Tiny COGS in the big machine

You Say COGS …

.. I say Cost of Service, Cost of Revenue, Cost of Product

I going to have fun and really mess with you on this.

But sit yourself down with some cocoa, pull up a blanket and let me tell you a story of the olden days.

Back when almost all business was conducted with goods – the best definition of goods comes from the US Uniform Commercial Code “as those things that are movable at the time of identification to a contract for sale”.

COGS – Cost of Goods Sold – was then (perhaps) an easy accounting concept – it was/is all the direct costs associated with the goods being sold. Things like raw materials, components, packaging, labor to assemble and ship, cost of warehousing, cost of shipping, and … well that’s where the messing will start later.

So, when you take the COGS from the revenue, you have the profit made by each unit of product – generally referred to as Gross Margin or Gross Profit.

But let’s get messy …

Say, in order to create the product (e.g. a cell phone) you need to buy special tools and equipment, and even a factory for assembly. And, even if those costs are capitalized and depreciate over time – are they really fixed or variable cost (lets the messing begin) – and if no phones are sold, that is still a fixed expense, but is it really COGS?

Now move in the digital age, and in particular packaged software and SaaS.

There are still costs associated with each of those products, just not raw materials or components (unless its embedded software). For packaged software, the COGS would be, e.g. the cost of a CD, the packaging, the allocated costs of a CD burner, labor costs of burning, packing, and shipping the CD. But still essentially the cost to produce and deliver the product.

I’m OK with calling that COGS.

But for SaaS, there isn’t a CD and labor to create and ship it. SaaS costs are things like server costs, storage costs, bandwidth costs – or more likely the cost of Amazon Web Services. And salaries of SysAdmins to make sure the server is delivering service, and support to make sure the service keeps delivering service.

COGS? Well an accountant would say “yes” – and be correct. But it’s not goods, so Cost of Service is generally considered more descriptive. Or Cost of Revenue. Or if you want to a general term … Cost of Product.

But … they are just labels for the same thing, and their purpose is the same … to determine how profitable the product or service or goods are.

And to leave you with one last mind-mess, consider how IFS 15 or IFS 102 (if you have less than £632,000 revenue) will really mess with revenue recognition for SaaS companies.

You haven’t heard of them? Maybe you should be asking your accountant why the hell not?

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