stripe or PayPal for subscription payments, are a direct cost because they are incurred with each sale and are necessary to collect revenue.
API usage fees for third-party services integrated into and fundamental for the core functionality of the SaaS product also contribute to COGS. For example, a location-based app might incur fees for using a mapping service API, or a messaging platform might pay for communication APIs. Costs for specific data feeds or external content libraries directly delivered as part of the SaaS product are also included.
Distinguishing from Operating Expenses
Properly classifying costs as either COGS or operating expenses (OpEx) is essential for accurate financial reporting and understanding a SaaS company’s profitability. COGS represents the direct costs of delivering the service, while OpEx encompasses the indirect costs necessary to run the overall business.
Research and Development (R&D) expenses, for instance, are generally classified as OpEx. This includes the salaries of engineers developing new features or products and costs for R&D tools, as these are related to future product enhancements rather than the current service delivery.
Sales and Marketing (S&M) expenses, such as advertising costs, sales team salaries, and lead generation efforts, are also considered OpEx. These costs are incurred to acquire new customers and promote the business, not to deliver the core service to existing ones.
General and Administrative (G&A) expenses, which cover executive salaries, human resources, legal, accounting, office rent, and other overhead, are distinct from COGS. These are broad business costs that do not directly fluctuate with the volume of service delivered.
The “direct versus indirect” principle is key: if a cost is directly tied to the production and delivery of the service, it is COGS; otherwise, it is an operating expense. Correct classification allows for an accurate calculation of gross margin, which provides insight into the profitability of the core service before considering broader operational costs.