The Software as a Service (SaaS) business model has gained significant traction in recent years.
And it’s no surprise as the business model streamlines operations, lowers costs, and has huge potential for scaling up.
But what does the SaaS business model involve, exactly?
In this article, we’ll explore the SaaS business model in detail, including the different ways to compose one (with examples) and its pros and cons.
We’ll then delve into key metrics that every SaaS business should track to measure success.
Further Reading
- Discover everything about Revenue Churn (+ 4 effective ways to crush churn and boost profitability).
- Find why PQLs are better than MQLs for your SaaS business.
- Want to exceed your previous quarterly profits? Start tracking your Average Revenue per User (ARPU).
This Article Contains
- What is a SaaS Business Model?
- Types of SaaS Business Models
- 5 Examples of Successful SaaS Companies & Their Business Models
- 5 Considerable Advantages of the SaaS Business Model
- 4 Main Disadvantages of the SaaS Business Model
- 8 Crucial SaaS Metrics to Track
- 4 Key SaaS Business Model FAQs
What Is a SaaS Business Model?
The SaaS (software-as-a-service) business model entails leasing cloud-hosted software to customers, often with subscription plans.
The business model is characterized by customers making recurring payments to rent the software, rather than buying the software with a one-off payment. In return, users can typically expect frequent updates to the software’s features.
Here’s where it gets interesting:
A SaaS founder can create a custom business model to suit their product offerings. Each SaaS company can choose how they want to price, deploy, and earn revenue from their products.
Let’s look into the different aspects that would make up your custom SaaS model.
Types of SaaS Business Models
To develop your SaaS business model, you need to consider four main factors:
- How you price it
- How you deploy it
- How you sell it
- How you make revenue
Below, we’ll explore which types of models you can choose from for each of these factors.
1. Pricing Models
You can choose from several possible pricing structures, such as:
- Freemium: You offer a free version of your software, typically with some limitations (e.g., available features, seats, storage.) Customers who find value in the freemium version may upgrade to a paid plan with fewer limitations.
- Flat fee: Customers pay a set monthly or yearly price to access an unlimited version of the SaaS application.
- Tiered pricing: You offer several pricing plans for customers to choose between based on which features they need.
- Pricing per user: You charge a monthly or yearly fee for each user or active user in a team. For example, if a customer has a team of six using your product, they’d be charged for six users
- Pricing by usage: You charge users based on their usage. For example, you could limit pricing plans in terms of credits, transactions, storage, etc.
- Hybrid pricing: You combine two or more pricing models. For example, you can use freemium and per-user pricing simultaneously by offering your product free for up to three users and charging for each additional user.
2. Deployment Models
Cloud computing relieves customers of having to store app data locally, so most SaaS software is hosted on the cloud and accessed remotely via the internet.
However, you can also offer the following deployment types:
- On-premises: While it sounds counter-intuitive, some SaaS companies do offer on-premises deployment. This means the SaaS provider must manage all the setup, infrastructure, and maintenance the customer needs to host the app on-site. On-premises deployment is usually only beneficial for large enterprises.
- Hybrid: You can offer a cloud-based service for some customers and on-premises deployment for businesses that need it.
3. Sales Models
Another thing to consider is your sales approach – how you plan to get users to convert into paying customers. There are three main ways to do this:
- Marketing-led: Your marketing is your primary mechanism of attracting and converting customers.
- Sales-led: This model uses marketing to get a potential customer interested. Sales representatives then step in to interact with each potential customer one-on-one.
- Product-led: The product-led growth (PLG) model focuses on getting people to use your product, through a demo, free trial or freemium version. You then implement a customer success strategy that helps users discover your product’s value, which leads them to the paid plan. So, your product drives your conversion rate without much sales input.
- Hybrid: You can also use these strategies in combination. For example, you can attract users to try your product with a free trial. Then, once they have reached the activation point (value discovery), your sales team can approach them to encourage them to upgrade.
4. Revenue Models
There are numerous ways for SaaS companies to generate a revenue stream from their product, such as:
- Subscriptions: You charge users a recurring fee to use your product.
- Add-ons: You offer optional add-ons (e.g., extra features, expanded customer support) and add the cost to subscription fees.
- Advertising: Instead of charging customers to use your product, you can sell ad space on your product.
- Affiliate links: Alternatively, you can have other companies pay you to include affiliate links that generate traffic for them.
- Channel sales: If your product is quite niche, you may need to channel your sales through a third party. For example, if your product is a page builder for Shopify, you could channel sales through the Shopify app store.
- Physical products: Some SaaS companies sell physical products related to their software. For example, a time-tracking software company might sell a physical time tracking device.
To put all this into perspective, let’s look at a few examples of successful SaaS businesses and the components that make up their business models.
5 Examples of Successful SaaS Companies & Their Business Models
Below you can see how these five successful SaaS companies created business models that work for them:
1. Zoom
Tool type: Video conferencing tool.
Business model:
- They use a hybrid pricing model. They offer a freemium version that anyone can use for 40 minute meetings, but offer tiered per-user pricing plans for professionals and companies who frequently need longer meetings.
- They use a hybrid deployment model. They mainly offer a cloud service, but can also provide on-premises deployment.
- They use a product-led sales model. They offer a free entry point, allowing people to experience a limited version of their video conferencing software. Its ease-of-use and easy access skyrocketed their growth during the pandemic.
- Their SaaS revenue model is mostly based on subscriptions, but also includes add-ons and physical products in the form of hardware solutions designed to improve audio and video for small to larger conference rooms.
2. Slack
Tool type: B2B messaging app.
Business model:
- Slack has a hybrid pricing model. They offer an extensive freemium version with messaging, 1:1 audio and video calling, and a 90-day message history. They then offer tiered per active user pricing for companies who require features like multi-person audio and video calls, unlimited message history, secure guest collaboration, and more.
- They work on a cloud-only deployment model.
- Slack’s sales model is also mainly product-led. The free version of the app is highly effective at showing users the value of the product as well as the value of upgrading. Additionally, Slack’s extensive user base makes the app more attractive to B2B customers, so they require little marketing and sales effort.
- Their revenue model is mainly based around subscriptions, although they do offer one paid add-on – Slack Enterprise Key Management, which allows enterprise customers to encrypt messages and files.
3. Dropbox
Tool type: Cloud storage SaaS solution.
Business model:
- Dropbox has a hybrid pricing model with a freemium plan that offers up to 2GB of storage for one user. They offer tiered per-user plans, which are also usage-based. Users can upgrade if they need more seats, more storage, higher transfer limits, and better data security.
- They offer only cloud deployment.
- Their sales model is mainly product-led as the free version is very popular, but strategically limited to encourage users to upgrade.
- Their SaaS revenue model exclusively relies on subscriptions.
4. HubSpot Sales Hub
Tool type: Sales CRM (customer relationship management) tool
Business model:
- HubSpot uses a hybrid pricing model. Users can access a heavily-limited free version with features like 1:1 emailing and one personal meeting link. Their paid plans have a tiered per-user structure for companies who want to commit to using the sales CRM in the company workflow.
- Their deployment model is exclusively cloud-based.
- They use a hybrid sales model. HubSpot has seen unprecedented success with marketing-led growth via their extensive content marketing efforts. However, they also utilize sales tactics to drive conversion.
- Their revenue model is mainly subscription based. However, they also offer six paid add-ons which expand limits on things like prospect lists, number of teams, your API call volume, etc.
5. Basecamp
Tool type: Project management tool
Business model:
- Basecamp has a hybrid pricing model, although they do not offer a free plan. Instead, they have a simple two-plan tiered system. One plan includes per-user pricing, while the other offers a flat fee for unlimited users. Both plans include all features, but the unlimited plan offers some extra storage, priority customer support, and annual billing.
- Their deployment model is cloud only.
- They use a hybrid sales model, combining mainly marketing and sales growth strategies. However, they also spotlight their product with a 30-day free trial that allows users to experience all the product’s features.
- Basecamp has a subscriptions-only revenue model.
Clearly, SaaS can work brilliantly as a business model. Let’s explore some of its benefits.
5 Considerable Advantages of the SaaS Business Model
Here are five ways SaaS can benefit your company:
1. Retention and Recurring Revenue
When you create a SaaS product vital to customers’ workflows, your users can become extremely loyal to your product.
This can lead to years of consecutive customer retention and a constant supply of monthly recurring revenue rather than a once-off profit.
Check out how you can use your recurring revenue to calculate the Magic Number for your business.
2. Scalability and Agility
Cloud computing lets you quickly roll out changes to your SaaS software so you can efficiently pivot to keep up with new trends and demands.
Therefore, SaaS allows for far more agility than the traditional software model and makes it easier to scale up or down your offering as needed.
3. Global Market Access
Since SaaS products are generally hosted on the cloud, customers can access them globally without issue. This broadens your market potential.
Furthermore, SaaS products with low entry barriers (e.g., affordable pricing plans) may appeal to users in emerging markets.
4. Virality
Word-of-mouth marketing is another knock-on effect of customer loyalty. When an existing customer finds value in your product, they’re more likely to spread the word in their networks.
This can lead to a virality effect where the popularity of your product becomes a key driver of acquisition and conversion. Think of products like Zoom and Spotify, where it becomes beneficial to use the product because your network is using it.
5. Anytime, Anywhere Accessibility
SaaS products can be used wherever there’s an internet connection and allow for collaborative workflows.
This is particularly advantageous for B2B tools because you can appeal to companies that work both in-office and remote.
However, you should be aware of some downsides of the SaaS model.
4 Main Disadvantages of the SaaS Business Model
Here are the main challenges you may face in the SaaS industry:
1. Large Capital Investment
There are a lot of up-front costs associated with launching a SaaS product, such as:
- Hiring developers and UI designers
- Purchasing the software licenses
- Training, onboarding, and paying employees
- Paying legal fees
- Complying with data protection regulations
- Protecting your intellectual property
- Paying business insurance
- Renting and maintaining office space
What’s more, your SaaS company isn’t likely to be profitable immediately. You’ll have to reinvest most of your early SaaS revenue back into the business. It’ll take a while to recoup your initial expenses.
2. High Stakes for Retention vs Customer Churn
As mentioned, customer loyalty and recurring revenue are massive benefits of SaaS. However, it also means that customer retention is a make-it-or-break-it metric for SaaS companies;
You’ll need an aggressive strategy and excellent customer service to manage your churn rate. If you struggle with customer churn, it‘ll be hard to maintain a consistent revenue stream from your existing customer base.
Additionally, customer churn will harm your customer lifetime value (CLV).
3. High Complexity
Creating and maintaining SaaS software can be very complicated. You need an extremely knowledgeable team to:
- Develop an app that works and looks good.
- Set up robust security protocols and keep them updated.
- Craft a pricing system and reliably collect payments.
4. Tough Competition
SaaS is a booming industry with new players constantly entering the space. Therefore, the competition is fierce. Even if you have a unique idea, it’s easy for other companies to piggyback on them and establish themselves as competitors.
As a SaaS business owner, you must have your finger on the market’s pulse to avoid falling behind and losing (or never gaining) customers.
So, how do you stay on top of factors like retention, customer success, and average revenue?
Let’s look at some SaaS metrics you can track to evaluate the success of your SaaS platform.
8 Crucial SaaS Metrics to Track
Here are the most important metrics a SaaS founder should track to measure growth:
- Customer acquisition cost (CAC): The total cost a company incurs to acquire a new customer.
- Customer Lifetime Value (CLV) or Lifetime Value (LTV): The total value a customer brings over the course of the customer relationship.
- Monthly recurring revenue and annual recurring revenue (MRR & ARR): The amount of predictable revenue a company generates monthly or yearly from recurring payments (subscriptions).
- Customer churn rate: The percentage of customers who stop using a company’s product or service during a given period.
- Customer retention rate: The percentage of customers a company keeps over a certain period.
- Conversion rate: The percentage of potential customers who take a desired action, like signing up or becoming paying customers.
- Activation rate: The percentage of new users who discover the product’s value (based on a milestone action).
- Customer engagement score (CES): A measure of customer engagement or satisfaction with your product and customer service, often based on surveys or feedback tools.
Finally, let’s explore the answers to some frequent queries about SaaS business models.
4 Key SaaS Business Model FAQs
Below, we’ll answer five common questions relating to SaaS business models:
1. What Are the Stages of a SaaS Business?
A SaaS startup will typically experience the following three phases of growth:
- Early-stage SaaS startup: You’re pre-profitability and working on customer acquisition. You have a small team and are seeking seed funding.
- Rapid growth: You’re generating SaaS revenue and possibly producing profit. Your customer base, team, and expenses are growing. You continue seeking investment capital to scale.
- Stability/ maturity: You’re profitable and have a steadily growing audience of loyal customers. Investment opportunities are aimed at acquisitions and expansion to new markets.
2. Is a SaaS Business Model Right for You?
You may be a good fit for the SaaS industry if:
- You have a good idea for a product and a market to target.
- You’re prepared to deep-dive into understanding development and how to optimize growth metrics.
- You’re money savvy and understand how to turn a software company into a profitable investment.
3. When Can You Expect Profitability in a SaaS Business Model?
It could take up to 24 months or longer to achieve profitability for your SaaS application.
In this time, you’ll have to fine-tune your product, find its place in the market, and grow your customer base.
However, there are ways to speed up the journey to profitability. For example, you can improve your early cash flow by targeting high-value customers and incentivizing them to pay up-front for a multi-year contract.
You can also prioritize spending your investment capital on hiring the right people to carry out exceptional marketing, sales, and product management processes out the gate.
4. Does SaaS Always Mean Subscription-Based?
The subscription model is a prevalent SaaS approach. That’s because it’s essentially a system of leasing or “renting” to customers for a recurring fee.
However, a SaaS business owner needn’t stick to the subscription model.
For example, they could offer a perpetual license, charge by usage, or provide the software for free and charge for customizations.
Successful Scaling with a Suitable SaaS Business Model
The SaaS business model has revolutionized the software industry, offering amazing benefits from greater profits to enhanced agility.
However, SaaS also has its unique challenges that companies must be aware of, such as high up-front investments, competition, and complexity.
The value you can gain from SaaS depends on how you construct your business model to fit your product and the market.
No matter how you choose to approach SaaS, there’s one thing every company needs — customers.
If you need help with customer acquisition, Startup Voyager has the solution. We can help you achieve exponential organic traffic growth through well-optimized blog content, so you don’t have to rely on costly paid advertising.
Ready to see your SaaS platform succeed?
Contact Startup Voyager today to get your SaaS solution in the spotlight and on page one.