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Leading indicators: cost of goods.

Compared to most other products, software is relatively inexpensive to manufacture. But manufacturing and other production-related costs {"cost of goods sold" or "cost of sales") are nevertheless a major expense area for most PC software companies. Our ongoing analysis of data from 42 public companies (Soft.letter, 10/22/93) shows that COGS expenses now typically account for 24%-26% of total revenues--a ratio that is likely to keep rising as prices decline and products become more complex.

In fact, the relationship between price and COGS becomes especially clear when we look at the eight companies in our database with the highest three-year average COGS ratios. These eight companies all market low-priced titles, and most support relatively large numbers of SKUs, which adds substantially to their inventory and fulfillment overhead. (The COGS category also includes royalties, a major cost element for most consumer companies.) For these companies, COGS generally represents the company's single largest expense category, sometimes accounting for more than 50% of total revenues.

Among business software companies, COGS takes a smaller bite--usually between 17% and 24% of revenues. But COGS is still a substantial expense category even at these levels. Wider use of electronic distribution, CD-ROM disk media, less costly packaging, and better manufacturing and distribution technologies may help business software companies keep COGS costs under control. But if cost-control tactics fail, the industry's basic business model may end up focusing more on traditional manufacturing and less on pure intellectual property issues.

[TABULAR DATA OMITTED]
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Copyright 1993, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Publication:Soft-Letter
Date:Nov 4, 1993
Words:247
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