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Cost of Goods sold is an important metric because not only is it informative on its own, but it is used in the calculation of other vital metrics. Simply put, COGS is the amount that is spent on the delivery of your product or service. When you understand the amount required to provide your service, you can make strategic decisions to make delivery more efficient and ensure you're turning a reasonable profit.
Calculating COGS is quite easy, only addition is required! Simply add all expenses that go into the production of your product or service, not including operating expenses.
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Understanding what goes into calculating your COGS means that you are acutely aware of exactly it costs to deliver your product. That way, when analyzing how to optimize your revenue, you'll be able to pinpoint where your cash is going and where you could possibly cut costs. As with most metrics, COGS doesn’t give you the whole story on its own. However, you will use it to calculate your gross profit. You’ll use your gross profit to calculate your gross margin so it’s critical that your expenses are placed in the correct category and that COGS is accurate.
As mentioned above, one of the items included in calculating COGS is customer success. Some argue for customer success costs being under sales and marketing in operating expenses (OpEx). This is tricky, because customer success can be focused on sales (i.e. upselling). However, we view customer success as being retention focused; keeping your customers happy and informed is a key part of delivering your product and increasing your stickiness, which is why we include it in COGS. Unless your CS team is almost exclusively focused on up-selling, we default to including it COGS but there are exceptions.
If your company has both recurring subscription revenue and one-time services revenue, make sure to track the COGS for each of those revenue streams separately. The costs to maintain your subscription services vs the costs to deliver a single implementation are going to be different and involve a different strategy. Your VCs and investors may want to know your gross margin on your software business separate from your services work.
Cost of Goods Sold is one of the metrics where improving means decreasing, or even simply optimizing. The more efficient your COGS is, the lower your spend will be when delivering your product or service. Having an optimized COGS doesn't mean just arbitrarily cutting costs; it necessitates you finding ways to deliver your product using fewer resources, improving the output of your customer-facing headcount, etc. Make sure that lowering your spend won't disproportionately affect your ability to provide your service.
To improve COGS, take stock of your tech stack and distinguish the necessities from the "nice-to-haves." This way, you're not just eliminating what's most expensive, which could cut into a critical function. Additionally, you'll want to review your expenses and make sure they're properly categorized. If you're including something in COGS that really belongs under Sales and Marketing, your COGS will be inaccurately inflated, and will be difficult to pinpoint how to reduce.