Cloud services and optimization of COGS in the eyes of CFO

One of the major costs of a SaaS company (after employee's costs) are cloud costs / usage of compute, storage, data transfer costs. In a SaaS business model, the Gross Margin (GM) could be about 80-90%. Optimizing those costs should decrease the Cost of Goods Sold (COGS) and increase the GM rates.

Is high GM being essential for Saas Companies?

In its article Why Gross Margin Matter, Villi Iltchev indicates that he is " often surprised how little attention companies pay to gross margin in SaaS businesses. From what I’ve seen, founders have little appreciation of why gross margin matters until a startup reaches some scale"; " Higher Gross Margins Drive Higher Valuations".

Let's first look on the COGS for Software-as-a-Service (SaaS) Business

This is a list of the general costs that comprise the COGS for a SaaS business and are not part of the Operating Expenses:

· Application hosting and monitoring costs.

· Employee costs related to keeping the production environment running.

· Employee costs for customer support/success of the application, but excluding any sales costs for up-sells, or cross-sells.

· Data communication expense.

· Software license fees for products embedded in the application.

· Website development and support costs.

· Professional services and training personnel costs (Should be broken separately).

· Costs of subscriptions.

Costs that shouldn't be include in COGS:

· Sales commissions.

· Allocated overhead charges.

· Customer success costs associated with cross-selling/up-selling.

· Product development costs.

· Third-party software uses in-house for operations, but not packaged in your product.

One of the most popular web services is AWS (Amazon Web Service)

AWS pricing model and costs

Pricing fundamentals:

1. Compute - charges on hourly bases. You will pay only for the resources that you use.

2. Storage - charges you for GB. You will pay only for the GB that you use.

3. Data Transfer - charges per GB only for the data that goes out.

AWS pricing models:

1. Pay-as-you-go - allows you to easily adapt to changing business needs without overcommitting budgets and improving your responsiveness to changes. You can adapt your business depending on need and not on forecasts, reducing the risk of over positioning or missing capacity.

2. Pay less by using more - You can get volume-based discounts and realize important savings as your usage increases. Pricing is tiered, meaning the more you use, the less you pay per GB.

3. Save when you reserve - For certain services you can invest in reserved capacity. You can save up to 75% over equivalent on-demand capacity. When you buy Reserved Instances, the larger the upfront payment, the greater the discount.

Costs Optimization

AWS models allow you to optimize your costs:

1. Right size your service - it is very easy to upscale, but it is not easy to downscale. Use minimum resources and then upscale according to your needs.

2. Reservation benefits - you can reserve of the resources up front - the resources that you are sure about them.

3. Elasticity benefits - time scheduler - allow you to switch on and switch off your services.

4. Track and manage services – software that allows you to track all the uses of the resources it is helps you optimize your usage.

AWS Pricing Calculator - The calculator allows you to estimate individual or multiple prices and use templates to appraise complete solutions.

Whether GM is important for SU at the early stage or just after maturity, it is important that the CFO will examine in depth the revenue model of the company and calculate its optimal web services costs model. Optimization will improve company's spending, cash flow and valuation.

Related Links (Sources):

1. AWS Pricing: https://aws.amazon.com/pricing/?nc2=h_ql_pr_ln

2. Why Gross margins Matter: https://twosigmaventures.com/blog/article/why-gross-margins-matter/

3. YouTube: AWS Pricing Tutorial: https://youtu.be/1rVG0qfOGDU