The Saas Business Model: Everything You Need To KnowBy Los Silva
Despite being a relatively new type of business model that has come about with the rise of the internet, 80% of businesses are already using at least one Saas application. Saas is a unique business model, totally different to a traditional buy/ sell model, as it is completely online and dependent on the internet. It is still growing and changing rapidly and may require special interests or skills meaning it is not for everyone.
If you have ever wondered about what a Saas business model is, or have considered starting up or acquiring a Saas site, but are not quite sure how they work, read on where we explain all about one of the more complicated, but also intriguing, online business models.
So what actually is Saas?
Saas stands for Software as a Service. Instead of a traditional business that sells goods in exchange for a one-off payment, Saas exchanges use of a particular software in exchange for an ongoing subscription fee. Oh, and it’s all online, so there are no physical goods to manufacture, store or transport.
The software is hosted in the cloud, so you can forget about end user licenses to download the software or complex infrastructure to host the software. Instead, customers will pay a membership fee, allowing them to login to an account where they can fully access the software product and features directly online. While the Saas business owner sells the membership and access to this.
We’re talking Slack, Salesforce and Dropbox. Individuals or businesses will sign up to software-based solutions that they will need to use during an ongoing period of time. These services could be organizing teams at work, colleague cross-office communication, file transfers and many other things.
The Stages of setting up a Saas business model
Ok so we have established what Saas is. But how does one go about beginning a Saas business, and what are the stages involved?
- Set up – Firstly, you need to actually create the software for your Saas business. This might involve outsourcing developers and programmers to design the software and hiring UI designers to make the product user friendly, or perhaps even coding the software yourself. Either way, key step number one is coming up with a service that will provide a solution to people’s problems, and actually works.
- Hypergrowth – With a Saas business, there will always be that awkward growth spurt phase, that is if your product has success once it hits the market. Once people start showing an interest, you will usually go through a stage of exponential growth, while new customers sign up. This can be a tricky and expensive time, as scaling the business up to support all the new customers may involve expanding data capacity, storage, and other technical details. This is also a period where you will need to iron out any problems with the software that might emerge in this phase.
- Stability – If you make it through the difficult growing pains of hypergrowth, the business should eventually plateau and reach a steady level of new custom. As well as this, you should reach a point where the infrastructure is all set up and so you can now take on as many new customers as you need with ease. It is at this point you should start to see the fruits of your return, although you will also start to notice a churn rate, referring to the number of people that unsubscribe from the service and drop off.
Examples of Saas businesses
Slack started in just 2013 and has quickly become one of the fastest-growing B2B Saas companies. It has over 3 million paying users, increasing its value from $0 to $5 billion in only 4 years. Slack is an office chat tool, allowing for easy collaboration and communication in the workplace. They have nailed their user and integration-friendly interface, helping maintain their 30% conversion rate.
Salesforce is one of the first Saas companies created in 1999. It was one of the first companies to release cloud-based software products that were available immediately online. Salesforce is a Customer Relationship Management (CRM) product, where companies can centralize data and manage all stages of the sales process easily. The product is easy to use, collaborate on remotely, and with easy updates as the user business grows.
Dropbox was the fastest Saas company to reach $1 billion in revenue. It is a remote file storage and sharing cloud site. As the company allows you to define your file structure, as well as edit and sync to devices, there is an Infrastructure as a service element too (Iaas). Dropbox regularly updates and offers new extensions to create an easier user experience in conjunction with third party apps to keep the customer base happy.
Pros and Cons of Saas
So we know what Saas is and how it works. Let’s recap some of the pros and cons of running your own Saas business.
- Recurring custom – As the Saas model is a subscription it means you will get recurring customers, and therefore recurring income, each month.
- Loyalty from Customers – The customers that use your service are likely to integrate it into their own business and come to rely on it. Therefore, even if other similar, or even improved, software options become available, invested customers will be unlikely to abandon ship.
- You can update and refine the product constantly, to keep customers engaged.
- Start-up costs are large – As well as the costs of creating your software which could involve hiring developers and coders and UI designers. You are then likely to need to continue investing money through the growth phase to increase the capacity, capabilities, and security of the software to support larger numbers of customers.
- The Hypergrowth phase – this can be a difficult phase and many solid products will still struggle to overcome the costs and obstacles. Be prepared to reinvest any profits at this stage to expand data capabilities etc and resolve any issues with the software. You may need to hire a team to handle the maintenance of the business.
- A Saas business can be more difficult to maintain than other business models as either you need to understand the programming and coding behind the software or you need to hire a team of people to be able to run it for you.
- It can be more difficult to sell a Saas business as again, it may have more niche buyers who can understand the business or are willing to take it on. Finding a broker with experience in the SaaS industry can make things easier.
Terms to know
So we briefly touched on the churn rate above. But what exactly is it and how do you calculate it? The churn rate refers to the percentage of customers that cancel and drop out of the service over a period of time. It is important to know the churn rate, as a measure of how healthy the business is and how well it is going. You can calculate it in the following way: Number of churned customers per month divided by number of remaining customers. Read our guide on SaaS churn rate for more info.
LTV (Customer Lifetime Value)
This refers to the total amount of money you will receive from one customer in their lifetime of using your product. It is useful as a measure of how the business is doing, as well as accurately predicting revenue and profit. You also can use it to make sure your customer is spending more in their lifetime than the cost you spent acquiring them (Customer Acquisition Cost). Calculating the LTV is a little complicated, but here’s a quick overview.
Take your average purchase value, multiply it by the average purchase frequency rate to determine customer value. Then, once you have calculated the average lifespan of a customer, multiply that with the customer value. That is your LTV.
CAC (Customer Acquisition Cost)
As mentioned above, the CAC refers to the cost of acquiring a customer. It is best to measure this against the LTV, a healthy business aiming for an average at least a 3, meaning every dollar you pay in would result in $3 out.
Expanding a Saas business
So, if you overcome all the obstacles and reach a stable point with your Saas business, what next? Time to grow and expand! Here are a few ideas on how to grow your Saas business:
- Offer a free trial
- Offer higher-end packages to existing customers with extra benefits
- Upgrade the software to make it faster, easier to use, or add new features
- Increase organic traffic by SEO optimizing, creating content, or diversifying your marketing channels
- Add an affiliate marketing program
So there you have the Saas business model explained. A slightly more complex business model than some, but if you have the right skills or interests it can be an extremely profitable one. It also has many benefits such as long-term, recurring income, and if big enough, it is a business model that can be run by a team. Is it a good match for you? Check out our SaaS listings here to find out.
Also Read: How Saas Company Valuations Work?