What Every Entrepreneur Should Know About Software as a Service Business Model
Many enterprises today are adopting software as a service business model to enhance their efficiency. In this article, we shall discuss various things that every entrepreneur should know about the SaaS model.
Understanding the SaaS Model
SaaS is a software delivery model that allows users to access data from any internet connection-enabled gadget or web browser. The SaaS application can range from unified communications to office software and numerous other business applications available today.
Software development companies manage and control the databases, servers, and code infrastructure. This practice is a shift from the on-premise traditional software distribution model that was popular in the past. For the on-premise model, customers pay a one-off upfront fee for software installation and a small annual price for maintenance and service.
SaaS subscribers pay a monthly fee, with others opting for an annual subscription service. Some SaaS companies offer end users a freemium share of the application with restricted functionality. Customers can leverage this feature to test the product before investing in it. Many times, SaaS products are available for businesses and private consumers.
SaaS is Fast Becoming Mainstream
Entrepreneurs who are not ready to develop an IT infrastructure adopt a SaaS solution, which becomes crucial for their operations. For example, sales teams can use SalesForce to improve customer experience.
SaaS companies can generate income from various revenue streams. However, recurring revenue from their subscribers is their principal source of income. Companies can offer monthly or annual subscription services - MRR and ARR (monthly recurring or annual recurring revenue). Through the subscription fee, customers gain access to various features, products, and software applications.
Pros of the Software as a Service Business Model
· Constant Recurring Revenue
Income in the SaaS business model is predictable, seeing that existing customers hardly discontinue their subscriptions. Experts in the startup business industry suggest that only 5% of subscribers cancel their subscriptions within a year.
· Reduced Friction
Many SaaS applications are available for a flat monthly or annual pricing model. Further, there being no hidden costs makes it easy to encourage new customers to sign up for the service.
· Enhanced Customer Relationship
SaaS consumers access and utilize the application frequently. Doing so allows SaaS companies to evaluate how consumers interact with their product while giving them insights on how and where to improve.
· You do not have to Customize SaaS
While some SaaS applications available today do not allow customization, others allow minimal personalization. This characteristic gives software companies enough time to improve their service instead of modifying it for every client.
· Cross-gadget Compatibility
You can access SaaS applications from any gadget with a reliable internet connection, making the model ideal for multiple device users.
Cons of the SaaS Business Model
· High Configuration Costs
Customers will not invest in a half-baked product. SaaS providers must invest sufficient monetary resources to develop their product. Some studies suggest that SaaS developers will need up to $100,000 to build their inaugural SaaS version.
As is the case with other businesses that operate through the internet, SaaS businesses are vulnerable to data loss and malicious attacks. SaaS providers must invest heavily to secure their customer data and applications.
· Can be Copied Easily
SaaS can be distributed globally with ease giving potential competitors access to the software. Malicious users may duplicate its features. As a result, SaaS providers must develop new features regularly and devise customer acquisition strategies to maintain relevance.
What End-users Should Know about the SaaS Business Model
Before adopting a SaaS business model for a small enterprise, understand the software coding, or programming. Ensure the seller owns all the branding, intellectual property, and coding of the SaaS business. You want to be sure that you are purchasing the whole deal and not a fraction of the SaaS business model.
Understanding the churn rate, customer acquisition per customer (CAC), and LTV (Lifetime Value) is critical for decision-making. These metrics are life indications of the business, which makes them crucial. If you want to purchase the SaaS business model, choose one with consistent customer growth levels.
Avoid SaaS business models with explosive growth because they can result in various problems when it comes to scaling. Buying a stable business instead of one that is still navigating an immense growth cycle is ideal. A firm enterprise allows you to adjust your marketing channels and optimize the venture.
What Sellers Should Know about the Software as a Service Business Model
Each SaaS business model seller should identify ways to expand their LTV. At the OneStop DevShop, we have an able team of experts ready to help you make informed decisions. We will even guide and help you find the ideal business for sale that meets your expectations.
A high LTV number or one that shows promising signs of increasing makes the company more attractive. Remember, you will need to lower your churn and CAC too to enjoy the best results. You can do so by adjusting subscription pricing and marketing channels.
Having a good development team ready to transfer to the new client is a crucial factor. You will need to ensure that the end-user understands your software and how it operates. You can do this by training buyers or giving them a training manual to read and understand the business and the SaaS model.
Let your consumers understand the negative features of the service. Many times, unfavorable features may encourage new customers to buy the SaaS business.
Other Cloud-Based Models
Apart from SaaS, other main groups within the cloud computing realm are Paas (Platform as a Service and IaaS (Infrastructure as a Service). Let us discuss these in detail.
· Infrastructure as a Service
IaaS is a service delivery model that provides computing infrastructure via a virtual network instead of onsite servers. With this service, companies can build and run their operating systems, network, and storage. In the past, organizations had to run their data centers, workstations, and local servers. However, cloud service providers deliver these resources today. IaaS offers various advantages that include:
IaaS providers have back-up data centers to counter extensive outages.
Businesses do not have to invest in personnel or hardware to develop onsite data centers. You can change your computing power, meaning that organizations will not pay a regular fee. Further, they can reduce their volume during the off-peak season.
Consumers such as e-Commerce establishments can expand computing power whenever they have massive network usage.
IaaS companies spend colossal amounts of dollars to enhance the safety of their systems. Doing so spares end-users from building internal security systems. Some of the popular IaaS providers in the market today include Google Cloud, Microsoft Azure, and Amazon Web Services.
· Platform as a Service
PaaS gives end users a computing platform to build and run their custom applications. It also allows developers to work together in the applications eliminating the need for physical presence. Here are some benefits of the PaaS model.
Convenience and Simplicity
Using PaaS eliminates the need for developers to create a collaboration platform. Further, developers can access all the tools they need from the application.
Enhanced Development Cycles
Seeing that PaaS platforms focus on collaboration, building applications happens faster with minimal obstacles.
PaaS providers upgrade their platforms regularly to incorporate new frameworks and standards in the development of applications.
With PaaS, users do not have to develop an onsite development tool, which can be cost-saving.
Crucial SaaS KPIs and Metrics
To succeed in the software as a service model, you must be capable of acquiring customers, retaining, and monetizing them. To increase resources and efforts in SaaS, customers should monitor their success level every step of the way. SaaS providers should exercise caution when it comes to metrics. It is worth mentioning that the process of tracking numerous metrics may not only hinder your focus but can also slow growth. Here are some of the metrics in each of the applications we have mentioned before.
1. Acquire Customers
Reports suggest that more than 10,000 SaaS providers are registered globally, making the space overly crowded. Due to this, acquiring new customers can be difficult and costly. For example, in the 2019 financial year, Slack spent up to $230 million to acquire new users. To maintain manageable costs, users should determine the performance of their marketing and sales drives. The following metrics will come in handy to help you achieve your goals.
Customer Acquisition Cost (CAC)
CAC demonstrates the amount of money you invest to win a new customer. Experts opine that CAC can kill startups seeing that many businesses do not identify low-cost customer acquisition strategies. Knowing the amount you spend to get new customers and determining highly profitable marketing avenues is critical to making profits. To find out the customer acquisition cost, divide your total sales and marketing expenses by the number of customers the business earned within a specific period.
Conversion Rate (CR)
Conversion rates demonstrate the number of people that handled a specific process to completion after starting it. SaaS users leverage CR to analyze the effectiveness of every marketing campaign. To calculate the conversion rate, divide the number of people completing an action by the number of people that started it.
Remember, you can use conversion rates on different user flow sections. An example, in this case, would be an advertisement on LinkedIn and other social media platforms. Let us assume 500 hundred people will see your product on their feeds once the advert runs, 20 of them click on the ad, while 50 register. The result you get will yield varying conversion rates based on your calculation. In this case, the ad conversion rate would be:
200/500 = 0.4%.
Your advertisement to sign-up conversion rate would be 50/500 = 0.1%.
Conversion rates allow users to test various marketing techniques. For example, you can drop your advertisement at different platforms, regions, or times to determine the most effective channels. It is worth mentioning that there is no standard conversion rate. Instead, strive to be consistent in enhancing the metric.
Customer Acquisition Rate (CAR)
This metric involves establishing the speed at which you are winning new customers. You can do so by calculating your rate of customer acquisition. CAR offers users an overview of the performance of your acquisition attempts within a specific period.
To calculate your CAR, divide the number of acquired customers by the extent of the selected period. For example, assuming you got 1000 new users within four months, your customer acquisition rate would be 1000/4 = 250 customers per month.
Users can compare their CAR across their business timeline, which allows them to evaluate their attempted acquisition drives from a comprehensive perspective. Often, SaaS customers offer a significant lifetime monetary advantage. As a result, you should strive to maximize your customer acquisition rate to give users the best experience.
Product Qualified Leads (PQL)
PQLs are potentially involved consumers who have used your products meaningfully before. They are critical when it comes to tracking your SaaS business model and feature a freemium model element. When you approach a PQL in a bid to convert them into paid users, they will already have encountered your product broadly.
This approach does not need promotional or marketing techniques. You can identify product-qualified leads by checking users who recently became paid users. Here are some tips you can use to make the search process easy.
- Check the features they use
- The speed at which teams or an individual is embracing your product
- Usage and spending patterns
- Product interest from interactions and shares on social media platforms
3. Customer Retention
Seeing that acquiring SaaS customers can be costly, you want to retain existing ones for as long as you can. Use the following metrics to determine how long users are hanging on to the service, why they leave, and what you can do to retain them.
Knowing and calculating your churn rate is a critical metric for SaaS companies. Here, you will need to separate revenue churn from customer churn. Revenue churn is the degree to which a business is losing revenue within a specific period.
Customer churn is the percentage of customers that abandon your service within a certain period. Many times, SaaS businesses will be assessing these metrics on a monthly and annual period. You can calculate customer churn as follows.
Subtract the number of customers at the beginning of a period from the number of customers at the end. Divide the result by customers at the start of a period.
Assuming your business had 1000 customers at the beginning of the month and 800 at month-end, your consumer churn would be 1000-800/1000 = 0.2%. Use the same formula when calculating revenue churn on your MRR (monthly recurring revenue) rather than the consumer count.
Net Promoter Score (NPS)
You can measure your customer’s satisfaction level on your product through the net promoter score. This metric allows you to assess the amount of value your consumers are acquiring from your products.
With NPS, you can determine the possibility of consumers recommending your product or business to others. It runs on a scope of 0-10, where zero indicates your customers would never recommend your products, and ten shows that they would highly recommend them. NPS comes in different groups, which are:
- Promoters or customers leaving a 9 to 10 score
- Passives or customers leaving a score of between 7 and 8
- Detractors or customers leaving a score of between 0-6
To measure net promoter score subtract the portion of detractors from the percentage of promoters. The result you get should be between +100 and -100. For example, let us assume you have 50% promoters, 25% passives, and 25% detractors. Your NPS would be 50%-25% =25%
Every SaaS company offers different CRM tools and features that their consumers can use. In this case, you would need to define the key components and build metrics based on them. For example, an organization such as Dropbox could analyze the number of files their customers upload and their storage options. A video platform like Zoom would analyze the mean session duration for each video call and the sound and video quality.
Determine the main features critical for your product experience and develop standards around them. Understanding how consumers are interacting with your products helps you identify better strategies to improve their experience.
3. Monetizing Customers
The next step after acquiring customers would be monetizing them. Here are various metrics you can use to determine the amount of revenue your business makes per customer. You will also learn how to maximize your revenue model.
Monthly Recurring Revenue (MRR)
Recurring revenue is the foundation of SaaS businesses. Predicting the amount you can earn per month or annually is crucial, and this is where MRR becomes ideal. To calculate your company’s MRR, all you need is to summarize the total company revenue from paying customers per month.
If you understand the ARPA (average revenue per account), you can calculate MRR by multiplying it by the total number of consumers the business has. You can increase your monthly recurring earnings by:
- Increasing your subscription charges
- Scraping off the limit on an existing price
- Upselling via add-on features or multiple pricing plans
- Abolishing your free plan to attract paying customers only
To determine whether any of these strategies are viable for your business, all you need to do is test separate pricing models.
Average Revenue per Account (ARPA)
ARPA calculates the amount of revenue an average account generates. Often, ARPA calculation occurs monthly, but it can also happen quarterly or annually based on your billing span. To calculate ARPA, you need to divide your total monthly recurring revenue by the total number of customers your business had during that specific month.
Assuming your MRR is $200,000 and you have 10,000 customers, your ARPA will be $200,000/10,000 = $20 per account. ARPA comes in handy to facilitate its calculation for different customer clusters. This formula allows you to establish customers who generate the most revenue and aim your acquisition drives towards them.
Customer Lifetime Value (CLV)
CLV lets you determine the amount of money users spend on your service during their membership. Customers who maintain your service for longer and those that spend on it have a high lifetime value.
Determining the amount you get from each customer allows you to evaluate the amount of money you can invest to gain them. Further, you can classify your LTV into separate customer groups, which helps you target them better. To calculate CLV, you first have to establish your ARPA and customer churn rate.
You will then divide the ARPA by the customer churn rate. For example, assuming your ARPA is $1,000 with a 10% churn rate, your CLV would be $1,000/10% = $10,000. It is worth mentioning that measuring LTV makes sense only for businesses with numerous customers. Often, small businesses suffer massive fluctuations, and this makes LTV difficult to predict.
SaaS Business Model Growth Strategies
You can grow your SaaS business using different methods. Your key competencies and strategies that have worked over the years determine the approach you choose. Here are some tips to help you grow your SaaS business with ease.
· Increase Organic Traffic
According to experts, organic search traffic from platforms such as Bing and Google are high converters. To elevate your organic search, you can use various tools to check where your brand is ranking.
· Adopt New marketing Platforms
To experiment with a new strategy, you should have robust objectives. Ensure you will invest sufficiently in your preferred marketing platform to reach a wider audience. You can use various techniques to implement this strategy. For example, you could convert your best-performing content into a YouTube Video. You can also post engaging content on different integrated marketing platforms like MailChimp.
· Integrate Product Upsells
Product upselling is an excellent option you can give your existing customers. Not only does it serve them effectively, but you will also generate more money. Upsells can be high-end packages where consumers pay extra per month to enjoy additional features, data storage, and benefits.
Businesses can opt for a once-off upsell, possibly a comprehensive information product like an impactful webinar to help users understand how to leverage software to gain competitive edge. You can even convert a detailed informational article in PDF adobe format and send it to your consumers through email.
This idea is also known as the freemium model, where businesses attract customers by offering restricted functionality free of charge. With time, the customers adapt to the product and convert it into paying customers.
Whichever upsell version you choose, consider the costs involved. You can then capture it in the ultimate pricing that customers will later pay for the upsold service.
- Software as a service business model comes with numerous applications that both providers and their customers can leverage to grow their companies.
- You can leverage a wide range of metrics available to scale up your business.
- SaaS solutions are available for both small and medium-sized businesses.
Contact us today and learn more about SaaS. Our experts will help you accomplish your goals.