Whether you already have a SaaS product or are considering building one, you need to study SaaS business models as much as possible. It’s a rapidly changing industry and what was once taken for granted just a couple years ago (that SaaS companies make revenue from selling subscriptions) is now not the whole story.
SaaS companies can also increase revenue by selling services or charging extra for premium onboarding and ongoing support.
Yes, subscription-based revenue still forms the backbone of most SaaS business models, but there’s still much to learn about the pricing strategy for subscriptions as well as additional, creative ways to add revenue.
In this post, learn the pros and cons of SaaS businesses, as well as how to optimize your revenue streams.
SaaS business model explained
The SaaS business model means selling a cloud-based software (typically accessed via web app or mobile app, but also sometimes via a desktop app) at a monthly or annual subscription fee.
SaaS—which stands for software as a service—is now used by nearly every business and most consumers. Popular B2B SaaS companies include Slack, Mailchimp, and QuickBooks Online. Consumer SaaS products include budgeting apps like EveryDollar and Adobe Creative Cloud.
While it’s not impossible to build a B2C SaaS, it’s much, much harder to create something of value and grow it sustainably, when many consumers expect apps of any sort to be free or extremely low cost.
On the other hand, SaaS businesses that solve problems in B2B markets can grow to large valuations much more quickly, and predictably.
SaaS business model pricing
When most people think about SaaS business model pricing, they consider the difference between three types of products:
- Free trial
- Sales demos only (no self serve)
“Freemium is an acquisition model, not a revenue model.” – Patrick Campbell, CEO of ProfitWell
But the reality is that Freemium is a form of marketing. It’s not a revenue model. A 4% conversion rate from Freemium to paying customer is considered “really good,” meaning that the free version of your software is intended to spread the word and bring in mass amounts of volumes of free users, but not necessarily to bring immediate revenue. In fact, many Freemium products with large user bases struggle to monetize successfully.
That’s why (if you decide you can support Freemium), you should treat it as a marketing expense and strategy, not part of your revenue streams.
SaaS business model pricing refers to what you charge your actual paying customers.
Initially, most SaaS founders use anecdotal information to set their pricing, such as:
- Asking people in your target audience what they would be willing to pay for your software
- Researching what your direct competitors are charging and charging either more or less than them depending on market saturation and the additional functionality you will provide (If you’re adding small amounts of additional functionality and competing against already successful companies, you should typically charge less. If you’re solving an even bigger problem in a more complete way than your competitors, you can possibly charge more.)
- Creating pricing tiers that reflect three or four different types of users—the subscriptions may be set off something as simple as volume or might offer advanced functionality for larger businesses
These are all smart ways to set your pricing initially, but later on, as your business grows, you’ll need to test your subscription piers and their individual pricing amounts. You should also check that each pricing tier accurately reflects the value being given, so that your largest accounts aren’t being undercharged (which hurts revenue), and your smaller customers aren’t being overcharged (which causes churn).
Pros of the SaaS business model
The SaaS business model has plenty of pros. Here are some of the things that make SaaS products great for founders:
- Recurring revenue
- Highly scalable
- Low barrier to entry: anyone who sees a need can hire an expert dev team to build a tool
- Tons of untapped opportunity in established markets, emerging markets, and niche markets
- Allows for lots of different low-cost marketing strategies including side project marketing and affiliate marketing
- Can create stickiness and loyalty, keeping the same customers for years
Cons of the SaaS business model
Of course, the SaaS business model does have some downsides. If you’ve vetted your SaaS concept, these shouldn’t scare you away too much.
- Churn from customers
- Hosting and maintenance costs associated with scaling can make growth unsustainable if your pricing isn’t optimized
- High upfront costs: most SaaS companies lose money for approximately one year, while they work to build up a large enough user base to break even and then move towards profitability
- Increased competition, and new players entering all the time
SaaS revenue streams
Subscription fees aren’t the only way to add SaaS revenue.
Here are all of the ways that you can increase revenue as a SaaS company:
- Monthly and annual subscriptions
- Additional cost for hands-on implementation (typically enterprise)
- Additional cost for custom integrations
- Additional fee for API (or including your API in your higher subscription tiers only)
- Additional cost for premium support (or including premium support in your higher subscription tiers only)
- Services that can be purchased inside of your platform in addition to the SaaS subscription fee, such as design work, bookkeeping, or anything else
- Additional fees for more storage or data processing
When you first start your SaaS business, you’ll want to prioritize selling your core subscription and validating product-market fit. Once that is achieved, and you know which marketing channels provide a favorable customer acquisition cost, you should double down on those channels and then divert some of your attention towards adding additional revenue streams that will further support growth acquisition.
How to optimize your SaaS revenue
When it comes down to it, there are two main ways to optimize your SaaS business model to allow for hypergrowth:
- Lower your CAC
- Increase your LTV
Let’s explore some strategies within each.
Lower your CAC
To lower your customer acquisition cost (CAC), you need to focus on acquiring the right type of customers at the lowest possible cost. To do so may require better targeting, different marketing channels, or even a slightly different target audience.
Here are a variety of ways you can lower your CAC:
- Remove or create a freemium model
- Remove or add the requirement to enter credit card information before free trial
- Target a different industry niche
- Target smaller or larger company sizes
- Use uncommon advertising platforms for your niche (such as Instagram or Outbrain)
- Create high quality content marketing
- Create a low cost “side project” to product viral growth
As you can see, working on lowering your CAC isn’t just about improving your targeting, but also questioning whether you have the best possible target audience.
Increase your LTV
Increasing the Lifetime Total Value (LTV) of your customers is another way to optimize your SaaS business model. Of course, within this huge category, is a whole host of strategies.
How to increase the LTV for your SaaS:
- Improve user onboarding via better guides, webinars, emails etc.
- Optimize the pricing for your product (typically the creation of higher priced tiers that reflect the value you provide to your larger accounts)
- Offer services, such as team training or even custom professional services such as marketing management, bookkeeping, etc.
- Do customer research and analyze product usage data to discover top reasons for churn, and work to combat these
- Create additional features that make your product more sticky, such as a high value API that both increases revenue and reduces churn
3 SaaS business model case studies
Let’s take a look at three very different SaaS business models that are working for real companies:
- Lower costs versus main competitors
- More pricing tiers versus main competitors (and no freemium)
- Enterprise software sales with additional services
1.) OneUp: Adding functionality that popular tools don’t have (at a lower cost)
You wouldn’t think that we need new social media tools on the market, and yet apparently there’s still room. Using their blog as the main channel for new user acquisition, social media scheduling tool has launched and grown to $10k MRR in just 11 months. Not bad considering they are relying on organic growth and word of mouth.
What makes the tool special is that they’ve added a feature that social media heavyweights Buffer and Hootsuite don’t have, and that’s the ability to re-use social media posts. Even better, they’ve added this for less than half the cost of comparable subscriptions (based on number of social media accounts and number of scheduled posts).
2.) Monday.com: A new twist in a saturated market
Of course you’ve heard of Trello and Asana and Basecamp. With these big players already in the market, how was Monday.com able to surpass a $1 billion evaluation in 2019 when their 2016 revenues totaled just $4 million MRR?
Well, there are a few reasons:
- They put a powerful new twist on project management software. Monday.com focuses not just on the assignments of small, individual tasks, but also managing big projects over longer periods of time and allocating team resources.
- More pricing tiers for better profitability with each customer account, but no freemium model so they can get immediate results with paid advertising.
- Targeted prospective customers with YouTube and Instagram advertising (instead of LinkedIn) so they could have a low CAC that allowed them to massively invest in rapid growth
You can see how adding a simple twist to an existing SaaS category and tightening up the revenue streams allows a small player to dominate a big market.
3.) Brightpearl: Nicheing successfully & increasing ARR with services
ERP software (Enterprise Resource Planning) is known for being overly complicated, challenging to customize, and not cloud based. It’s a generic type of software designed for the integrated management of all key business processes–from customer service to procurement to human resources.
Depending on the industry, an ERP could help a business manage just about anything. But with that overarching value proposition comes a lack of speciality that frustrates enterprise users across a variety of roles. Brightpearl, a cloud-based ERP software designed for retailers and wholesalers, has designed every future for the ecommerce use case, both direct to consumers and business to business. By doubling down on their niche, they were able to go from near failure to $10 million ARR in a little over two years.
Part of the reason Brightpearl has been able to succeed is the addition of custom services, namely implementation support and team training.
Not sure if your SaaS business idea is likely to succeed? Check out our recent blog post on vetting your SaaS ideas.
Also make sure to take our free course, SaaS School, which walks you through the creation of a successful SaaS business from A to Z.