By 2024, the global Software as a Service (SaaS) market is expected to grow by 21.4%, reaching a market size of $185.8 billion. With the European market predicted to increase by 18.8% in the same time period.
Research has also found that 85% of small business owners plan to invest more into SaaS solutions by 2020, and that on average, businesses are already using between 25 and 100 SaaS applications.It’s no surprise that the SaaS sector is growing. Used by organisations large and small, SaaS companies offer innovative, indispensable services with easy-to-use interfaces that slot seamlessly into business operations.
And, not only that, they are a low-risk, cost-effective model for customers who pay a monthly subscription to rent the service. They can cancel at any time, decrease or upgrade their package and enjoy more flexibility than owning the software outright.
Paying for SaaS applications that are accessed via the internet avoids the significant investment involved in developing software in-house, hosting it on servers and maintaining IT infrastructure. Many businesses simply can’t afford to pay for developers to create a bespoke piece of software for their business. However, most do have the budget to cover a small monthly fee for a state-of-the-art SaaS service that does the job perfectly anyway.
In this article, we’ll analyse just how SaaS businesses work, the different stages they go through from launch to stability and the key elements of success.
The SaaS Business Model
The SaaS business model works by offering customers the use of software that can be accessed via the internet and paid for by subscription.
The customer doesn’t need to worry about purchasing licenses or training staff to be able to manage the software internally. Customers can also be assured that they won’t have an expensive piece of unused software sat on their server – if a customer no longer needs a SaaS application, they can simply cancel their subscription.
The SaaS business model has proved successful for a number of business functions, including:
- Customer relationship management
- Supply chain management
- Business intelligence
- Enterprise resource planning
- Web conferencing
- Content management system
- Enterprise asset management
- Business process management
And the end user includes companies in sectors such as:
- Banking, Financial Services and Insurance
- Oil and Gas
- Professional Services
However, the business strategy for a SaaS company differs to that of a business selling one-off goods and services. SaaS organisations must create innovative software that fosters lasting customer relationships.
The aim is for customers to sign up for the long term, consistently paying their subscription fee month after month, year after year.
Successful SaaS Business Model Examples
A hugely successful SaaS business model example is Google.
Google offers a number of products beyond traditional search and advertising. Google Drive is a cloud-based document storage system. It also has a range of Google Apps, such as Gmail, shared calendars and video meetings.
Microsoft is another shining SaaS business model example. Its Microsoft Office 365 has staples including Word, Excel and PowerPoint alongside email and video conferencing all hosted in the cloud. This allows users to collaborate and connect in real time.
Other well-known SaaS organisations include:
- Mailchimp – email marketing, ads, landing pages, and CRM tools
- Zoom – video conferencing, webinars, screen sharing
- Slack – workplace instant messaging
- HubSpot - marketing, sales, and service software
- Salesforce – sales and customer relationship management
- Shopify – ecommerce platform
- Dropbox – file hosting and cloud storage
The joy of the subscription model used by SaaS companies is that of recurring income.
Customers are renting the software and paying monthly which means excellent ongoing income potential rather than a one-off payment. Customers often simply set up a Direct Debit for their use of the software and it’s collected reliably and safely each month and deposited in the business’ bank account.
With guaranteed recurring income, cashflow is flowing rather than stalling and attention can be focused on business growth opportunities. Being able to predict forward-looking revenue – the amount of revenue expected to repeat – enables smoother operations, better forecasting and fewer financial worries.
However, glitches do occur when a customer cancels their subscription mid-month and a refund is due, or downgrades their package to a cheaper option. So, it’s not all smooth sailing. But the subscription economy is fast becoming the norm, and SaaS organisations are thriving on this kind of business model.
Upfront Investment and Continual Reinvestment
Many entrepreneurs who have set up a SaaS company are now reaping the rewards of recurring revenue.
However, SaaS companies require a significant upfront investment to get the software and infrastructure up and running.
This includes hiring technical staff to develop, program and code the software, managing data storage and security, owning all intellectual property and developing stand-out branding.
The founder might be a software developer who led the charge in designing and developing the software, however it’s likely they needed to invest in hardware and marketing expertise to get the business off the ground.
And, because a SaaS company is developing a partnership with customers, any profits they make will need to be continually reinvested into maintaining and evolving the software. For example, by tweaking the user interface to make it as easy and attractive to use as possible or adding functionality that customers have requested.
If a SaaS company doesn’t continually delight its customers, they’ll cancel their subscriptions or switch to a competitor that does offer that additional feature.
Three Stages to Success
There are three stages in the success of a SaaS company, each needing to be carefully managed.
- Start-up – first step is to program a workable product, test it, launch it and acquire the first customers.
- Explosive growth – if the SaaS application is a winner and the target audience loves it, then there’ll be a huge number of subscription sign ups as people adopt the application. This scale phase can be tricky to manage as the business rushes to scale up bandwidth, hardware, data storage capability or hire new developers to cope with any problems with the software that arise. The business might need to invest in a customer service team to react quickly to any issues flagged by newly acquired customers to keep them happy and on board.
- Stable business – at this stage a SaaS business has reached a consistent level of customer growth. They’re enjoying a healthy profit and reinvesting it to improve their offering rather than behind-the-scenes operations as needed in stage two. Customer churn becomes more of a focus at this stage as customers start to unsubscribe.
Excellent customer service is critical for a SaaS company. Ideally, a SaaS application becomes embedded in a customer’s business and they find they can’t imagine operating without it. The application has improved efficiency, accuracy, staff happiness, and their own customer service.
Customers then become very loyal to the SaaS business – but only if they are treated well. The SaaS subscription business model is a long term, committed relationship that needs constant attention and nurturing. It’s not a one-off, casual transaction; it’s an ongoing partnership.
SaaS entrepreneurs have a completely different mindset to a one-off software sales person. They’re open to continual feedback, evolving customer needs, regular upgrades, speedy fixes to issues, and pricing discounts or bundles.
A willingness to invest a lot of time at the start of the relationship is also necessary. In depth training of a new customer on how to get the most from the application will improve their user experience from the outset. And if they are using the application to its full potential and improving their business operations, then they’ll stick around for longer – and potentially recommend the application to their peers too.
Running a SaaS business involves setting up some robust processes and systems from the outset. Developing software without any clear plan or goals soon becomes an unproductive mess. And if one lead developer moves on and no one understands what they were working on or where to find it, then the business could be in trouble.
Setting up clear processes and systems enables a business to scale rapidly as well as onboard new staff quickly and identify roadblocks or potential issues before they arise.
It’s also important for an SaaS business to understand its churn rate, customer lifetime value (LTV) and cost acquisition per customer (CAC), especially when the business has reached the stable phase and, inevitably, some customers start to leave.
To increase profitability, and keep recurring income stable for as long as possible, a SaaS business’ aim should be to increase LTV and decrease churn rate and CAC. The very best SaaS companies keep monthly revenue churn at around 0.58%, which is about 7% revenue churn per year.
SaaS leadership teams are always looking for growth opportunities. These could include new marketing channels, finding ways to boost organic SEO, continually improving the product, or bringing out new iterations or add-ons.
SaaS company pricing strategy is crucial to get right. Business’ must consider the price that attracts long term customers and brings in revenue.
Undercharging for the application could bankrupt a SaaS business, overcharge and the customer won’t feel they are getting value for money and soon unsubscribe.
There are a number of ways that SaaS companies are charging customers for their subscription, these are:
- Flat rate pricing – charging a single fee for a single product with a single set of features, usually paid monthly, or with a discount if paid annually.
- Pay as you go pricing – a customer is charged based on their actual usage of the application that month. If one month they use more, they get charged more, and if one month they use less, they get charged less.
- Tiered pricing – packages with differing features so a customer can opt for the one they want depending on budget and features. Usually three options with a low, middle and high price point.
- Per user pricing – charging by the number of users who are signed up to access the application, no matter if they use it or not.
- Per active user pricing – only charging for the actual number of active users, no matter how many users are signed up.
- Per feature pricing – packages that are charged by the number of features they include.
- Freemium – offering a ‘free forever’ basic package, often as part of a tiered strategy to get customers using the service with the intention to migrate them onto a paid package.
Additional Revenue Streams
As well as selling a subscription to a SaaS application, there are opportunities for additional revenue streams that can help boost profits.
These can include:
- Upselling new products or feature add-ons to existing customers
- Adding more benefits for additional cost e.g. storage, speed, data, users, downloads etc
- Charging for new versions rather than automatic upgrades
- Setting up an affiliate program for others to sell the application
- Charging for application program interfaces (API) that integrate the SaaS application with other software
- White labelling the product, or a version of it, for another to sell on under their name
- Selling advertising space on the application
- Charging for additional reporting
- Charging for additional customer service or training
SaaS Business Model Success
SaaS businesses successfully operate on a subscription-based model, offering customers easy and affordable access to secure, scalable and invaluable software that can be accessed easily via the internet.
These applications help them run their businesses – and lives – more efficiently. As such, they are firmly embedded in business operations and many customers remain loyal for a lifetime.
Customers pay a monthly fee and this guaranteed recurring income enables businesses to forecast effectively and invest into business growth activities. However, an initial investment upfront is required to design and develop the software, then to test it and purchase all the IT infrastructure required to run it.
The market for SaaS applications is only set to skyrocket in coming years as more applications are developed to address evolving business and consumer wants and needs.