Software-as-a-service is cloud-based software that businesses license on a subscription basis. It takes traditional on-site data collection, storage, and software applications and makes them available anywhere in the world. This takes the burden of purchasing and maintaining expensive equipment and on-premises software away from companies. SaaS products offer up-to-date solutions at a much lower cost to businesses. Companies who specialize in these products are the mainstay of our technological landscape. We have come to know and rely on giants like Salesforce, Zoom, and Slack.
The SaaS Business Model
The core of the SaaS business model is the subscription payment method. Customers pay to utilize cloud-based software that a company maintains. The SaaS business handles all of the security and data storage. Many subscription options can be used, from a flat monthly fee, a fee per user, or a tiered fee schedule based on the number of functions of the software that the customer uses.
Due to the platform’s flexibility, SaaS businesses can often update their products, allowing customers to have access to the latest technologies and solutions. The SaaS business follows a three-stage model that we are going to explain in greater detail.
Stages of a SaaS Business Model
Any SaaS business will go through the early stage, growth stage, and mature stage. Each phase entails different levels of necessary funding to thrive. A company will be focused on creating a product-market fit and securing an early, loyal customer base in the early stage. These startups will be operating on a tight budget with a small, dedicated team.
The next stage is growth, where the business will be working to scale quickly. Ideally, the SaaS business will utilize various tactics to obtain the development necessary to stabilize their business and reach maturity. They will begin to take more risks, seek out more significant markets, and push the limits of their product’s success. It is all about establishing a track record and creating metrics to track successes in order to continue growth. This is when a business can try marketing strategies like working with social media influencers and gathering customer testimonials on their product. At this point, they will be seeking angel investors or venture capital in order to initiate fast growth.
Once a SaaS business hits the mature stage once it has a proven track record of success. The company has a loyal audience that is hungry for its product offerings. The business focus will shift from customer acquisition to customer retention. This is also the time to fine-tune the offerings. Engage in objectives such as current price assessment and adjustment, additional or updating of product features, and brand building.
Through every stage of a business’s life cycle, funding has to be kept in constant consideration. Without proper capital funnels, even the best SaaS business can find themselves faltering. The lifecycle of the funding stages usually looks like this:
#1 Seed Funding
This is the earliest stage of funding. With no track record to prove a business’ validity, gaining outside funding is difficult. As a result, most startups rely on personal funds, borrowing from family or friends, or even business credit cards.
#2 Series A Funding
Series A funding is available once the company is first officially founded. After that, stock options are first sold to the company’s founders, angel investors, and those close to them. It is also the time for investors who firmly believe in a company can purchase stock with the hope of them growing exponentially in value.
#3 Series B+ Funding
When a business has launched and has a proven track record, a proven business model with successful operating procedures will allow Series B funding where the company’s stock because available and attractive to a larger market.
Important SaaS Business Model Metrics
Once a business has reached the stage of seeking and securing funding, success in the capital acquisition will depend on being able to verify vital business data. Investors must have access to the information that defines the health and validity of a business. This information is also crucial to the daily operations and planning of the business owners. Healthy record keeping and processing of data metrics will allow a business to constantly assess how their company is performing overall.
#1 Monthly Recurring Revenue
Monthly Recurring Revenue (MRR) is the amount of money your business is expected to bring in every month. This is the functional metric by which your company’s success will be measured. Growth in your MMR equates to the development of your business. In contrast, lowering the MMR means your business is shrinking. Therefore, a shrinking MMR needs to be addressed swiftly to stop further losses.
#2 Customer Acquisition Cost
Tracking how much it costs your company to acquire a new customer is a good indicator of how your business is operating. This includes the amount of time it takes sales reps and marketing dollars spent. If it costs more to acquire a customer than the customer will bring in MRR, then the health and longevity of the business can be compromised.
#3 Lifetime Value
Considered to be the most viable metric, the Lifetime Value (LTV) is the average customer revenue multiplied by the gross margin divided by customer churn rate. Churn rate equals loss. This is the number of customers who cancel their subscriptions. Churn can also refer to revenue churn. Some amount of loss is expected in small and medium businesses—less than 10% annually or 3% to 5% of the monthly portfolio. Larger businesses strive for a churn rate of 1% or less.
#4 Customer Retention
This metric tracks how long a customer is retained within the subscription model. This can be assessed at a monthly or yearly rate. Retaining customers can lead to growth. For example, Up-selling and contract expansion can leave a company showing less churn rate even though some customers are lost.
Successful SaaS Business Model Examples
A staggering 93% of SaaS startups fail within the first year. Issues like product-market fit, cash flow issues, or experiencing more churn than growth all contribute to this number. Looking at successful SaaS ventures can be a helpful way to understand the business model. Businesses like Slack and Zoom have adapted the ‘Freemium” model. By allowing users and teams to access their product for free, they build a loyal following. Users switch to a subscription to access premium portions like additional storage and unlimited meeting times and seat numbers
Pros and Cons of the SaaS Business Model
With any business venture, there are pros and cons to consider. Some of the pros are the rapid growth potential, ease of deployment, and predictable income. Being cloud-based, the model is open to a large customer pool. Being on the cloud also means updating or changing the software is more manageable than with traditional software. Subscriptions will ensure that a company has a steady income to rely on.
There are a few downsides that need to be considered as well. The SaaS market is relatively saturated. Also, the upfront costs are higher. If you are not able to gain traction quickly, securing additional funding may be tricky. This creates a higher risk for the business owner. The amount of churn in the industry also must be taken into account. As markets shift, business priorities change, and competition increases, a company must stay relevant to not lose customers. This can cause revenue loss and leave the business on slippery ground.
In Conclusion
While the market for SaaS applications may be full, there is still room for growth. Gaps in existing product offerings and existing needs within microniches leave plenty of room for startup SaaS businesses. The SaaS business model has proved time and again to be a successful venture when appropriately managed.
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