The Software As A Service Business Model Explained

Software as a service (SaaS) has been one of the largest and fastest-growing market segments since 2019. Businesses are now investing in SaaS companies, spending nearly 50% more on these cloud technologies than in previous years. For entrepreneurs, few industries are as exciting and lucrative. But it’s not enough to just dive in and go for it. The software as a service business model is a unique model that requires a specific, but reliable strategy. 

What Is SaaS?

SaaS is a delivery model of centrally hosted software that is licensed to customers via a subscription plan. If a company leases its software through a central, cloud-based system is technically a SaaS company. 

These companies maintain responsibility and oversight of servers, databases, and any relevant software that allows people to access and use their products. Some of the most popular SaaS companies are Adobe, Google, Salesforce, Slack, and more. 

The way that SaaS companies lease their product is through subscription plans. These plans can vary greatly from company to company. SaaS business models offer different services and different applications within their systems. Different subscription plans give different access to different services. Many offer a regular plan with one or two other plans that offer more access and increased services. 

What Is The Software As A Service Business Model?

The software as a service business model includes a number of factors that are unique to it. There are three in particular that are important to take note of. 

Recurring Payments

In SaaS, clients do not buy hardware. The software as a service business model involves providing a subscription service for software. Recurring payments usually take the form of monthly recurring revenue (MRR). This makes accounting for revenue potentially difficult because SaaS offers a service, not a product per se. 

When your customer signs up and subscribes, you will get some money upfront. It is imperative that this initial cash not be counted as revenue until it’s been properly earned. It is a liability until the terms of service have been completed. A customer can ask for that money back at any point if the service isn’t delivered.

Revenue recognition is one of the most fundamental aspects of running a successful SaaS company. 

Heightened Customer Retention

All businesses care about customer retention. In SaaS business models, however, it is ten times more important. Customer retention is what keeps SaaS companies afloat. Because you cannot lay claim to all of your customers’ subscription money until a term of service has been completed. 

If you sign a customer for one year or twelve months and they leave after two, then you’re without ten months of recurring revenue. As a result, it is critical to put a significant value on cultivating customer relationships and upselling. 

An existing SaaS customer spends more money on average than a new one. It is in a SaaS company’s best interest to upkeep and maintain higher-quality customer service. If you don’t, or if the quality of customer service is poor, your customer is very likely to jump to a competitor. 

No matter how great the product, poor customer service can break a company. 

Consistent Updates

In order to maintain and increase customer retention, SaaS companies need to consistently provide small and frequent updates to their services. Plenty of companies provide “next-gen” product versions, but SaaS has to continuously update and patch to stay above water. 

This is the nature of being in the software industry. Software vulnerabilities can put customer information at risk from hackers. Nobody wants that. That’s why continuously assessing and updating security fixes is a top priority in the software as a service business model. 

Since SaaS companies host their own products, they can push updates as needed. They can release new features or enhance prior versions whenever they want. Between consistent updates and quality customer service, SaaS companies have the potential to be highly responsive to customer base feedback. 

This is a real-time luxury that most other industries do not have. 

How Are SaaS Companies Built?

Generally speaking, there are three critical stages as to how to build and develop a SaaS company: Setup, Growth, Stabilization. 

Setup

This is the early stage where the foundation of the company is established. These are fairly typical processes. Founders discover the need for the products they intend to develop, identify their target market, and create the product. 

This is also the opportunity to create an effective marketing campaign and sales strategy, consider various customer support plans, and organize finances. 

Growth

Once the product has hit the market, it’s time to expand. This is arguably the fun part. Because there is seemingly no limit to how far a SaaS company can expand in its market, it’s possible for a SaaS to expect new customers. This creates a sudden demand for marketing, sales, and customer service teams. 

This is when a company has to act quickly in order to capitalize and secure a loyal customer base. Ideally, this growth will be accompanied by additional revenue. Companies then reinvest the capital back into their products and services. That way they have the resources necessary to meet their customers’ needs. 

Stabilization

Now that the business is beginning to acclimate with a steady incoming stream of customers, that means the company does not have to invest in more overhead. If the SaaS company has wisely invested in customer service software, marketing automation, and consistent product updates, they are on the right track to stabilization. 

Why This Business Model Works

The software as a service business model is new but reliable. The evidence of this can be found in the amount of money that other industries have begun to invest in SaaS. How many office spaces use Slack to communicate? How many designers use Adobe? As our technology advances, so does the SaaS industry. 

It’s never been a more exciting time to enter the SaaS industry. Entrepreneurs, take note.