How Does the SaaS Business Model Work?
Essentially, the SaaS business model is based on the concept of software being housed on a cloud infrastructure (and therefore accessible through a web browser), with companies paying a monthly subscription to get access to this software. The SaaS model is becoming more popular among organizations. To make a SaaS product valuable, it is generally necessary to have a substantial level of technical expertise coupled with substantial amounts of user interface design abilities.
SaaS companies, in general, are among the most complicated business models we have covered in our series of explainers.
The most significant distinction between SaaS firms and software companies is that SaaS is hosted in the cloud rather than on-premises. Essentially, this eliminates the need for an end-user license to activate the program and the requirement for any infrastructure to host the software. Instead, the SaaS business is responsible for hosting its membership. The client has to log into their account in order to get access to everything.
SaaS is in High Demand
As you can see, this is a service that is very appealing to customers. Many small business owners who do not want to invest large sums of money in building out their information technology infrastructure opt for a SaaS solution, and that SaaS solution often becomes extremely important to their operations.
For example, sales teams that use Salesforce or customer service departments that use Zendesk. SaaS businesses remove this risk from the customer who utilizes the service for their company and typically pay a modest monthly membership fee in exchange for the service.
Even though there are many methods for a SaaS company to generate revenue, the recurring membership fee is usually the most important source of income for a SaaS business. Annual and monthly recurring income is the most common type of recurrent revenue established (ARR or MRR). This membership fee allows the client base to have access to the products and capabilities of the software that the company provides.
3 Stages of a SaaS Company’s Lifecycle
There are three primary stages that any SaaS company will go through throughout its development. Most people understand the Startup period, and then everyone dreams of the Stable Golden Goose phase when the money is just starting to flow. Hypergrowth is one of the stages that are seldom discussed, despite being one of the most stressful times for cloud Software solutions during which they either succeed or fail.
Let us have a look at the three phases:
- Getting everything up and running, developing a functional product, and putting it “on the market” to gain your first few clients are all part of the startup process.
- When a market responds well to your product, you will almost certainly see an enormous amount of growth very soon as companies embrace your software. While this sounds fantastic, it will always result in you spending more money since you will need to grow in terms of data storage, bandwidth quickly, and other technicalities to serve the newly gained clients.
Remember how clients of SaaS solutions frequently like the product because it relieves them of the responsibility of setting up an IT infrastructure for their company? They do not have to build one because your SaaS product provides the backend for them as part of their membership in your company.
- The Stable Golden Goose – This is the point at which your SaaS company has reached a stable state. You are beginning to make a respectable profit and gaining new clients quickly will not strain your infrastructure the way it would during the hyper-growth period. You will also get acquainted with the term “churn,” which we shall discuss in more detail later.
A large number of SaaS products are very excellent, but the inability to handle hypergrowth problems may lead many firms to fail. In the Growth Strategies part of this explainer post, we will discuss various strategies for mitigating this risk to a certain extent.
The Advantages of the Software-as-a-Service Business Model
The beauty of the SaaS business model is that your consumers may develop a strong emotional attachment to your product. This is particularly true if your SaaS solution represents something critical to their respective companies, as described before. As a result, they are often accepted as “members” of your mysterious organization.
Examples include Zendesk, which sells software that assists companies in developing a successful customer support strategy. However, since Zendesk is so critical to a company’s success and essential to that business process, the firm is unlikely to abandon Zendesk entirely in favor of new and better ticketing software, although the new and improved solution may be superior.
This devotion may result in client retention that will continue for years and years, contributing to the growing recurrent revenue that makes SaaS businesses so lucrative.
This is the second significant advantage of using a SaaS approach. Because of this, every client is technically just renting your software every month rather than purchasing it fully as part of a one-time transaction.
That implies that you will earn a small amount of money from that client every month. A regular income stream is typically the goal of people who become engaged with internet companies, and the SaaS business model is built on the concept of repeating income.
Cons of the Software-as-a-Service Model
The ability to generate recurring revenue is very appealing, yet the tremendous amount of money required to get your SaaS company up and running is not nearly as appealing.
It is necessary to make several initial expenditures, such as employing qualified engineers and programmers, as well as UI designers, who will combine their talents to make your product as user-friendly and efficient as possible from the outset.
Once you have gotten a product off the ground and have a small number of customers who have shown the model’s worth, you will almost certainly have to reinvest all of your earnings — as well as more money — in order to grow the company. When your company proliferates, you will need to extend your data capabilities, security, and storage and have your staff on standby to handle maintenance and deal with any unexpected problems that may arise during this period of rapid expansion.
Another disadvantage of SaaS, apart from the fact that it is a capital-expensive business model, is that it is not always a straightforward offering. While the concept is straightforward to comprehend, managing the actual product efficiently may be challenging, even for those familiar with the underlying code.
Selling a SaaS product may be more challenging since you deal with a more limited pool of potential business customers than you would be dealing with, for example, someone interested in starting an Amazon FBA or lead gen company.
