The Definitive Guide to Cost of Goods Sold (COGS) for Software Companies
What belongs in COGS?
The allure of SaaS is that you can build software once and reproduce it over and over again for basically nothing.
While this is theoretically true, the rubber hits the road by examining a company’s gross margin (if it’s burdened properly). As a company grows it’s revenues, it’s cost of goods sold as a percentage of revenue should go down. This means the company becomes more efficient in providing it’s services to customer’s over time, as certain elements of it’s cost structure do not scale linearly with money coming in the door.
This is what the experts call “operating leverage.”
SaaS companies strive to reach +80% gross margins at scale. That means for every $1 of revenue the company brings in, there’s still 80 cents left over to pay for operating costs (like selling / marketing the current products, and building new ones).
I’ve highlighted the median gross margins by sector that I track on a weekly basis here at Mostly metrics:
With that target in mind, there’s a constant pull and push between CFOs and their finance teams as to what should go “up there.” Arguing that teams like Customer Success or certain elements of cloud infrastructure (BI tools!!!!) should go in OPEX alleviates the pressure you put on your gross margin, and make the company look more efficient.
People try to game the system in whatever way is more useful to them. And they also “play dumb” when it comes to shuffling stuff downward on the P&L.
This guide dives into what should be included in a software company’s COGS, how to handle nuanced cases like Customer Success, and how to avoid common pitfalls in categorizing costs. Don’t leave home without it.
1. The People: Customer Support, Customer Success, and Professional Services
Until AI agents fully take these jobs over (I’ll just keep pounding 0 to talk to a human), Customer Support and Customer Success personnel belong in COGS. Customer Support is a no brainer. Customer Success may be more nuanced.
Customer Support Labor: Break / fix tasks. I forgot my password… My preferred layouts are jacked up… can you help me troubleshoot this configuration issue… Support labor is a clear fit for COGS because these roles directly enable users to continue using the product and receive its promised value.
Ask: “Do you need this to keep the customer on the platform?”
Customer Success Management (CSM): This is more complex.
If Customer Success teams focus on activation, onboarding, training, and ensuring customers realize the product’s value, they belong in COGS, as they’re providing a necessary service to keep customers engaged and satisfied.
However, if CSMs are tasked with upselling or have sales quotas, those roles should be in Sales & Marketing (S&M). This distinction prevents inflating gross margin by keeping sales-driven costs out of COGS, ensuring COGS is purely about the delivery of the core product, not its sale.
Ask: “Does this drive massive upsell?”
Putting the department nomenclature aside for a sec, once you get the color of what people do, you can make the call.
It’s common to get the question from VCs when they are sifting through your P&L: “So, tell me what type of work your customer success reps do.” Make no mistake - it’s a test.
Professional Services are another team that belongs in COGS.
Financial analysts have long turned their noses up at professional services revenue.
It’s (usually) one time
It’s (often) sold at cost or heavily discounted
It’s (reluctantly) purchased by the customer who wishes this damn thing would just work out of the box
Professional Services are a necessary evil.
And many companies will try to shuffle some of these resources into Sales, which is in OPEX.
Another question (ehrm, “test”) you’ll get from VCs: “Is this really people being sent to your customers to make them successful?”
If so, they go in COGS.