CEO and Founder of Kruze Consulting
Everybody loves a high gross margin company. Entrepreneurs love it. The venture capitalists love it. Public investors love it. Everyone wants to have a high gross margin company, but when you start loading a lot of expenses into the cost of goods sold that by nature reduces your gross margin. The equation for gross margin is revenue minus cost of goods sold equals gross margin.
Thus, everyone should be very careful about loading expenses into cost of goods sold. Now, of course, you want do it on a GAAP basis, and that’s how we do things at Kruze Consulting, and that’s why this guidance is so helpful.
Companies look at customer success in two different ways. Some companies treat that as purely a support organization. Others treat it as a sales organization, they’re in charge of upgrading or upselling clients and that’s how they pay for those people to work at the company.
On one hand, if your company treats it as purely support, and there are no commissions, there are no revenue targets, then that should be in cost of goods sold. Put those support costs in cost of goods sold because it’s part of the cost for delivering your service.
On the other hand, if your Customer Success Organization has milestones and commissions and revenue targets, then that is definitely a sales and marketing expense. It should go into sales and marketing in the operating expenses category.
it’s not going to impact your gross margin. Now, there’s something really important here to point out, which is in early-stage companies, oftentimes, the people who are doing support also have like three other jobs. This is the beauty of working at an early-stage company. You get a lot of variety. At Kruze, we see a lot of times where the head of operations is answering questions or the software development team is actually answering support questions. Or maybe there’s one support person, but they’re doing something completely different half of their time.
In those cases, you really want to be smart and you really want to allocate only the portion of the time equivalent to the portion of the salary for that person or those people into COGS. That said, if someone’s doing half their time in operations and half their time in customer support, allocate half of their salary into customer support in COGS, you do not want to fully burden the COGS with people salaries who are doing other things. The danger in that is it could make your gross margin look really low or even negative.
Sometimes, we have companies coming from other accounting firms that sell a SAAS product that should be very high margin. And we look into the cost of goods sold, and we see that they’ve got tons of salaries and stuff that’s not applicable loaded in cost of goods sold, which again, depresses the gross margin. And this is a big deal for investors. When they’re looking at your profit and loss statement and thinking about the potential of the company, they are absolutely not going to invest in a company with a negative gross margin. That’s the old thing where you’re selling $100 bills for $90. You cannot scale that business. You can’t make up in volume. It’s a bad business. People are not going to want to invest in it.
That’s why, at Kruze Consulting, we take such care and we really focus on what needs to go in the cost of goods sold and customer success is really one of those big ingredients.
Be careful, be smart, make sure you do it on a GAAP accounting basis, fully load the cost of goods sold where appropriate, but also be careful because if people are revenue producing and have commission structures, they should be going into sales and marketing in the operating expense category.
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