Understanding the SaaS Business Model: How Does it Work?

The Saas Business Model Explained

Of all the new kinds of enterprise solutions made available by the advent of the internet, one of the most disruptive, most useful and most recent has been the software as a service (SaaS) business model.

Many a startup has either pivoted to this promising new SaaS business model, or has been founded implicitly to take advantage of the SaaS revenue on offer in today’s active market.

With SaaS companies enjoying an aggregated industry-wide market value that’s projected to rise over $25 billion per year going forward, now is an excellent time to move into the SaaS business model in your own organization.

However, to succeed in doing so, it’s vital to understand the SaaS business model excellence in action – the tactics, organizational structures, and key metrics by which to gauge your startup company’s prosperity.

What is the SaaS Business Model?

In truth, the SaaS business model is both new and complex enough that understanding its potential, as much as the key metrics and deliverables that will be expected of you when creating one, can prove a somewhat daunting task.

Are you tracking the necessary KPIs? Do you know your CAC? When do you need to raise more capital? We've helped SaaS founders answer these questions time and time again.

We even have a Business Model Template that will help you set goals and communicate them effectively to investors.

Every SaaS startup exists because it has identified – and intends to sell the solution for – a pain point, problem, or area of unnecessary friction in enterprise.

Commonly, the SaaS business model targets B2B solutions, such as inventory management and order tracking for ecommerce, or more effective inter-organization communications solutions for companies.

Helping business owners and their teams coordinate more effectively within a given company is a strong SaaS business model in today’s market too – as software companies like Zoom and Slack can attest.

However, many SaaS business model ideas have also been created with the intention of helping business owners better connect to – and engage with – their customer base. For example, Mailchimp email marketing keeps end users informed and inspired when an organization releases new products – and is especially popular in the rapidly growing ecommerce market.

Whatever the intention of the SaaS solutions in question, software companies develop these platforms primarily by utilizing the powers of cloud computing. In fact, a popular startup idea in today’s market is developing a SaaS business model that helps those businesses struggling with their digital transformation to take advantage of cloud computing in a more user-friendly way.

As you can imagine, many companies who provide solutions like this do so while relying on revenue streams beyond one-time software purchases. In fact, because SaaS solutions lean on cloud computing so prevalently, their MRR and ARR frameworks charge users a subscription fee.

How Does the SaaS Business Model Actually Work?

With an understanding of the SaaS business model’s success in mind, we can more effectively drill down into what makes for a successful SaaS business model.

In order to succeed in marketing any startup offering SaaS solutions, it’s vital to ensure that your team comprises software developers who are able to take complex cloud computing challenges and convert them into user-friendly platforms.

SaaS companies are looking to grow their monthly revenue streams and capitalize on a strong and engaged user base for profitable ARR and MRR key metrics. As a result, you will rarely see any SaaS business model using one-time pricing models alone.

In fact, even if they do, there’s likely to be some variety of premium subscription offering or “Pro Level” measure of support in most SaaS companies today. This kind of freemium SaaS offering is able to cater to a casual user base effectively, while adding a feeling of prestige and added functionality to its monthly subscription customers.

More frequently, however, SaaS business model designs are built to capitalize on recurring monthly revenues. This is true of both enterprise-level startup ideas to solve B2B problems, as it is B2C marketing solutions or consumer-level SaaS solutions to make daily life easier.

Because of the monthly subscription model being used throughout the SaaS software market, the customer acquisition cost (CAC) is relatively low – although pricing will be a strong factor in how likely users will be to commit to the monthly subscription.

In fact, one of the key metrics to track in any SaaS business model or any software company intends to deploy is the level of customer churn – especially in the early months.

Many SaaS solutions use the allure of a free trial period before monthly subscription expenses kick in for end-users. This adds a level of pressure for any SaaS startup to demonstrate excellent value and versatility in their platform before their true subscriptions begin.

A big area of customer churn is often found in free trial users who stop using the product before their monthly subscription fees begin – and a key area to overcome in the growth stage of any such startup is removing the friction between that trial period and the more-profitable monthly recurring revenue.

To attain strong customer retention, your startup will need to provide an almost flawless level of service, and convenience so compelling that end-users can no longer imagine their personal or professional lives without your SaaS solution.

A challenging endeavor – yet one well worth overcoming, thanks to the potential rewards of the SaaS industry (when done right).

Types of SaaS Business Models

All SaaS business model varieties out there require a team of software developers to not only create the SaaS solutions themselves, but also to update and maintain them over time.

Not only that, but cybersecurity is a chief concern throughout the SaaS market today. Because of the nature of this kind of startup, it is highly likely that sensitive data on customers, end-users, and other businesses in all kinds of industries will be using your SaaS platform’s cloud computing infrastructure. A data breach or successful hack against your startup could be disastrous.

Because of these continuous expenses, on top of the usual costs of developing a startup throughout (and beyond) its growth phase, having a keen understanding of the best SaaS business model – and how to avoid customer churn – becomes one of the key metrics to get right.

When creating SaaS software products for use in the everyday consumer market, a freemium SaaS business model often works best. Consumers don’t always have access to the kinds of enterprise-level capital that would enable monthly subscriptions – and they would need to see a tremendous level of value in their personal lives to subscribe to such a SaaS platform.

For example, imagine if PayPal used a monthly recurring revenue subscription model for every single one of its users. Paying customers would not see value and would have abandoned the service long before it became as prosperous and ubiquitous as it is today.

In fact, PayPal is a great example of a SaaS business model success for transactional revenue models. That’s because PayPal levies a small fee on customers – whether average consumers or enterprise level clients – for certain kinds of transactions.

This kind of transactional revenue makes a good SaaS business model for companies such as ecommerce payment gateways. A subscription model would be less successful here by far – it makes sense to simply take a small fee for services rendered per transaction.

Cryptocurrency exchanges such as Coinbase are another example of the transactional revenue SaaS business model.

Examples of the SaaS Business Model

The idea of the SaaS business model is older than we might first think – in fact, many of the oldest surviving such software companies are examples of a successful SaaS business model in action, yet came to be before the advent of cloud computing.

Many of the free or freemium SaaS solutions active in the market today are ones that have found success by becoming almost indispensable to the way in which companies operate today.

Think of examples such as Zoom, Trello, Slack, or Monday. You may well already be aware that these examples include those that use both a freemium and a monthly subscription model – another example of that strategy in action is HootSuite.

End-users can scale their monthly subscription level up and down according to the marketing and social media needs of their business – or simply use the SaaS software for free.

While it can be tempting to stick with the relative simplicity of a subscription model with competitive pricing, keep an eye on how this affects your customer relationship key metrics and overall customer churn levels. A kind of subscription fatigue is creeping into many areas of entertainment, media and even software companies today – so experimenting with another SaaS business model could work in your favor.

Pros & Cons of the SaaS Business Model

When generating a new startup – after identifying the challenge to overcome or deliverable you intend to offer your end-users – it pays to contemplate what SaaS business model design philosophy truly is going to bring to the table for you.

For example, SaaS products often require software developers to remain on board long-term, in order to squash new bugs, keep users’ data safe, add new features, upgrade systems to be compatible with new computer operating systems or smartphone handsets, and so on.

Would it be wiser to simply create a startup product that consumers and businesses can purchase from you via an ecommerce website for a one-time fee? That depends on the kind of services you intend to render through your startup innovation.

Because the world is so connected today, cloud computing empowers most modern SaaS solutions – meaning SaaS business model strategies need to lean towards the annual recurring revenue (ARR) key metrics required to sustain operating both the business and the SaaS platform.

One of the key pros of a successful SaaS business is that its monthly subscription key metrics are very high. This demonstrates a high level of customer loyalty, and this advantage is becoming ever more difficult to secure in the competitive startup landscape of today.

On the flip side, it’s vital to remember that one of the biggest disadvantages of the SaaS business model is that it’s capital intensive – both to get your startup going and into its growth phase, and just to operate day to day.

This is not a startup idea that will ever generate any entrepreneurs passive income. It will be a lot of work throughout your SaaS product’s lifespan – and that also includes the complexities of ensuring you have good software developers to keep on top of the enormous volume of necessary coding and cloud computing infrastructure.

What are the Key SaaS Business Model Metrics?

Seeing success in your business model means tracking key SaaS metrics, which include:

• Customer churn rate – how many end-users are abandoning or ‘bouncing off’ your product per week, per month, per year?
• Customer acquisition cost – are end-users contributing to your revenue streams or is your product giving away too much for free?
• Monthly subscription numbers – are they growing, stagnant, declining?
• Cash flow – are there areas in the value chain of your SaaS business model where you can strategically employ upsells or value-added solutions?
• Customer Lifetime Value - having your sales team getting new users on board is only part of the work. Whether through monthly fees or upfront payments, how can your business model promote increased LTV?

SaaS Business Model Growth Strategies

The key to successful SaaS solutions in the market comes from identifying and solving a problem – and doing it so well you can charge for the service.

As a startup, your goal will be tackling the challenge you want to overcome, and working with software developers on cloud computing solutions that resolve the issue.

Once that’s accomplished, you’ll move into your growth phase – marketing to your chosen demographics and, if successful, seeing tremendous numbers coming in for ARR and MRR.

However, this is the pivotal moment – sustaining the excellence of your service, and keeping pace with innovation in both your chosen market as well as in the cloud computing ecosystem overall.

Over time, you’ll likely identify new challenges, new opportunities and greater potential – and from there, must decide if you want to launch new products within your SaaS business model to address them or create a new startup accordingly.

To aid in your journey, download our SaaS Company Operating & Valuation Model Template now. We’ve streamlined the process of creating a SaaS valuation model. Here’s how to get started:

1. Visit our template webpage and click “Download Now For Free!”
2. Provide some basic information about your business, such as the founder’s name and your SaaS company website.
3. Click "Let's Scale" to start the download.
4. Open the template using Google Sheets or Microsoft Excel.
5. Input your company’s financial data into the designated fields.
6. Review the comprehensive financial models generated by the template, which will help you determine the appropriate public trading value for your SaaS company.

SaaS Business Model FAQs

What kinds of entrepreneurs suit the SaaS business model?

This kind of startup is not for everyone and certain entrepreneurs are far more likely to flourish. Investors who are experienced in working with cloud computing and software developers are likely to see promising returns – and likewise, strategically minded or innovative entrepreneurs with solid SaaS solutions will enjoy a very receptive market.

Are all SaaS companies subscription based?

No – this kind of SaaS business model is widespread, but isn’t the only option open to SaaS founders. Understanding your customer base is one of the key metrics to monetizing your SaaS ideas – and you might find greater success through one-time purchasing, freemium models, or transactional revenue fees (remember the PayPal example).

How do I grow my SaaS business?

The growth phase of any startup is exciting – and many of the winning strategies from the startup world will also apply to your SaaS business model. Think organic traffic growth, strong customer retention strategies, wide scale marketing campaigns and effective networking – especially for B2B SaaS platforms.

What is the SaaS Revenue Model?

The most frequent SaaS business model strategies used today are as follows:

• Monthly subscription revenues that charge users a recurring fee to access the cloud computing functional of the SaaS product
• Transactional revenue models, as seen in ecommerce SaaS solutions where fees are cut per monetary transaction, delivery fee, ad placement etc.
• Freemium, often used in a B2C SaaS business model – software is free to use, but has added functionality purchasable within
• Ad-based revenue, in which non-intrusive ads are placed throughout SaaS solutions