How the SaaS Business Model Works

saas business model

The SaaS business model has become very attractive in recent years for a number of different reasons. 

It is mostly operated through a cloud, which means that the costs to start are minimal in comparison to other business models, while the potential to quickly grow your company is high. 

If you are thinking about starting your own SaaS company, consider both the benefits and drawbacks to see if this business model fits your vision and aspirations. 

In this article, we will cover the basics of the SaaS business model: what it is, what makes it so special, as well as the benefits, the drawbacks, and the stages that SaaS companies go through in their development. 

Jump to Section

What Is a SaaS Company?
What Makes the SaaS Business Model Special?
SaaS Business Model Benefits
SaaS Business Model Drawbacks
The Stages SaaS Companies Go Through

What Is a SaaS Company? 

SaaS stands for Software as a Service. It is a business model in which companies provide a cloud-based software solution that the users access from anywhere via the Internet. 

Customers usually have to pay a monthly or annual subscription fee to access the application, but everything else falls on the shoulders of the SaaS company: feature upgrades, security, customer support, and general service maintenance. 

There are many types of SaaS companies, but they generally fall into two categories: B2B and B2C. 

B2B companies provide services and software for other businesses, from organizational to financial tools. Great examples include Slack, Google Cloud, and Zoom. 

On the other hand, B2C companies focus on the people who use their services for personal use. Some of them are Dropbox, Adobe, and Canva. 

Often, SaaS companies are able to cater to both personal and business users with their software, thanks to their different package levels. 

What Makes the SaaS Business Model Special?

SaaS is a completely new type of business model that is changing the way companies work. Below are listed some of the main points in which it stands out. 

Recurring Revenue

Traditional business models usually rely on one-time purchases and attracting as many new customers as possible. 

SaaS companies, on the other hand, are more concerned with recurring revenue. Why?

Recurring revenue is different because it’s more reliable

Once you gain a certain number of customers, they continue to pay their subscription for an indefinite time, thus ensuring fairly regular income. 

There are different types of recurring revenues. 

The most important ones to track for SaaS are MRR (Monthly Recurring Revenue) and ARR (Annual Recurring Revenue). 

 Product

These two metrics help you maintain consistency better and track trends over time. 

MRR is more frequently used to determine a company’s profitability, but both metrics are important for SaaS business models. 

SaaS businesses that offer yearly subscriptions are more likely to use ARR than MRR, but both are important benchmarks to track recurring revenue. 

With either one, it’s easy to predict your company’s future cash flow and budget accordingly for further investment in your business. 

Focus On Customer Retention, Not Acquisition

Keeping customers you already have is essential to SaaS. 

There’s a reason they say selling products to existing customers is cheaper than acquiring new ones. 

According to some statistics, it costs 5 to 25 times more to attract a new customer than to retain a current one.

That applies to SaaS businesses even more. User retention is the top priority for anyone who aspires to start a SaaS business. 

Your product should be an integral part of your customers’ lives so that they continue paying their subscriptions—but leaving it at that and hoping for the best is not a solution. 

Customer retention starts from onboarding. Even if you managed to attract a new customer, with difficult onboarding you’re likely to lose them quickly. 

Retention should be even more important than acquisition. 

Loyal and active users keep a constant stream of revenue that can help your business grow, so you should strive to make them happy from the very beginning and avoid churn. 

Also, users provide helpful feedback on your software that enables you to pinpoint their needs so you can keep up with the competition. 

What is more, satisfied existing customers can be used as a reference to encourage other companies to use your product. 

Data Driven Decision-Making

Having a good grasp of a company’s metrics is important, no matter which business model you follow. 

However, it is particularly important for SaaS because they need to keep customer behavior in check, especially because of the ability to quickly grow the user base. 

Depending on the type of SaaS you are, you’ll have to keep track of different metrics, but the most important ones of them are:

  • ARPU: annual revenue per user, which means how much revenue you’re getting per each customer
  • MRR: monthly recurring revenue
  • Churn: how many people stop using your product
  • Conversion rate: how many people turn from free trials to paying customers 

With these metrics, you can easily see whether your marketing strategies are working, as well as predict which customers are more likely to convert, or which of them have the highest lifetime value. 

Detailed information about your customers will help you make better decisions on how to improve certain aspects of the product. 

The goal is to effectively analyze your revenue funnel and make sure that every invested dollar is helping your business grow further. 

More importantly, data will ensure that your company is stable and growing in a predictable way. 

SaaS Business Model Benefits

Running an up-and-coming business can be stressful, but there are certain benefits in the Saas business model that appeal to many. 

Predictable Revenue

Successful SaaS companies boast a relatively steady monthly and annual income. For the most part, they’re not dependent on seasonality, trends and one-time niche ideas. 

Committed users are the foundation of their success, as acquiring a subscription means that you can easily predict your monthly and annual revenue for a long time to come. 

As customers have to renew their plans to use the service, you can map out your future according to the number of subscription renewals. 

For example, if you’ve been getting 20 new paying users each month, then you can easily predict your growth trajectory for the next six months. 

Even a small degree of predictability will help you make informed business decisions and strengthen your position in the business world. 

It can help you understand the changing market, strategize, and adapt to it.

Ability to Reach Users With Different Budgets

Another great benefit to the SaaS model is that it’s able to provide value to a lot of users with different needs and budgets. 

They are not inventing a new product for every tier of customer, but limit the usability of their product for different price ranges.

SaaS companies can offer a wide variety of pricing tiers for their product in which you get more features for a heftier price, yet the basic functions are available for a more favorable price—or even for free, like we see from the Monday.com example below. 

 monday.com

Most SaaS products offer a free trial to attract potential customers with great product features so that they later convert into paying users. 

It is a strategic move that helps the company in several different ways. 

They can see which features are more attractive and useful for their customers, but also get a better idea of what the users are willing to pay for. 

In addition, there are those customers (e.g., enterprise accounts) who require more extensive product customization. With different pricing tiers, SaaS businesses can appeal to their needs as well. 

Overall, the ability to reach users with different budgets with a single product allows SaaS companies great flexibility and market adaptability. 

That way, they can target different demographics at the same time, and expand their market.

Scalability

The biggest pull of SaaS is scalability. 

There are a lot of success stories of companies that have grown overnight. That success doesn’t happen to everyone—but there is a great potential for any SaaS business to scale. 

Nevertheless, scalability doesn’t refer only to growth; it’s also about flexibility and versatility

 Business model

For example, it also means being able to recover from unexpected crashes and having cost-effective methods of doing business. 

One of those methods is the remote hiring process. 

As digital businesses, SaaS companies can recruit top talent from anywhere, without being bothered with the same expenses like traditional businesses. 

It is important to have a clear view of your current user situation, as well as your marketing and sales plans to see how much you can scale. 

Just thinking about scaling your business should help you determine next milestones and risks which in turn further help you optimize your product. 

All of this prepares you for the growth of your company with improved efficiency and consistency. You will certainly become a formidable competitor. 

SaaS Business Model Drawbacks 

As with any business model, there are some risks and drawbacks involved in SaaS that many aren’t prepared for. 

Let’s take a look at a few of them. 

Strong Competition

When people see a new and profitable business model, they always want to jump on it. The same is happening with SaaS. 

It’s an easy business model to follow and almost anyone with a bit of funding and an app idea can start a SaaS company. 

However, there are also a lot of competitors who look at successful products, sales strategies, marketing campaigns and pricing structures, and try to copy the approach. 

With SaaS companies, everything is on the web, so it’s not too difficult to gain access to that kind of information. 

Moreover, other factors are also contributing to this increase in the number of new SaaS companies. 

For instance, there is a lot of available early funding for startups and many SaaS employees go on to start their own companies in the same industry.

Therefore, with so many businesses offering similar services at competing prices, it’s difficult to find your unique selling proposition and gain new customers.

This is especially true if those customers are used to one type of service. 

Additionally, it’s easy to lose existing customers if you’re not constantly developing according to their needs and one-upping your competition in the process. 

Customers have the luxury of choice. In those circumstances, increasing value for their money is the biggest challenge SaaS companies face. 

Security 

SaaS companies are more vulnerable than others to frequent cloud breaches and data loss. 

One of the top concerns for customers using the product is whether or not the personal data they’ve trusted you with is stored safely. Once that trust is lost, it can never be gained again. 

Therefore, as your business grows along with the number of customers you service, it becomes increasingly important to have sensitive user data protected. 

At Regpack, we pay a lot of attention to data security, and here is an excerpt from our security page.

 Line

Spending on security is expected to rise up to $3.1 billion worldwide in 2021, but security solutions have never been more neglected. 

Data breaches in some high-profile SaaS companies have resulted in user data being sold on the dark web. 

In fact, 2019 was one of the worst years for breach activity, with over 4 billion records exposed. 

In 2020, there were fewer breaches than the year before, but the overall number of exposed records increased, with usernames being the most exposed type of data. 

Data can be stolen from companies of any size, but the bigger players garner more attention. 

However, that doesn’t mean you shouldn’t neglect your customers’ security. If left unchecked, these breaches can destroy your company and your reputation. 

If you lose their trust, users are quick to leave—thus impacting your revenue. 

The Stages SaaS Companies Go Through

If you plan on starting your own SaaS company, you should understand the different stages your business will go through. 

The Pre-Startup Stage

This is the first stage of any SaaS business. 

In it, you are looking at a specific problem and trying to find a solution for it.

You need to figure out if your plan will work out—and you can do that by assessing the market, talking to advisors, researching and reading. 

At this stage, you are still exploring your options and opportunities. 

This is also where you create your business plan.

Other activities that happen at this stage include seeking financial backup, talking to potential customers, and networking. 

Many SaaS businesses fail at this stage. 

Some notable risks include a lack of funds for initial infrastructure and development costs, or neglecting to align their business plan with scalability.

Therefore, make sure to keep in mind all of those factors as you map out your future.

The Startup Stage 

In the startup stage, you have a finished product. With the product completed, you can be on your way to find your first paying customers. 

For some time, you might experience very slow growth or even negative cash flow, but don’t be discouraged.

This is the stage where you’re making a name for yourself

Therefore, you need to establish the value of your service. 

Never forget that your product and recognisability will likely change as you learn more about your customers and the market. 

Focusing on scaling too much in this phase is counterproductive. Instead, it is more important to refine your product and start monitoring metrics and analytics

If you fail to do that, you can expect higher user churn because you failed to identify your ideal target audience and overspent on new customer acquisition. 

The Growth Stage

Anyone who starts a SaaS company usually sets their sights on jumping to this stage early on. 

It is the most exciting stage to be in because that’s when your business is really coming into its own and expanding.

Here, you can expect increased traffic and conversions

The awkward beginner stages are behind you, and you have a better grasp of your sales and marketing. As a result, you can predict your growth with more ease and certainty. 

Nevertheless, you should not neglect to monitor your user metrics even this late in the process. 

 Online advertising

Your main focus at this stage will be reshaping an existing product, improving conversion rates, and acquiring new customers. 

Now is the time to be particularly mindful of new competitors that might steal or copy your ideas. 

Also, keep track of your funds to handle the costs of growth. 

At this stage, you are practically on the cusp of greatness, so you cannot afford any missteps—financial or strategic.

The Maturity Stage

This is the stage you have been working towards. 

You have proven to everyone that your product has value, and now you can branch out with new products and services.

Here, the company can now test new plans of action

 At this point, a lot of companies also think about their exit strategies, whether to be bought by another company or by raising capital as a publicly traded company through an IPO. 

Growth might be slower here, but that doesn’t mean it should grind to a halt entirely. 

Your existing customers are a well of valuable information that can help you solve any issues with your product, particularly now that they are more familiar with it. 

At this stage, your main focus should be looking for acquisition opportunities, investing in experiments, and global growth

One of the biggest mistakes you can make as an established SaaS company is losing your relevance.

This can happen if you neglect to improve your existing products with new and improved features, or ignore the needs of the market.

Therefore, make sure never to neglect those aspects of your business efforts.

Overall, the development of a SaaS company is an exciting path, and if you take all the necessary steps in each stage, you will reach maturity much faster.

Conclusion 

Starting a new business can be stressful but knowing what to expect is enormously valuable in making any important decision. 

SaaS business model is appealing, with its predictable recurring revenue and scalability. 

Even the strong competition inherent to the business model should not be a problem for those with well-thought-out and unique business plans. 

Now that you’ve learned more about the different stages SaaS companies go through, it will be easier to determine whether the risks (especially security concerns) outweigh the chances of being the next big thing in the software business. 

You will be in a better position to make the right decisions for your business.

In any case, one should never forget the importance of building a loyal customer base and focus on retaining them for the foreseeable future to ensure the aspiring revenue and growth. 

About The Author
Asaf Darash
CEO and founder of Regpack

Asaf, Founder and CEO of Regpack, has extensive experience as an entrepreneur and investor. Asaf has built 3 successful companies to date, all with an exit plan or that have stayed in profitability and are still functional. Asaf specializes in product development for the web, team building and in bringing a company from concept to an actualized unit that is profitable.

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