Everything You Need To Know About The
SaaS Business Model
Did you know that the global SaaS market size is projected to reach $307 billion by 2026? That is definitely not a small amount.
There is no denying that the SaaS business model has become extremely popular and lucrative in recent years.
But why is the SaaS business model thriving?
The most obvious answer is that it fits the world’s current needs.
Even before the pandemic, SaaS solutions brought an innovation that streamlined business processes and made life easier for people.
But the pandemic has even increased the whole world’s demand for SaaS products.
Businesses were forced to take their operations online. Jobs had to be done remotely. Projects and tasks had to be managed digitally.
And it’s not just the businesses.
Even our everyday consumers turned to Zoom for communication and education. Netflix, Hulu, and other streaming services were the only ways to see movies on-demand. More and more people have used Slack and Discord to gather and manage communities.
In this article, we will talk about the SaaS business model: what it is, its pros and cons, potential revenue streams, and a lot more.
So let’s dive right in.
What Is The SaaS Business Model?
“SaaS” stands for “software as a service”. This business model is a popular and profitable way for businesses to deliver software products to their customers.
As for how it is different, we could look at it from how it is different from other software models and from other business models.
SaaS Software VS Software Licensing
SaaS solutions are very different from the traditional enterprise software models, which provide users with license keys or physical installations of the product.
For business-to-consumer (B2C) solutions, the software was just installed on the user’s computer.
For a business-to-business (B2B) solution, on the other hand, the software had to be installed on a company’s in-house server and all its computers.
SaaS products don’t need all that IT infrastructure.
SaaS solutions are hosted online and accessed via subscription.
This allows users to easily access the software from any device at any time, without having to worry about deploying or maintaining it themselves.
The SaaS Business Model VS Traditional Business Models
What really sets SaaS apart from traditional business models is its subscription-based revenue model. This is in contrast to the traditional one-time transactions.
Traditional business models rely on one-time sales. You find a new customer and try to sell your product. Once they buy your product, you move on to the next customer.
But with the SaaS model, the customer relationship is continuous.
What’s more, subscription-based revenue models enable SaaS businesses to bring in recurring revenues and be more flexible with their pricing.
They usually offer tiered plans or custom solutions tailored to each customer’s needs.
But let’s not get ahead of ourselves. We’ll talk about the pricing models as we go through this blog post.
Because of its subscription-based nature, the SaaS business model not only relies on getting new customers in order to succeed. It also needs to retain customers for as long as possible.
In fact, keeping your existing customers is often more important than finding new ones.
Pros and Cons Of The SaaS Business Model
Now that we know what the SaaS business model is, it’s time to talk about its pros and cons.
There are several reasons why the SaaS business model has become so popular in recent years. Let’s take a look at some of the most important ones.
- Recurring revenue
- Flexible & highly scalable
- Undiscovered opportunities in the market
- Lower-cost marketing
Recurring Revenue: The subscription-based nature of the SaaS business model enables companies to bring in recurring revenues.
This is a huge advantage for SaaS vendors as it provides them with a more predictable and stable income stream. That makes sales forecasting a whole lot easier.
And when you’re able to predict your future revenue, you can make smarter business decisions.
Flexible & Highly Scalable: One of the biggest benefits of SaaS solutions is that they can be scaled very easily.
Firstly, this means you can accommodate businesses of many different sizes.
This is unlike traditional software, where the only businesses that can purchase them are those that can afford to have their own in-house servers.
Sure, small businesses can still install basic software, such as word processors and spreadsheets.
But if we’re talking about project management and other company-wide software, it’s mostly just the enterprises that have the necessary IT infrastructure for them.
Secondly, it is easier for SaaS users to scale up their usage as needed.
This is because SaaS solutions are usually priced on a per-user or tiered model.
Your customers can start with a smaller-scale version of your product with access to a smaller set of features.
Then as their needs grow, they can simply upgrade to a higher tier that gives them access to more features or more seats for their users.
This is much more difficult with traditional software, where businesses would have to purchase an entirely new license for each additional user.
Undiscovered Opportunities In The Market: The SaaS business model enables companies to tap into new markets and uncover new opportunities.
You see, the SaaS industry itself is still growing. There are a lot of pain points in the market that are still yet to be addressed by a SaaS product.
This means that there’s still a lot of room for new businesses to enter the market and carve out their own niche.
Who knows? If you find a target market that has a high demand and low competition, that could be an opportunity for a Blue Ocean Strategy.
Lower-Cost Marketing: Last but not least, marketing a SaaS product is usually cheaper than marketing a traditional product.
This is because most of the marketing happens online. And there are many digital marketing channels that are very effective but relatively low-cost
Sure, you may place some online ads here and there. But the other organic and inbound marketing campaigns are ones that will do the heavy lifting in getting leads and converting them into customers.
Of course, this doesn’t mean that marketing a SaaS product is always cheap.
It depends on how competitive your market is and how well you’re able to execute your marketing campaigns. But in general, it will usually be cheaper than traditional products.
While the SaaS business model does have many advantages, it also has its own drawbacks. Let’s take a look at some of them below.
- High upfront costs
- Increasing competition
- Churn can incur heavy losses
High Upfront Costs: The first disadvantage of the SaaS business model is that it requires a substantial upfront cost to set up.
This is because all SaaS solutions need an in-house server or cloud hosting solution to run on.
You will also have to pay for maintenance and security, as well as ensure that your servers are running smoothly at all times.
This means not only do you have to invest financially in setting up your product. But you also have to hire people who can manage and maintain your servers.
And if you’re planning on launching a large-scale SaaS product that will cater to hundreds or thousands of customers simultaneously, then this might require a significant financial outlay.
Increasing Competition: As the SaaS industry continues to grow, so does the level of competition.
This is because as more and more businesses discover the advantages of the SaaS business model, they will want to get a piece of the pie.
And since it’s relatively easy to set up a SaaS product, we can expect to see an influx of new players in the market in the near future.
This means that you need to be prepared to face stiffer competition and find ways to differentiate your product from the rest.
Churn Can Incur Heavy Losses: Another disadvantage of the SaaS business model is that it’s susceptible to churn.
Churn is when customers cancel their subscription or fail to renew it after their initial contract expires.
This can be a big problem for SaaS businesses because it can lead to heavy financial losses.
This is because not only do you lose out on the revenue from that customer, but you also have to bear the cost of acquiring a new customer to replace them.
To combat this, you need to have a strong retention strategy in place.
This involves creating loyalty programs, providing excellent customer support, and continuously improving your product so that your customers see value in staying with you.
Stages Of The SaaS Business Model
To better understand the SaaS business model, we need to grasp its life cycle. We need to know how it starts, how it grows, and the common end-game for SaaS companies.
A SaaS business usually goes through four main stages:
Let’s talk about them one by one.
The first stage of a SaaS company is known as a pre-startup.
This is when the idea for your product still hasn’t taken off and you’re still doing research and exploring different options to make the business work.
During this phase, it’s important to get validation from potential customers.
You need to do some market research to gauge whether there’s actually a need for your product in the industry.
In other words, you need to establish a good product-market fit so that you can ensure that people would actually buy your SaaS product.
Your GTM strategy contains the blueprint of how you will market and sell your product from start to finish.
Once you have all your ducks in a row, it’s time to officially start your SaaS business.
This means building out your product and getting ready to launch it into the market.
You might need some seed funding at this stage. So you should also be working on securing investors or finding other ways to finance your venture.
During the startup phase, your main focus should be on acquiring your first batch of customers and getting them to use your product.
This would also be a good time to gather feedback on your SaaS solution and further refine it based on what you learn.
Once you’ve managed to gain traction and start seeing a steady stream of customers, it’s time for the next stage: hypergrowth.
This is where your team scales up and starts pumping in the resources to really grow your SaaS business. If done right, SaaS businesses can grow exponentially.
In fact, a SaaS growth framework called the T2D3 framework follows that a SaaS business can triple its recurring revenues every year for two consecutive years. Then triple every year for three consecutive years.
That framework could get you from $2 million to more than $100 million in annual recurring revenue (ARR) in just five to six years.
Still, that kind of growth is so much easier said than done. It requires a lot of strategic planning and execution.
To achieve hypergrowth, you need to focus on scaling your marketing and sales efforts.
This means expanding into new markets and coming up with creative ways to reach more potential customers.
You also need to make sure that your product is able to keep up with the demand. This means continuously improving it and adding new features that will appeal to your target market.
In the earlier stages of your SaaS business, you may have chosen to start by catering to small and medium-sized businesses.
But in the later parts of your hypergrowth, you eventually need to move upmarket. This is where you start offering enterprise SaaS solutions to big companies.
The last stage of the SaaS business model is maturity. This is when your growth starts to plateau and you start stabilizing your business.
At this stage, you might want to focus on diversifying your revenue streams and exploring new ways to grow your business.
You could start selling other products that complement your main SaaS offering. For example, let’s say you have a customer relationship management (CRM) platform. You could develop an add-on social media marketing or telephony solution to go with it.
We’ll talk more about the SaaS business model’s potential revenue streams as we go along.
In the maturity stage, you might also want to think about the end game for your SaaS businesses.
Most SaaS companies go through either of two routes: going public or selling their company to a larger corporation.
Making Your SaaS Company Public: If you’re looking to grow your SaaS business on a large scale, one option is to go public.
A successful initial public offering (IPO) can give your company the boost it needs to continue scaling up and reaching new markets.
However, offering an IPO comes with its own set of challenges. For one, it requires significant resources and time in terms of process, planning, and execution.
On top of that, there’s also the risk that your company could fall short of market expectations after an IPO. This could negatively impact your stock price and affect investor confidence in your company moving forward.
Selling Your SaaS Company: Another option for growing your SaaS business is to sell it to a larger corporation or strategic investor.
This can be a good strategy for exiting your business and reaping the rewards of your years of hard work.
However, you need to make sure that the buyer is a good fit for your SaaS company. Otherwise, you could risk losing control over your own product and even end up being dissolved as part of the deal.
SaaS Pricing Models
Now that we’ve gone over the different stages of the SaaS business model, let’s take a look at some of the most common pricing models for SaaS products.
The most important thing to keep in mind when choosing a pricing model is what value your product provides to your customers.
Your pricing should be aligned with the perceived value of your product in the eyes of your target market.
With that said, here are some of the most common SaaS pricing models:
- Freemium Model
- User-Based Pricing
- Usage-Based Pricing
- Tiered Pricing
- Customized Pricing
- Hybrid Pricing Model
The freemium model is one of the most popular pricing options for SaaS products. It involves offering a free version of your product that’s supported by limited features and functionality.
This option lets users try out your product without having to commit upfront. And it gives you an opportunity to convince them to upgrade to your paid subscription plan later on.
This is one of the most common pricing models for B2B SaaS solutions. It involves charging customers based on how many individual users are accessing your software.
This model works well for products that are used by a large number of different people, such as human resources (HR) or CRM platforms.
However, it can also lead to higher costs for companies with a large number of employees.
This is not to be confused with user-based pricing. The usage-based pricing model involves charging customers based on how much they use your software.
But how do you measure the extent to which your customers are using your SaaS product? It can vary depending on the nature of your SaaS platform.
Let’s have some examples:
Number Of Contacts: This is more common among marketing and CRM SaaS products. With this kind of usage metric, you charge customers based on the number of contacts they have in their address book.
This makes sense because this figure can accurately reflect how much value users are getting out of your platform.
Number Of Emails Sent: This metric is often used by marketing and sales SaaS products. In this case, customers are charged according to the number of emails they send through your software.
This could also work if your SaaS product can send SMS or other types of messages.
This works well for platforms that help users automate their email marketing or sales outreach efforts.
Call Minutes: This metric is often used by voice over Internet Protocol (VoIP) and call center SaaS products. In this case, customers are charged according to the minutes they spend using your software to make calls.
Storage Allocation: This is a more common usage metric for SaaS products that offer online file storage or data backup services. With this type of pricing model, customers are charged based on how much data they store in the cloud.
Credits: This is a useful usage metric that can be used for just about any type of SaaS product.
With this type of pricing, customers are given a certain number of credits to use your software. Once they run out of credits, they need to buy more in order to continue.
This usage metric is very useful for SaaS products that have a lot of scalable functionalities.
For example, let’s say you have an all-in-one CRM software that enables users to score leads, send emails and text messages, and make phone calls. The whole package.
Since there are a lot of features, you can use credits to access each of them.
One email could cost one credit. One minute of a phone call could consume another credit. One batch of lead scoring could take up one more credit. And so on.
This type of pricing can be very flexible and can be adapted to just about any type of SaaS product.
Tiered pricing is one of the most common pricing models among SaaS products today.
This pricing model involves offering different packages or plans to customers, each with its own set of features and price.
With this type of pricing model, you can target a variety of customer segments based on their needs and budget.
You might have one package for individual users, another for small businesses, and yet another for enterprise-level companies.
With this type of pricing, you work with each customer to come up with a unique price that meets their specific needs.
This type of pricing is usually only used by enterprise-level companies that are selling very complex products that require a lot of customization.
It’s also important to note that customized pricing is more common among businesses that sell their SaaS products through direct sales channels.
So if you’re planning to use this type of pricing, you’ll need to have a team of experienced salespeople who can close deals with big customers.
Hybrid Pricing Model
The hybrid pricing model is a combination of any of the other pricing models. This can be very useful if you want to offer a variety of options to your customers.
For example, you could have tiered pricing with additional charges per user. Or you could also throw in a free plan and customized pricing among the choices.
The important thing is to find the right mix of pricing models that will work for your business and your target market.
Just be careful not to make your pricing structure too complicated. You don’t want to confuse or overwhelm your customers with too many options.
Potential Revenue Streams Of The SaaS Business Model
There are a number of different revenue streams that can be used with the SaaS business model.
Some of these include:
- One-Time Fees
- Upsells and Add-Ons
- Priority Customer Support
- Custom Integration
The bulk of the revenue for SaaS businesses comes from subscriptions. This is where customers pay a recurring fee, usually on a monthly or annual basis, to use your software.
This type of revenue stream is very predictable. This can be helpful for SaaS companies that need to know how much money they’ll be bringing in on a regular basis.
Some SaaS products also charge one-time fees. This could be for things like set-up, installation, or training.
It could also be for special features or add-ons that are not included in the regular subscription.
One-time fees are not as common as subscriptions, but they can still be a useful revenue stream for SaaS businesses.
Upsells And Add-Ons
Many SaaS companies also offer additional features or functionality to users as part of their subscription packages. These can include analytics tools, advanced customer support, or other specialized services.
This can be a great way to boost revenue and increase the value of your product over time.
Priority Customer Support
Another way to generate additional revenue is to offer premium or priority customer support.
This could be for things like faster response times, dedicated account managers, or other VIP treatment.
Not all customers will be willing to pay for this type of service, but those who do can be a valuable source of additional revenue.
Another potential revenue stream is custom integration. This is where you work with a customer to integrate your software with their existing systems.
This could be a one-time fee or it could be an ongoing service contract.
It’s important to note that this type of revenue stream is typically only available to enterprise-level businesses.
Key Metrics For The SaaS Business Model
There are a number of metrics and key performance indicators (KPIs) that are important to track for any SaaS business.
Some of these include:
- Recurring Revenue
- Average Revenue Per User (ARPU)
- Churn Rate
- Customer Acquisition Cost (CAC)
- Customer Lifetime Value (CLV)
One of the most important metrics for a SaaS business is recurring revenues, which measure how much money you’re bringing in on a regular basis.
This can be measured as monthly recurring revenue (MRR) or annual recurring revenue (ARR).
Average Revenue Per User (ARPU)
Another key metric is ARPU, which measures how much revenue you’re generating per user.
This metric can be helpful in determining how effective your pricing model is and whether or not you’re getting the most out of your customer base.
Churn rate is a metric that measures the percentage of customers who cancel their subscription or stop using your product over a given period of time
It’s important to keep an eye on this metric as it can be a good indicator of customer satisfaction.
Customer Acquisition Cost (CAC)
CAC is the metric that measures how much it costs you to acquire a new customer. It is your total marketing and sales costs divided by the number of new customers you’ve acquired.
This metric can be helpful in determining your marketing and sales strategies
It’s important to keep an eye on your CAC and make sure that it’s in line with how much total revenue you can potentially generate for each user.
Speaking of which…
Customer Lifetime Value (CLV)
The CLV is a key metric that measures the total value of each customer over their entire lifetime as a user of your product.
This can give you valuable insight into how much revenue you stand to potentially generate from each customer, which can be helpful in setting pricing and marketing strategies.
The CLV can also be measured against the CAC to determine how much return on investment (ROI) you are getting for each customer.
You see, the CLV is often divided by the CAC to get your CLV:CAC ratio. This ratio exactly indicates how much revenue you are making for each dollar you spend on customer acquisition.
Ideally, the CLV:CAC ratio should be 3:1 or higher.
Final Thoughts About The SaaS Business Model
The SaaS business model is an increasingly popular and effective way to generate revenue from software products.
But with all of its potential and untapped opportunities, it also comes with its challenges.
The key to success with the SaaS business model is to focus on creating a product that provides value to customers and solving a real problem
If you can do that, then you’re well on your way to success. From there, it’s important to track key metrics so you can optimize your pricing, marketing, and sales strategies over time.
Want to learn more about how you can grow your SaaS business? Visit our blog here.