SaaS Business Model: Your Gateway to Profitability
SaaS or software as a service is the new era of doing business for the service industry. Companies are shifting from traditional brick and mortar towards SaaS to do business in a better way. SaaS is software being offered online through a server. Interested users pay the subscription fees to access that software. The fees can be divided into per month basis or yearly basis – depending on the pricing plan of the company. Let’s look into some of the details regarding SaaS before diving into the SaaS business model.
Software for SaaS Business
Software is held on the cloud as a service – which is why it is accessible from anywhere for its paid users. Traditionally, you would buy the software physically and install it on your computer. The traditional method had limited usage as you can only use the software on that computer. Because of its limited accessibility and the extensive time process of buying the license, the shift towards SaaS came into existence. People just rent software online, which is accessible on many devices. Due to the software being stored in cloud computing, accessibility is very high.
For users, SaaS is quite impressive; however, even for companies, SaaS is a lifesaver. First, you can give access to many users online if they pay the fees. You don’t need to worry about the licensing part as it is quite easy to get the software on cloud computing. The best example of SaaS is Google Apps.
How does SaaS work?
Software as a service is quite successful; however, software as a product has many limitations. In order to successfully provide software as a product, you need to get the license and upgrade the hardware in order to run the software. In SAAP, your money is spent on customization according to user requirements. If every product is customized, the company needs to spend a fortune on it. Furthermore, if the company rolls out an update, users have to update the software – either buy updated software or download from the internet, this process is lengthy and requires time.
Companies that opted for SaaS instead of SaaP are quite happy with what they got because the developers avoided the limitations present in SaaP. Since SaaS is available online, the model is quite useful and requires only one thing, the internet. The updating is also easier with SaaS since the software is available online, the developer can update the software without the user putting extra effort to download it.
Scalability for SaaS Business Model
Scalability is also a massive advantage of SaaS. When I say scalability, I mean there are no restrictions in terms of regions or countries. You can provide the software to the user in any country – near or far, and it works the same for all. Also, if you run out of storage, you need to ask cloud computing to provide you with more digital space. Since it’s easier to scale bigger, the cost is quite cheap.
To further understand the SaaS business, let’s look into the different phases of it. There are three distinct phases of a SaaS business that every company goes through. The startup phase is quite easy and understood by most companies; however, after the startup phase, when the hyper-growth phase comes – it gets real tricky. This is the stage where companies either make it big or lose it all. Let’s look further into these stages and what they mean for a company.
- Startup Phase – at this phase, companies go through an initial stage of everything. First time setting the service or a product. First time going to the market and getting initial customers.
- Hypergrowth Phase – if you are an immediate hit in the market, your service or product would sell very fast and easily. However, with more companies or users opting for your software, you would need a bigger server, bandwidth, data, and other technical components. Only after you expand yourself, you will be able to support the increase in customers. This stage is crucial because it requires a lot of money to survive – that is if your service or product being offered is an instant favorite. Many companies rely on the software itself to provide backend infrastructure to them through their subscriptions, which is why companies love the SaaS product. The IT infrastructure provided by the SaaS company allows users to freely use the software in their organization without investing anything substantial in IT infrastructure.
- Stable Golden Goose – If a company survives, hyper-growth phase, it reaches the stable golden goose phase. This phase is when the business has leveled out and began to provide substantial revenue. Acquisition of new customers is not hard anymore, and the company won’t need to worry about the limits of IT infrastructure.
Even though many companies offer the right SaaS products, they still fail to survive because of the hyper-growth phase. We will further talk about how to mitigate the risks associated with the failure of a SaaS company later in the article.
SAAS Business Model
Even though SaaS seems quite impressive, it isn’t that easy to be successful at. Many companies underestimate the impact that different indicators have on the business model for SaaS. This becomes the biggest reason why some companies fail. The business of SaaS contains significant indicators that a company should understand to get the most fruitful result out of it.
Check our SAAS industry Financial Models and Business Plans
Let’s discuss those performance indicators and how they impact a company’s success.
Customer acquisition cost or CAC is the sum of all expenses which are incurred to acquire one customer. Acquiring a single customer has many different costs associated with it. These costs include marketing costs + outsourcing costs + other costs. CAC is calculated as a ratio with LTV, which is the lifetime value.
LTV is the lifetime value of a customer. This means that all the revenue earned through one customer will be that customer’s LTV. The total revenue earned is divided by the number of customers in order to get LTV value.
MMR is monthly recurring revenue, which is the amount of revenue that comes in every month. This measure shows the company’s ability to retain its customers. To calculate MRR, you need to multiply the net user per month by the subscription fee.
Churn is the customers who have left the company’s services. Churn shows the loss of revenue in addition to the loss of customers. You can calculate MMR churn by multiplying net users who have unsubscribed by the subscription fee.
The Economics of SAAS Business Model
SaaS is a service being provided for the customers, which is why the generation of profits takes quite long. Sometimes you might need to wait a few months before actually seeing any profit in the business. In terms of costs, they are incurred long before the profits start coming in, so you need to inject money into the business for the first few months. However, if you successfully survive those few months, the profits will be good enough. Customer acquisition cost is quite high, even at the beginning of the business.
CAC increases as the number of customers increase. Due to the cost being high, initially, businesses see negative cash flow. However, things start to change after breakeven is achieved and the money starts coming into the business. Therefore, you need to be prepared for a few months of negative cash flow before you get to see a positive one.
Following are the expenses of the SaaS business model,
- COGS or Cost of Goods Sold
- Sales & Marketing Costs
- Research & Development Costs
- General & Administrative Costs
When you use a business model, you can track your costs and ensure that no extra charges are incurred. This way, you can control the costs in order to make it more efficient. If you have more customers, try to keep your CAC in check and avoid the negative cash flow as much as possible. However, for the first few months, it is quite difficult to have a positive cash flow. Once the revenue starts to cover up the cost, you will see a change in your cash flow. We have found that, if you charge fees to your customers on a yearly basis, the negative cash flow can be reduced.
What is Customer Churn VS. LTV in SaaS Business Model
Retaining customers is one of the most difficult tasks in any business. For SaaS business, it’s very common to have customer churn to some extent. Having a high customer churn is obviously not good for any SaaS business. Most businesses face difficulty in dealing with this issue. This concept of customers leaving your service is known as customer churn. LTV is directly affected by the customer churn rate. In order to mitigate the damages from customer churn, entrepreneurs opt for different ways of reducing it and try to attract more customers.
If you notice, SaaS companies always provide different pricing plans than traditional companies. Commonly, a SaaS business will have four plans, free, basic, pro, and enterprise editions. First, the company provides a free plan to customers in order to attract them. Once a customer starts to like a product, the company has a paid plan with different services that are not available on the free version. The free plan is used to acquire a customer, after retention, the company starts making revenue from it.
Ever wondered why the SAAS packages come in free, basic, pro, & enterprise editions? The company acquires the customers by providing freemium services, and once acquired other services are offered at a basic periodic price to him. This leads to retention and monetization. Also, a SaaS business can tweak some prices in order to attract customers.
SaaS Growth Strategies for SaaS Business Model
Let’s look into how the SaaS companies can mitigate the risks that we talked about earlier in the article. The strategies for growth depend on company to company and what works well for the business. There is no one size fits for all policy when it comes to growth strategies. Here we discuss a couple of growth strategies, especially for SaaS business.
Increase Organic Traffic
Organic traffic is the most powerful traffic which is best for converting customers. Google and Bing provide the best organic search traffic. There are many SEO tools that help in increasing such traffics for the SaaS business.
Introduce New Marketing Channels
When it comes to introducing new marketing channels, make sure to have a sufficient amount of investment. A better investment will yield a fruitful result. However, if you invest very little, then there is no point in investing at all. For example, you can take your best organic ranking and move it to a different channel like YouTube.
Upsells are upgrades that SaaS companies do in order to not only retain the customers but also provide them with extra benefits. The added services are good for customers who are interested, and in return, the company gets more earning. However, you need to make sure that the cost of providing that service is considered and factored in when coming up with a final price that the customer is going to pay.
In order to make your software run faster, you need to ensure regular checkups. This will reduce infrastructure costs and also point out the bad codes which are making the software slower. Just the removal of bad codes in the software will make a significant difference in terms of speed. Moreover, you can also hire a professional Business Consultant for continuous strategy planning and tracking.
SaaS has many advantages, and the business model it carries helps many organizations in moving towards profitability. You need to think out of the box and aim for more than monthly subscriptions. You can create multiple revenue streams that will provide you with higher profitability. Due to its high scalability, SaaS is extremely flexible in providing you the options you need in order to grow your SaaS business. You can ultimately accelerate your company’s growth if you create loyal customers and relationships that last longer.