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.
What types of entrepreneurs do best with the SaaS business model?
The SaaS business model is not for every entrepreneur. This is primarily due to the unique skills and knowledge necessary to grow and maintain this type of business.
While not the right fit for everyone, it is the ideal fit for some depending on who you are and what you are trying to achieve.
Entrepreneurs who like a hands-on approach
If you have previous tech experience and like to get your hands dirty to get the job done then the SaaS business model might be the right fit for you. You can deep dive into the product while learning how to lower CAC and raise LTV.
Entrepreneurs with strategic objectives
If you’re an entrepreneur trying to corner a specific market or demographic, then the SaaS model might be the right path for you. Make sure to choose an experienced SaaS development company that offers product strategy, prototyping, real user testing, and Laravel development.
Entrepreneurs that are portfolio investors
The SaaS business model is a great option for investors ready to dedicate a chunk of their capital. It offers tremendous income potential, a recurring income model, and a healthy dose of capital to really get off the ground
SaaS business model pricing
When most people think about SaaS business model pricing, they consider the difference between three types of products:
Freemium
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
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
How to optimize the SaaS business model
Optimizing your SaaS business model requires a unique touch to match what you use and what you do. Here are the fundamentals to get you started.
1. Establish structured approaches to your business and products
Successful businesses require structured approaches. They provide clarity to your employees, reduce waste of time and resources, and ensure the decision makers have what they need to make the most informed choices.
Structured approaches also benefit client relations. Be it customer acquisitions, tech support, or client management, structured approaches provide a consistency that your clients will appreciate and trust.
Additionally, the more organized and structured you are in the operations of your business the higher the valuation of your business will be. The reason is that potential investors or buyers can see the organization and know your optimizing resources and reducing waste.
While the list is endless, some of the key aspects of your business and products that should have structured approaches include:
Onboarding and training
Feature evaluations and applications
Monitoring app usage and cloud demands
Product reviews and new application audits
Evaluation process for new solutions
Portfolio management
Data security compliance
Software audits
2. Prioritize reviews and optimizations
Change is the only constant. What was a great solution yesterday may become a financial waste tomorrow. This is true for both the SaaS products you utilize to run your business and those you offer.
For many companies, the focus on growth results in the allocation of resources aimed solely at the roadmap. While this is important it can result in significant waste. For example, before purchasing a new SaaS product check to see if the feature you are looking for is offered in a product you’ve already purchased. This can save you from paying for redundant features.
Reviewing existing services, solutions, and processes will also allow you to optimize your resources and reduce costs. In turn, this will increase the value of your business.
3. Routinely audit products, licenses and agreements
Auditing products, licenses, and agreements is a must. Terms of use and license agreements change. Make sure to schedule audits of the software you utilize to ensure they still work within your busines’s applications.
Audits will also keep you aware of what products you're actually using and how. This will ensure you are only paying for what you need and getting the most out of what you have.
Lastly, auditing both your products and the SaaS products you use for data security and compliance is paramount. The last thing you want is to be dealing with the legal consequences of a data breach.
Buying and selling SaaS businesses
Another important aspect of understanding the SaaS business model is buying and selling it. Its valuation is unique compared to other business models, so it is important to understand the particulars.
The first thing to consider when buying or selling is the phase the SaaS business is in. There are three standard phases:
Startup: this phase involves getting everything up and running, taking the product to market, and acquiring the first few clients.
Hypergrowth: entering this phase occurs once the market likes your product and you must grow fast to meet the demands of businesses adopting your software.
Stable money maker: here the growth has stabilized, a healthy profit is streaming in, and acquiring new clients no longer tests the limits of your infrastructure.
Hypergrowth is the most challenging phase and success is independent of how good the product is. This growth will most likely cost a lot to support a growing customer base and work out the bugs of scaling your product.
Unless you are uniquely suited to manage a SaaS business through its hypergrowth, you should limit your buying and selling to the stable money-maker phase.
What buyers need to know about the SaaS business model
When preparing to buy a SaaS business, always keep in mind the confidence you feel in the product’s continued, stable growth. To support you in that confidence you’ll want to start by finding vetted and profitable SaaS businesses. This can be done by your own methods or you can utilize a third party such as Empire Flippers.
In the vetting process, also try to match your strengths to SaaS businesses’ weaknesses. If your talent lies in tweaking and growing marketing funnels, then consider products you know work well but need improvement in their marketing funnels. Similarly, if you’re a visionary, big-picture kind of person, then find ones with gaps in products you can readily fill. This will set the stage for a great undervalued purchase opportunity.
Another important factor is the business size. For smaller SaaS businesses it is imperative that you either know the programming or coding involved with the software or be prepared to utilize a service like DevSquad to tackle continued development. For bigger SaaS businesses the development team will be part of the package, but you need to make sure that the seller has outlined their processes and systems for potential team transitions.
Additional elements to consider in a purchase are:
Make sure the code, branding, and intellectual property is owned by the seller.
Make sure you are buying the entire package.
Numbers that are important to know are the churn rate, LTV, CAC. These are the vitals of the business. Think of them as blood pressure, heart rate, and temperature equivalents.
Existing KPIs are a plus.
Unless tackling hypergrowth is your specialty, avoid SaaS businesses in their startup and hypergrowth stages. A stable business is better suited for optimization.
How sellers can get top dollar for their SaaS
The first three things that need to be done when preparing your SaaS business for sale are:
Increase LTV
Reduce churn
Reduce CAC
Do your research. Part of that research involves developing an exit plan. The other part involves determining the worth of your SaaS business. What you think your business is worth is most likely not what other people think it's worth. Guides and tools are available to assist you in determining your business’s value.
Having a good development team in place is a definite plus. Utilizing our services for your DevOps enhances that benefit as the buyer will know they are getting a talented team dedicated to seeing the product come to its full potential.
Prepare a training manual that addresses both the business and the product. Include your KPIs, obstacles you have been facing, and where you see near- and long-term growth potential.
You’ll also want to present your business’ negative aspects. There is no business that is perfect and the buyer knows this. Trying to hide the negatives will create suspicion and dissuade many potential buyers. The negative aspects for you can also be the opportunity for them that ultimately leads to the sale.
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.
5 tips for making the most of the SaaS business model
Whether you're looking to grow, or preparing to sell here are some tips to get the most out of your SaaS business.
1. Calculate your break-even point
Your break-even point is the time at which your generated revenue will match the investments put in. Whether you are intending to sell or carry on with your business, knowing your break-even point will allow you to make the right strategic moves at the right time.
2. Know your cashflow and runway
Cashflow and runway are the ultimate deciding factors on how you can grow and at what pace—especially when entering the hypergrowth phase.
3. Build your business around your desired lifestyle
Be sure to build your business around your intended lifestyle. If you're focused on getting rich, go for it. But if your objective is a relaxed work-life balance, then make sure your business decisions reflect that. For instance, do not take on investors if you want stress-free business.
4. Track and improve your revenue-per-employee metric
Employees are the keystone of a successful business, but they are also the greatest expense. Understanding and tracking your revenue-per-employee metric is critical for success. While the energy sector holds the title, revenue-per-employee for SaaS ranks in the top five across all business sectors.
5. Solve one problem at a time
One of the biggest potential problems with SaaS products is feature overload. That is creating too many features under one product. When you are working on your roadmap and planning the trajectory of your business keep it simple and concise.
Finding more problems to solve is great, but carefully consider whether it fits within the product or should be a new product altogether.
Not sure if your SaaS business idea is likely to succeed? Check out our recent blog post on vetting your SaaS ideas.
