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April 2, 2024

The SaaS Business Model Explained: A Comprehensive Guide

Discover the ins and outs of the SaaS business model with our comprehensive guide. Learn key concepts, strategies, and best practices for success. Learn more!

The SaaS Business Model Explained: A Comprehensive Guide

The Software as a Service (SaaS) industry has experienced exponential growth over the past decade, fundamentally transforming how businesses and individuals use software. According to McKinsey, the global SaaS company market is currently worth about $3 trillion, and the estimates indicate it could surge to $10 trillion by 2030. 

"As of mid-2021, the median revenue growth rate of 100 public SaaS companies in the United States, with revenues above $100 million, was 22, with the top quartile's growth rates above 40 percent.", said McKinsey.

The SaaS business model is not just a buzzword; it has propelled several businesses to extraordinary heights. Adobe, for instance, has seen a massive boost in its recurring revenue—from 19% to 70%—after transitioning from a traditional software-selling approach to a cloud-based subscription model.

"SaaS remains strong, and there's more interest in this category. Investors see the stability and recurring revenue as attractive, willing to pay more for better businesses," said Nate Ginsburg, CEO of Centurica, in The Boopos Buzz podcast.

Understanding the SaaS business model can unlock new opportunities for growth, innovation, and competitive advantage, whether you are a new business buyer or seller. In this guide, you'll learn more about the SaaS business model and why it's a good time to invest in it. 

What is a SaaS business model?

SaaS is a contemporary software delivery model where software and associated services are provided over the internet on a subscription basis. It's the modern alternative to traditional software solutions, where businesses used to purchase software licenses and install them onto individual devices.

As a SaaS company, you lift the burden of setup, installation, or updates off the user's shoulders. Users are able to connect to and use cloud-based software providers from any device with internet connectivity. This revenue model relies on subscription, usually on a monthly basis pricing, where customers pay a recurring fee to access the service, as opposed to traditional software purchase.

How do SaaS business models really work?

The essence of a SaaS business model lies in its ability to transform complex cloud-based solutions into accessible, user-centric platforms. At the core of this model is the commitment to continuous innovation and superior user experience hand in hand with the revenue model you choose. 

Success with SaaS business models hinges on nurturing steady revenue streams. This is achieved through monthly or annual subscriptions rather than one-off sales, ensuring predictable and scalable Monthly Recurring Revenue (MRR) and Annual Recurring Revenue (ARR). The freemium approach caters to varying user needs, providing basic functionality for free while reserving advanced features for paid tiers.

Customer acquisition costs in SaaS business models are offset by the long-term value of customer retention. To minimize churn, especially post-free trial, SaaS companies focus on delivering undeniable value, ensuring the transition to paid subscriptions is seamless and justifiable.‍

A SaaS company's prowess is measured by its ability to maintain a delicate balance: offering a service so indispensable that it becomes a non-negotiable part of the customer's life or business operations.

4 SaaS business models and examples

Selecting a SaaS business model is a strategic decision that sets the pricing strategy for your venture's growth and scalability. Each model offers distinct pathways to revenue and customer engagement.

You should select the SaaS Business Model Type that aligns with your long-term vision for growth but also consider analyzing customer behavior, value perception, the sales team strategy, and market demand for your ideas.

1. Freemium

The Freemium model is a gateway for potential customers through cloud services with basic features at no cost, while premium features and additional services are gated. To succeed, you'll need to identify core features that provide immediate value and encourage users to upgrade for more advanced capabilities.

Example: Dropbox

Dropbox, with its freemium model, has capitalized on its user-friendly design and robust collaboration features to become a leader in the cloud storage industry. At the end of Q1 2023, it announced its total revenue earnings grew 8.7% YoY to over $611 million, and the number of paying users grew to 17.9 million.

2. Subscription / Flat-Rate

It offers various subscription fees (annually or monthly subscriptions, for example) and ensures each tier has clear, incremental value. In this SaaS business model, regular updates and unwavering support are vital to keeping subscribers from churning.

Example: Buffer

Buffer, a social media management software, offers a flat-rate pricing plan. The pricing is fixed whether you pay monthly or annually with a discount.

3. Usage

This model mirrors customer usage patterns of your software products. It's ideal for services with a fluctuating percentage of customers. Implement transparent tracking and billing systems to foster trust and align your service costs directly with customer consumption rates.

Example: Asana

Asana is a SaaS platform designed for team collaboration and work management. It follows a subscription-based pricing model. Pricing is primarily based on the number of users and features/functionality as the number of users increases.

4. Tiered

The tiered Pricing model answers diverse customer needs with multiple levels of service. Design each tier to target specific customer segments, from startups to enterprises, tailoring additional features to their typical use cases and budget constraints.

Example: Obsidian

Obsidian is an excellent example of how to tier SaaS pricing model according to user type and features. If a customer wants more features, Obsidian offers them an additional fee per bundle.

The phases of the SaaS business model

As with any business, a SaaS company goes through several growth phases. The technical aspects of it are a whole interesting subject by itself which we could dive in after, but we can summarize them as follows:

Startup stage

In this initial stage of a SaaS business model, an idea morphs into a tangible product, and the first customers come on board in the sales process.

Growth stage

During this stage, the business scales up, customer acquisition speeds up, and the product starts maturing.

Maturity stage

At this point, the company's growth rate reaches a stable plateau. New customer acquisition decelerates, and the focus moves to expanding existing customer accounts and curbing churn.

Renewal stage

Concluding phase, the business concentrates on retaining its customer base and identifying growth strategies, often through upselling, cross-selling, or introducing new products.

The key SaaS business model metrics: What really matters

‍Having defined SaaS business models and some successful examples, it's crucial to explore the key metrics that every SaaS business should monitor to determine its value and success:

  • Monthly Recurring Revenue (MRR) and Annual Recurring Revenue (ARR): The revenue model you choose is vital for tracking the consistent conversion rates from subscriptions.
  • Customer Acquisition Cost (CAC): This measures the expense of gaining new customers, essential for understanding marketing efficiency.
  • Lifetime Value (LTV): It predicts the average revenue a customer lifetime can generate over their interaction with the service, providing insight into long-term profitability.
  • Customer Churn rate: The rate at which currernt clients cancel their subscriptions is crucial for assessing customer retention and customer satisfaction.
  • Customer Retention Rates: They offer a direct look at how well a SaaS business maintains its customer base over time​. Of course, there has to be a sinergy between your sales team and a correct customer relationship management.

Why buy a SaaS business instead of starting one

Starting a business is exciting, but it has its own challenges. Michael Frew, tech executive turned into digital acquisitions evangelist, says:

"Look to acquire the business, find projects that you like, that somebody has already gotten customers, already done the marketing, has already done product market fit, it's past that part of the curve where 95 plus percent of businesses fail. Why not acquire instead of buy?" said Frew in an interview with Boopos.

The Saas business model, with its potential for scalability and recurring revenue, is an excellent opportunity for robust growth and profitability. By understanding how the model works, you can position a new business - or an existing one that you acquire - towards success in dealing with upfront costs the right way.

Learn how you can acquire a SaaS company with Boopos. Our innovative approach streamlines lending decisions and resolves acquisition financing challenges, giving you access to a directory of vetted SaaS businesses with great growth potential that have already undergone our due diligence process. Find out how you can finance your next SaaS acquisition!

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