COGs are the second highest expense bucket for most SaaS companies. If you aren’t continuously delivering problem-free, high speed and secure access to your SaaS product, customers won’t stay. Delivering high performance to an exponentially growing subscriber base costs a lot, which drives up COGs. In addition, you need to invest in your hosting platform ahead of the growth curve. Sales and Marketing gets a lot of deserved attention as the number one expense category, but COGS deserves close attention as the #2 most expensive area in running a SaaS company, given the dollars and significance to growth and renewals.
Average COGs for public SaaS companies last year was 35% of recognized revenue with roughly 30% of those companies spending over 40% of revenues on COGS. Given how big the number is, won’t it go down as revenues grow? One assumes that there are economies of scale as you bring on more subscribers to the same platform – isn’t that the promise of SaaS?
A LITTLE HISTORY OF SAAS COGS
A long time ago, in the early days of SAAS – say at least 10 years ago – conventional wisdom had it that SAAS COGs was a somewhat fixed cost, with efficiencies of scale as you grew your subscriber base, leading to highly profitable businesses. Costs per subscriber would go down as users increased and revenues went up. You might incur some additional costs for increased loads and to manage performance, but not at the same rates as revenues would increase.
Taking a look at SalesForce.com, conventional wisdom doesn’t seem to have had it right. When SalesForce went public in 2004, with revenues of $100M, COGs was 18% of revenue. 10 years later, at $4B in revenues, COGs was 24% of revenue. In 2008, the first year after Netsuite went public in 2007, COGs was 32% of $152M. In 2014, Netsuite’s COGs was about the same 32% on $556M revenues.
PRIVATE COMPANY COGS
With private SaaS companies, we see similar COGs of median 32% for all private companies, but for private SaaS companies with the highest growth rates, and highest average contract values, COGs are higher. Different growth rates as well as different applications and growth models show different COGs benchmarks.
DEFINING COGS FOR SAAS
For SaaS companies without a lot of professional services (one off implementation and consulting services), COGs is primarily the cost of hosting, plus depreciation and amortization of capitalized software. Here’s a summary of the Cost of Products definition we use in the OPEXEngine benchmarking:
“All direct expenses related to making or acquiring products that have been sold, including compensation associated with product management and administration, plus direct overhead for the production of software or SaaS products.
For SaaS companies, cost of subscription revenues primarily consists of expenses related to hosting the service and providing support, the costs of data center capacity, depreciation or operating lease expense associated with computer equipment and software, allocated overhead and amortization expense associated with capitalized software.”
2015 SAAS Benchmarking
Given changing hosting offerings and cloud technologies, it is critical to pay close attention to COGs. OPEXEngine conducts a comprehensive benchmarking for SaaS companies at different revenue stages and for different business models and growth rates. We benchmark Cost of Product and Cost of Services as well as total Cost of Revenue. In addition, we benchmark total hosting expense, and also break it out by 3rd party hosting expense and in-house hosting expense. For more information about the benchmarking and how to compare your company’s costs against peers, please contact us at: firstname.lastname@example.org or call us at: 617-674-4218.