As a founder, you want to give your software startup the best possible chance to succeed in a highly competitive market. An important consideration you’ll face is which business model you should choose.
The SaaS business model has truly exploded in recent years. Why is it so lucrative and popular, though?
Let’s check out some of the top benefits of the SaaS business model and why tech startup founders frequently choose it.
Right off the bat, the SaaS business model requires a much lower initial investment than other types of businesses.
Whereas starting a retail business costs $32,000 on average, you can get a SaaS product on the market for as low as $15,000.
Therefore, starting a SaaS business requires little physical inventory besides your laptop. You also don’t need much office space—your bedroom will suffice.
Additionally, if you need to hire new employees, they can work remotely and save you the cash you’d pay for rent, office equipment, and utilities.
Also, a cloud-based SaaS product doesn’t require manufacturing, packaging, storage space, or shipping. You can deploy and distribute your SaaS product at a much faster pace than traditional software that requires hard drives and on-premise installation.
Since those costs are eliminated from the start, let’s look at what you need to budget for when starting your SaaS business.
First, there is the issue of who gets to make the software.
You can develop the SaaS product yourself, or you can hire freelancers or employ a software development agency. An agency is somewhat more costly. However, opting for one alleviates some quality, execution, and reliability concerns.
You will also need to decide whether your SaaS product will be a tool or a platform.
A SaaS tool costs less to develop as it’s a more simple product. You can stack new functionalities and features as you go. Developing a SaaS tool application can range from $15-$100,000.
On the other hand, a platform encompasses multiple functions and tools that need to interact and function simultaneously. Building a platform can cost between $50 to 250k.
Another point to consider is whether your SaaS product will be primarily used on desktop or mobile. Mobile development incurs higher costs in terms of development and UX/UI design—and these can cost anywhere from half to double the price of your desktop version.
Ultimately, the price will depend on the scope of your SaaS product and your target audience. However, it’s best to keep things simple until you start seeing revenue and can afford to invest in new versions.
To calculate the total cost of your SaaS product, here are some factors to count in:
- Ongoing expenses like phone/Internet
- Hosting for the SaaS website or app; a cloud provider; CDN
- Supporting software: communication, accounting, CRM
- Ongoing development, support, and maintenance
- Staff payroll
- APIs and integration licenses
- Compliance/legal fees
By choosing the SaaS business model for your startup, you can get an MVP out quickly with lower setup costs and start generating revenue faster.
The recurring revenue model greatly contributes to the profitability of SaaS businesses.
SaaS businesses generally operate on a subscription-based model, offering their product for a recurring monthly or yearly fee.
This ensures a regular and predictable income stream, as opposed to one-off license purchases in traditional software businesses.
A steady stream of cash is essential to keep your business afloat and make more accurate plans for the future, but it also entails several other benefits.
Let’s go over them.
First, financial stability and regular income are attractive to investors. If you can demonstrate good MRR, your SaaS business valuation could increase by up to 8 times.
Recurring revenue and an established customer base mean fewer risks for investors and high scalability potential, which we’ll cover later on in the article.
Furthermore, recurring revenue creates more business stability. You know your team’s paychecks will be covered. This contributes to a more innovative and motivated team.
Your clients benefit from this focus on stability, too. Since you have a recurring income, you don’t have to frantically pursue new customers, and instead, focus on retaining existing ones through better service and support.
Moreover, getting a regular monthly bill simplifies users’ budgeting and accounting. Customers don’t need to fear they’ll lose the service overnight thanks to your automated billing system, timely reminders, and renewals.
Lastly, with a stable overview of the received payments over a specific period, you can adjust your plans more closely to your customers’ needs.
Your sales team can upsell a higher-tier plan if they notice a client is paying for extra services on top of their existing package every month.
Conversely, if they estimate that a client is paying for more than they use, and thus pose a high churn risk, offering a more limited plan means keeping the client in some capacity rather than seeing them leave.
A steady and predictable income enables you to run a healthy business and keep your staff motivated and efficient. You are therefore better equipped to improve your offerings.
As a result, better products and customer care keep your churn rates in check and drive down acquisition costs, leaving you with more money to invest back into the business.
Knowing precisely how much money you’ll receive each month is an advantage few business types offer. Therefore, recurring revenue is one of the strongest reasons to choose the SaaS business model for your business venture.
We’ve already mentioned the high scalability potential of the SaaS business model.
But what exactly does it mean when we say that your SaaS product and the SaaS business model are scalable?
Let’s first discuss what scalability means in terms of software.
Customers can expand the number of features they use, or cut down on them, depending on their unique needs. They can choose plans based on usage, the number of users, or a combination of features.
Small and large businesses alike can use the same product, whereas traditional software was often out of budget for the smaller companies.
In that sense, scalability signifies the flexibility and adaptability of the software to the end-user. This is made possible through its cloud-based nature, allowing for frequent modifications and their rapid deployment.
Now let’s see how this flexibility translates to your business.
In the early days of your startup, you are focused on the product-market fit and securing a steady customer base. Once your business revenue starts growing, it’s time to look for new ways to acquire customers and scale-up.
There are many ways to scale your SaaS product. You can add an enterprise-level plan to attract bigger clients with larger budgets. Below is an example of how pricing tiers scale-up in SaaS products.
Although such B2B transactions might come with a longer sales cycle, it still doesn’t compare to hefty budgets, and long approval processes companies underwent to acquire new software before.
Also, instead of targeting a few high-paying industries, you can optimize your SaaS product to solve pain points across several industries.
Another option is to expand globally to new markets since there are no physical boundaries to where you can deliver your SaaS.
As your product grows, you can add functionalities that will become attractive to some new audiences. You can make your SaaS integrate with other solutions, and reach industries you can’t fully serve on your own.
To support new acquisition efforts, SaaS businesses will likely invest more in marketing and advertising and build sales departments. New employees will be a prerequisite to support all these new users, and you’ll likely need to invest in infrastructure as well.
However, all your customers use a service you’ve already created once. With the right infrastructure, you can add hundreds or thousands of users without new production costs or logistics.
And the more customers pay for the service, the more of your operational costs are covered, so you can reallocate resources into scaling your business further.
Customer retention is the lifeblood of SaaS businesses. It’s only logical; maintaining good relationships with existing, regularly paying customers ensures a steady income.
For some business models, acquisition will take precedence over retention. A retailer needs to consistently sell many items to make a profit, yet one customer might not need to buy the same item ever again. Naturally, retailers are more focused on acquiring new customers.
On the other hand, SaaS businesses sell the same product repeatedly to the same customer, with no additional production costs involved.
For perspective, the average retention rate for retail starts from around 30%, whereas an enterprise-targeted SaaS should see around 85% gross retention and a SaaS for SMB around 75%.
However, because they rely on a subscription model, SaaS businesses are benchmarked by their Net Revenue Retention Rate, showing how much recurring revenue they incur from retained users. The current benchmark is around or slightly below 100%.
In time, as the customer makes recurring payments or upgrades their plan, their lifetime value increases, boosting profitability for the SaaS business. According to industry statistics, retaining 5% more B2B customers increases profits by up to 95%.
Not only that, but the same loyal customer can make up for revenue loss caused by churned users.
This is called “negative churn” in the SaaS industry, which is why some companies show a retention rate that considerably exceeds 100%.
But what makes the SaaS business model so conducive to customer loyalty and retention?
The core of a SaaS product is solving a problem or providing a benefit.
If your SaaS product does that for your customer, it becomes an indispensable part of their lives.
Although there might be similar, cheaper, or even better products on the market, it’s time and labor-intensive for the customer to test them out and transfer all their data. Therefore, they’ll stick to a tried and tested product they already own rather than switching to a competing business.
The convenience of the cloud also makes it easy for the customer to keep using the product and consistently gain value out of it. You can quickly update the service, solve any potential glitches, and regularly provide patches and security updates.
The product-market fit plays a huge role here as well. While developing your SaaS product, you focus on a specific niche or pain point, identify a gap in the market, and create something stunning to fill that gap.
If your ideal customer feels like the product was tailor-made for them, there’s a higher chance of them sticking around.
Lastly, SaaS businesses boast higher retention rates because they eliminate friction early on.
SaaS products often come with free trials and well-thought-out onboarding processes. Training and tutorials are available to make sure customers succeed with the product and don’t leave frustrated because they don’t see its potential.
Below is a glimpse of the onboarding process from Recruitee—a software solution for employee recruitment and onboarding.
Moreover, having the option to try out a product risk-free with no long-term commitment vets out potential high-churn risk users who would have left you quickly anyway.
Given the high costs of acquiring a new customer—five to ten times more than retaining an existing user—SaaS businesses invest more into good onboarding and retention strategies to ensure customers stay.
For the SaaS business model, retention generates a greater return on investment than focusing solely on acquisition. This makes the SaaS business model a highly profitable and lucrative one.
The SaaS business model is profitable for you as the founder, but your customers extract a lot of value from it too.
Not so long ago, purchasing software meant buying a CD or DVD and installing it on your computer, usually with some assistance from an IT professional.
Often, it was not possible to try the product beforehand, and you could only use it on the computer you installed it on (assuming the tech could support the software in the first place).
This was followed by a lengthy setup and training, combined with a constant risk of difficulties of integrating it with other legacy software. If you needed to update the program, it meant purchasing a new physical driver once or twice a year.
And if you found out there were features you didn’t need or some you’d have wished for that currently weren’t available, there was not much you could do—at least not without significant financial losses or additional investments.
Also, have we mentioned the high risk of a computer crashing and taking all your software and data with it?
All this causes significantly more trouble in a business setting than it would to a private user. Companies need to make the new software useful as soon as possible to prevent losing money on long purchase approvals, investment in new technology, training, and IT support.
SaaS products eliminated many of these problems for the end-user. They can be purchased and used in minutes on any device or operating system with internet access.
Since they don’t take up storage space, they don’t interfere with other systems, either, yet they integrate well with other SaaS tools.
New features, updates, and patches are rolled out frequently and users have minimal to no maintenance to take care of.
SaaS vendors can solve glitches and provide support remotely, thanks to access to usage logs and crash reports. Fixes are deployed rapidly and automatically, so there’s barely any downtime.
And in case of a device crashing, all data is still saved in the cloud.
SaaS products are user-friendly also because they come with various customization options. With a cloud-based SaaS solution, customers can easily switch to a plan better suited to their needs.
On top of convenience, we have to mention that implementing and using a SaaS solution is generally more budget-friendly. SaaS applications cost companies 77% less than on-premise software in terms of fast implementation and purchase price.
So, why is user convenience so important?
Well, this convenience and flexibility of a product drive tremendous shifts in how company software is procured.
According to a Softwareadvice’s survey, in 2008, 88% of companies preferred on-premise deployment. By 2014, that trend was turned upside down, and 87% of companies preferred cloud-based deployment.
Going forward, experts predict that public spending on SaaS products and cloud-based services will grow from $229 billion in 2019 to over $500 billion by 2023.
That’s a significant market for SaaS founders to carve out a successful business path.
Finally, another advantage of a SaaS business model is that you can easily measure the impact and performance of your business at any stage.
SaaS users purchase your product online and use it online too. SaaS businesses, therefore, manage a wealth of data, which they can analyze to improve their offerings.
More importantly, the recurring revenue model is highly predictable, which is an advantage transactional business models don’t have. Your ability to analyze the right data shows not just how much profit you made, but also how it came to be and how you can replicate that success.
To measure the financial success of your SaaS, you need to keep a close eye on the following metrics:
- Recurring revenue
- Churn and retention rate
- Upsell rate
- Acquisition cost
Your monthly recurring revenue (MRR) shows how much revenue you generate in a month.
Coupled with annual recurring revenue (ARR), which shows the amount of revenue you’ve generated over a year from recurring monthly billings, you can get a broader picture of your business health and growth over an extended period.
Tracking these metrics enables you to create more accurate short-term and long-term financial projections, and see how stable your business is.
Of course, not all customers stay for a year, or even a month. That’s where the churn metric comes in.
Losing one customer who pays for your most expensive plan is more critical than losing 2 or 3 customers on the lowest plan. For healthy financial growth, you need to track how much revenue you lose (revenue churn).
Losing individual customers (customer churn) is also an important metric that ties in with how well your business does overall.
You can get some churn signals by tracking what features your customers use, how often they use them, and at what times. You can even detect what users did prior to canceling the service.
This way, you can work on possible friction points. Not only may it help you prevent the problem from occurring again, but it will also ensure a better experience for other users, effectively boosting your retention rate.
The data can tell you how you acquire new customers and what the acquisition cost is.
For example, you can trace back to where you acquired your highest-paying clients. Did they complete a free trial? If so, how many of them converted to paying clients?
If they started with a more basic plan, but you see that one login is used on devices in different places, could you upsell the user to a plan that supports more users?
Last but not least, you can measure how many users sign in from mobile devices and work on optimizing the interface for a mobile version of your software.
Using these insights to your advantage will require some fine-tuning for your specific product, but the good news is that you have the data readily available. With the right KPIs, you can connect certain customer behavior to the success of your SaaS business.
You can’t improve what you can’t measure—but you can measure a lot in your SaaS business. Use it strategically to drive your business growth.
Choosing the SaaS business model for your startup is a wise decision: even a giant like Adobe switched to the cloud in 2012 once they realized the benefits.
Starting a SaaS business doesn’t require a lot of resources in terms of either space or cash. You can start distributing your product in no time.
The SaaS subscription model and recurring revenue make for great financial predictability. With the right metrics, you can make accurate and viable plans to scale your business.
Customers increasingly turn to SaaS products to simplify their lives and jobs. Take advantage of these benefits and grab a piece of that market share for your business!