What Is a SAAS Business Model and How Does It Work

SaaS market is becoming saturated fast. Most of the organizations operate their operations using SaaS services or applications, and the statistical number is more than 51% in late 2019. To get the incredible offers from SaaS and succeed in it, you need to know at least some basics about this business model.

Software as a service (SaaS) is comparatively a new business model which literary could not exist without the internet. In our modern era of the internet, many business models have formed, and SaaS is one of them and has become very popular nowadays. In this article, you are going to learn about the SaaS business model and its working method.

What is SaaS?

SaaS – Software as a Service is a distribution model or a platform where software is provided online by a third-party provider. The software or applications are hosted on a cloud server, and the customer can find those available for them over the internet. Users then pay the rent and can use the software or the application for a specific time period. 

However, SaaS is a combination of cloud computing, infrastructure as a service (IaaS) and platform as a service (PaaS). So, before learning details on the SaaS Business model, you need to know about these terms as well.

Cloud Computing: Cloud computing is a computing service over the internet (the cloud) delivers any hosted service. With the cloud infrastructure which can be opened through a web browser, people can run workloads remotely in a commercial provider’s data Centre (also known as “public cloud”).

Infrastructure as a Service (IaaS): This is a service that provides virtualized computing data or resources on an outsourced basis to deliver any enterprise maneuvers. In general, IaaS provides storage, servers, hardware, and network components. It is also known as hardware as a Service (HaaS).

Platform as a Service (PaaS): This is a platform from where developers can rent anything and the things they need to build their software or application. PaaS makes it easy in the process of application development (from the developer perspective) as all the backend management procedures happen behind the scenes.

SaaS Business Model – How it Works

SaaS business probably has the most complex business model comparing the software or IT service companies’ business model. The main difference between a software company and SaaS business is that SaaS is cloud-based. It repudiates the need to activate any software or any infrastructure to host the software by end-user license. Instead, you need a membership and log in to your account to have full operating access. 

SaaS business model run by some specific performance indicators. They are :

CAC: This means “customer acquiring cost”. In short, CAC is the total cost of gaining/converting one customer. Total cost is measured by marketing cost + outsourcing cost = other costs.

LTV: LTV stands for lifetime value. It indicates the total revenue earned from one consumer. It is measured by dividing the total revenue earned by the number of customers in a specific time period.

ARR: Annual Recurring Revenue (ARR) indicates the amount of revenue you expect to repeat. It does not include one-time revenue. It only includes the recurring earnings. However, the traditional financial reports have no concept of recurring revenue as it only displays revenue for a past period. But because of ARR, SaaS companies can start each financial year having the idea of what their revenues are going to be for that year. And this is called Starting ARRn.

MRR: This stands for Monthly Recurring Revenue. It is important to have an idea about how well are the consumers retained in the business. It is measured by multiplying net customers each month by the subscription fee.

Churn: This one indicates the customers who have not renewed their subscription and the revenue loss. It is measured by multiplying the total customers left each month by the subscription fee.

However, there are three main stages that every SaaS business goes through. To become successful in SaaS Business, you need to have a proper understanding of three of them. These are:

1. Startup: Startup includes starting and programming a working product and makes everything going well. It also includes “going to market” with the product/service to get your first few consumers.
2. Hypergrowth: If the market and the consumers like your product, there will be an immense amount of growth very quickly. However, this cost you more money as well. Because to cope up and to increase the growth, you need to expand your data, bandwidth, storage, and all sort of technicalities to support your newly attained consumers. This is the stage where you have to be cautious about how the customers love your SaaS products, and how more you need to grow your infrastructure and backend support through their membership terms.
3. Stable Golden Goose: You will get into this phase when your SaaS business has leveled out. Now, you have a reputation in the market and a vast customer base at your SaaS infrastructure. But do not forget to keep things running smooth and always upgrade your product and support. Otherwise, your level can be dropped, and you’ll lose your stable golden goose.

As SaaS is a subscription-based model, it takes time to earn the revenue and cover up all the expenses. The expenses of the SaaS business model generally includes: 

• Marketing & Sales Costs
• COGS: outsourcing costs, server costs, etc.
• R&D: Research & Development Costs
• Administrative and other Costs

You may now ask why the SaaS products/services come in free, basic, pro, & enterprise editions? We’ve got an answer for you:

The financial period of the SaaS business model goes through into three parts:  Acquisition, Retention, Monetization. 

Companies get the users by offering them freemium services, and once they have started using their services or products and become habituated, other services are offered then at a basic periodic price. And this leads to retention and monetization.

Key Strategies to Make Your SaaS Business Model Successful

Here are the 3 key strategies for SaaS companies in short :

1. Increase the Users Value

It’s a basic thing for all companies that they have to focus on the growth of their user base. You have to continuously develop your product and service to satisfy the current consumers and acquire new customers. You will also have to establish a valuable, meaningful good relationship with your customers and be mindful to increase their value and to retain them over time to minimize churn. 

2. Analyze Data in the Modern Economy

The traditional financial statement cannot provide future estimated values or cannot give the idea of what should be the next steps. But SaaS Business needs such values, with that you can have the idea about maximizing recurring revenue.

Sometimes you need the data of MRR, ARR, and sometimes QRR – Quarterly Recurring Revenue. You will also need the growth efficiency ratio to see how much new recurring revenue the company is earning with your current investment in sales and marketing. So, analyze data with the new/modern economy or the equations is important to be successful in the SaaS business.

3. Enhance Customer Relationship

Traditional ERPs or finance systems are not built to support the subscription-based business model. To make a thriving SaaS business, you need an infrastructure that helps you to enhance customer relationships, can change the pricing and packaging quickly to keep up with the market needs. You need a system that is also flexible, scalable, and smart enough to calculate recurring revenue, churn, and forward-looking metrics. And all these will optimize the customer relationship pretty well. 

That’s all for today. We hope you have understood the SaaS business model, and this guide might help you if you are thinking about starting a SaaS business.