Looking into the SaaS Business Model

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While SaaS has been around for a while, it seems that this branch of cloud computing is only becoming more and more popular. With a market that’s expected to grow to 145 Billion in USD by 2022, it’s worth paying attention to this increasingly viable model for organizations. But first, what is SaaS?

SaaS (Software-as-a-Service) is a cloud computing model that delivers software on a subscription basis. The vendors own and maintain the software, servers and databases while the customers pay a periodic fee to access the application. SaaS offers greater flexibility and savings to clients, since they aren’t responsible for the installation or maintenance of software or hardware needed to run the application, like in traditional software delivery models.

Why SaaS?

The model offers significant benefits in terms of its revenue structure and ability to scale quickly. Some of these include:

  • Consistent long-term revenue: Since SaaS usually works on a subscription basis, SaaS companies can lock in revenue for longer periods, such as yearly or multi-year subscriptions. This offers a certain amount of dependability in terms of revenue streams. If the customers like the software being offered, they’re likely to continue its use and can potentially become a source of revenue in the long-term.
  • Customer interaction and relationships: With SaaS, you are constantly providing a service, unlike a situation where a customer purchases a product and leaves. This means that communication with customers is much more frequent, allowing one to build a relationship with their clients. It also allows a company to better track their customers behavior and needs, through engagement and service complaints.
  • Flexible pricing models: Since SaaS models are built on subscriptions, there is lots of flexibility in terms of pricing. A company can offer free access for certain features or various levels of premium subscriptions. This allows the company to reach a greater customer base, since they can tailor their subscription to the needs of smaller and larger businesses. There’s also an ability to build on additional features and generate expansion revenue.

Some Challenges

Along with the benefits, there are significant challenges to implementing the SaaS business model:

  • Significant competition: SaaS has become an incredibly popular business model in the tech industry. This means there are various competitors, no matter what kind of service you’re offering. Competitors also tend to be tech savvy and innovative, making it more difficult to gain a competitive advantage.
  • Slow startup process: When starting a SaaS company, one of the biggest road blocks is acquiring the first few customers. Without having the product reviewed and vetted by other customers, it becomes difficult to convince clients to start paying for your product/service (especially when there are other well-known alternatives).
  • Quick pace/long-term commitment: While having long-term customers is a strong pro for the SaaS model, it also means there has to be an extreme focus on customer retention. Customer service needs to be exceptional, and in order to keep people interested, a company has to constantly be marketing to their customer base and coming up with new features for them to use. This generates a very high-paced, intense environment for development teams.

Measuring Success

SaaS is unique in that it’s heavily focused on data. There are various metrics that a company must keep track of to measure its performance. Let’s look at a few of these.

  • ARR/MRR: This stands for annual/monthly recurring revenue. This is measured by the consistent revenue generated by customers for that period and the expansion revenue. It’s also important to consider the net ARR which is ARR minus losses from churned customers.
  • ARPU: Annual revenue per user: Tells us how much revenue we’re earning for each active customer.
  • Churn: Rate that people will stop using the product or service.
  • Conversion Rate: this is the percent of people who become paying customers, whether from signing up online or through a sales person.
  • CAC: Cost to acquire a customer. Includes all sales and marketing expenses used to acquire the customer.
  • LTV: Lifetime value of a customer. Represents the total dollar amount you’re expected to receive from a customer over the length of time they will use the software. Should ideally be 3X CAC for a sustainable model.

Monitoring these metrics will give you a key indication of the company’s current health and future.

Best Practices

As with any other business model, there are best practices a company can follow to increase their chances of success. These include:

  • A focus on customer retention: The goal in a SaaS company is to achieve negative churn which means that the revenue from expansion is greater than the loss in customers. Churn can be prevented by identifying customers who are at risk before they’re ready to cancel. One measure for this is customer engagement (for example, how many times has the customer logged in? Which features are they using?). Tracking engagement becomes critical for identifying at-risk clients.
  • Development of expansion revenue: Expansion revenue allows a company to move beyond the traditional subscription revenue, and build stronger relationships with current customers. There are a few categories in which a SaaS company can generate additional revenue, such as developing additional features or charging for additional users, downloads or storage. A company should think about what aspects of their product add the most value for their customers, and build expansion revenue based off of this analysis.
  • Robust customer onboarding and education: In the subscription business in general, a customer is significantly less likely to renew their product if they don’t properly know how to use it or make the most of it. This is where the initial training and education comes in. If subscribers are aware of all the features and how they can best be applied to their unique business, they will reap the most value and be more likely to stay.
  • Strong communication: Constantly marketing, communicating and addressing complaints becomes increasingly important in a SaaS company. Not only is communication important when a customer is already gained, but also in the sales process. It’s important to set expectations about what the software can and cannot do so the client doesn’t feel like they aren’t getting their money’s worth.

Whether you’re starting your own company, or simply delving into the arena of cloud computing, it’s clear that the SaaS model isn’t going away any time soon. It’s worth it to take note of how this model has reshaped the tech industry and understanding its key drivers.










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Sarah Wright

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