Cost of Goods Sold (COGS)

Why it matters

COGS determines gross margin, and gross margin determines how much of every revenue dollar is left to spend on growth. Healthy SaaS targets COGS at 15-30% of revenue, which is 70-85% gross margin. AI products routinely break this rule: inference costs can push COGS to 40-60% of revenue, which makes an AI wrapper look financially like a services business, not software, and investors price accordingly. Solo founders also under-count COGS because they do their own support and onboarding for free; that cost becomes real the day you hire. Know your COGS per customer before setting prices, especially if usage-heavy features mean your most active customers are your least profitable.

Formula

SaaS COGS % = (hosting + third-party API fees + support + onboarding costs) / revenue x 100

Worked example

At $10,000 MRR with $800 in hosting, $1,200 in LLM API calls, and $500 in support tooling and contractor time, COGS is $2,500, or 25% of revenue and 75% gross margin. If customer LLM usage doubles without a price change, COGS jumps to $3,700 and margin falls to 63%.

Common mistakes

• Leaving your own support and onboarding hours out of COGS because you do not pay yourself; the cost appears the day you hire for the role.
• Booking engineering salaries into COGS (they are R&D) or ad spend into COGS (it is sales and marketing); miscategorizing makes gross margin meaningless.
• Pricing AI features flat-rate while paying per token; a handful of heavy users can push their individual gross margin negative.

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