Introduction: A Fresh Take on Cloud Costs
For decades, Cost of Goods Sold (COGS) has been a fundamental concept in finance and accounting, helping businesses understand the direct costs associated with producing goods or delivering services. Traditional industries, from manufacturing to retail, have long relied on COGS to make pricing decisions, forecast margins, and evaluate profitability.
However, in the SaaS world, cloud infrastructure costs are often categorized as operating expenses (OpEx) rather than COGS, leading to a misalignment between costs and revenue. This outdated approach can obscure the true financial picture, making it difficult for finance leaders to optimize profitability.
It’s time for a paradigm shift: SaaS CFOs should start applying COGS principles to cloud costs. Read on to learn why.
Understanding COGS and Its Role in Financial Clarity
COGS represents the direct costs associated with delivering a product or service. Traditionally, in manufacturing and retail, COGS has included raw materials, direct labor, and production costs—essentially, the costs required to create and sell a tangible product. However, in the SaaS industry, these direct costs take a different form. In SaaS, COGS includes cloud infrastructure, third-party services, and support costs tied to service delivery.
For SaaS businesses, COGS should include:
- Cloud infrastructure costs (compute, storage, networking) that directly support customer-facing applications.
- Third-party services required for product functionality, such as API integrations or security tools.
- Customer support costs that scale with service delivery and user growth.
- Licensing fees for critical software necessary for the product to function.
To implement this shift, SaaS companies should track these expenses at a granular level, allocating costs based on usage metrics such as compute hours per customer, storage per user, or API calls per transaction. By mapping cloud costs to revenue streams, finance leaders can make more informed decisions and gain a clearer picture of unit economics and gross margins.
The Relationship Between Variable Costs and COGS
Variable costs are expenses that fluctuate with production or service delivery volume. In traditional industries, these include raw materials, direct labor, and utilities, all of which directly impact COGS. In the SaaS world, cloud costs exhibit similar variability, scaling with customer usage, data storage needs, and compute power consumption.
The key challenge in SaaS finance is that many cloud costs behave like variable costs but are frequently misclassified as fixed operating expenses. This misclassification creates inefficiencies in financial planning and distorts gross margin calculations. By recognizing cloud costs as variable and aligning them with revenue generation, finance leaders can better optimize cost structures and enhance profitability.
To bridge the gap between variable costs and COGS, SaaS businesses should:
- Distinguish Between Fixed and Variable Cloud Costs
- Fixed costs: Base-level infrastructure necessary to support operations.
- Variable costs: Usage-driven expenses that scale with customer demand.
- Track Cloud Costs Per Unit of Output
- Measure costs per user, per transaction, or per feature to improve cost attribution.
- Implement dynamic pricing strategies that reflect true cloud cost variability.
- Ensure Gross Margins Reflect Cost Dynamics
- Regularly review financial reports to ensure cloud costs are correctly categorized.
- Adjust financial models to capture the impact of cloud cost variability on profitability.
The Hidden Problem with Treating Cloud Costs as OpEx
When cloud expenses are treated as fixed operating costs, it creates several issues:
- Lack of cost accountability – Engineering teams are often disconnected from financial goals, leading to unchecked spending.
- Distorted gross margins – If cloud costs aren’t properly attributed to revenue generation, SaaS companies may appear more profitable than they actually are.
- Difficulty in cost optimization – Without a clear link between cloud spending and customer usage, finance teams struggle to implement cost controls that align with business growth.
By reclassifying cloud infrastructure as COGS, finance leaders can gain better insights into cost efficiency, ensuring that spending scales in proportion to revenue.
How to Apply COGS to Cloud Costs
By leveraging the appropriate tools, companies can shift cloud spend from OpEx to COGS, thus improving cost attribution and margin optimization:
- Tie Cloud Costs to Revenue Generation
- Track cloud spend per customer, feature, or transaction.
- Implement cost allocation models that map expenses directly to usage.
- Analyze Gross Margins Accurately
- Measure cloud costs as a percentage of revenue to assess true product profitability.
- Compare gross margins across different customer segments or product tiers.
- Enforce Cloud Cost Accountability
- Work closely with engineering teams to ensure infrastructure decisions align with financial goals.
- Provide engineers with real-time cost insights to encourage cost-awareness in development processes.
The CFO’s Ah-Ha Moment: Making Cloud Costs Work for the Business
When SaaS finance leaders apply a COGS framework to cloud costs, they unlock powerful advantages:
- Build more accurate pricing models – Align costs with revenue to prevent margin erosion.
- Gain visibility into true gross margins – Leverage data-backed insights to understand the relationship between cloud spend and profitability, ensuring informed financial planning.
- Strengthen financial accountability and control – Establish cost governance frameworks that track, manage, and optimize infrastructure investments in alignment with business priorities.
Ultimately, treating cloud costs as COGS transforms the way finance teams evaluate profitability, making it easier to drive long-term business success.
Bringing It All Together
Cloud costs aren’t just another line item in OpEx—they are the backbone of SaaS product delivery. Reclassifying cloud expenses as COGS isn’t just an accounting change; it’s a strategic shift that brings financial clarity and empowers CFOs to drive sustainable growth. By embracing this approach, SaaS leaders can align spending with revenue, sharpen gross margin insights, and create a competitive advantage in an increasingly cloud-driven world.
The next step? Start tracking cloud costs like a COGS-minded CFO—and watch the financial impact unfold.
