Service providers do not report Cost of Goods Sold since they do not sell physical goods.  Some service firms, however, report the line item Cost of Revenue in their Income Statement.  Netflix, for example, reported nearly $10 billion in cost of revenues for the 2018 fiscal year.

Netflix Income Statements for the year ended Dec 31 2018 2017 2016
Revenues $     15,794,341 $     11,692,713 $     8,830,669
          Cost of revenues 9,967538 8,033,000 6,257,462
                    Marketing 2,369,469 1,436,281 1,097,519
                    Technology and development 1,221,814 953,710 780,232
                    General and administrative 630,294 431,043 315,663
Operating income 1,605,226 838,679 379,793
Other income (expense):
          Interest Expense (420,493) (238,204) (150,114)
          Interest and other income (expense) 41,725 (115,154) 30,828
Income before income taxes 1,226,458 485,321 260,507
Provision for (benefit from) income taxes 15,216 (73,608) 73,829
Net Income $      1,211,242 $       558,929 $       186,678

Cost of revenue was responsible for more than 70% of Netflix’s operating expenses in FY 2018 so it is by no means a trivial line item.

So what is cost of revenue?

There is no easy answer.

Cost of revenue includes any costs incurred to produce revenue.  You could also think of cost of revenue as any costs associated with the delivery and distribution of the service being provided.  Because this definition is fairly broad, the items that appear in cost of revenue can vary significantly between firms.

Examples from actual companies

For Netflix, cost of revenue is mostly comprised of amortization.  Netflix amortizes the cost of producing streaming content (Orange is the New Black) and the cost of licensing streaming content (an Avengers movie on Netflix).  Rather than report these costs as amortization expense, Netflix includes them in the cost of revenue.

Twitter also includes some amortization costs in its cost of revenue, specifically those related to internally developed software.  But Twitter’s cost of revenue also includes:

  • data center costs
  • hosting costs
  • tech support costs
  • energy costs
  • traffic acquisition costs
  • depreciation for its servers
  • compensation for its operations staff

Facebook includes many of these same costs in its cost of revenue, but also includes credit card and payment transaction fees.  Thus, if you purchase something using PayPal on Facebook, Facebook would include the fee charged by PayPal in cost of revenue.

Snapchat also includes cost of revenue in its Income Statement.

Snapchat Income Statements (in thousands)
For the year ended Dec 31
2018 2017 2016
Revenue $   1,180,446 $   824,949 $   404,482
Costs and expenses:
          Cost of revenue 798,865 717,462 451,660
          Research and development 772,185 1,534,863 183,676
          Sales and marketing 400,824 522,605 124,371
          General and administrative 477,022 1,535,595 165,160
Operating loss (1,268,450) (3,485,576) (520,385)
Interest income 27,228 21,096 4,654
Interest expense (3,894) (3,456) (1,424)
Other income (expense), net (8,248) 4,528 (4,568)
Loss before income taxes (1,253,364) (3,463,408) (521,723)
Income tax benefit (expense) (2,547) 18,342 7,080
Net Loss $     (1,255,911) $     (3,445,066) $     (514,643)

While Snapchat’s cost of revenue also includes costs related to data infrastructure and hosting, it includes amortization costs and the cost of advertising measurement services.  These costs were not mentioned by Facebook and Twitter, which suggests there is some variation in cost of revenue even among companies that have very similar business models.

How can I find out what’s included in Cost of Revenue?

Look at the notes to the financial statements.

Netflix, Twitter, Facebook, and Snapchat all describe which costs are included in cost of revenue in the notes to their financial statements.

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