How SaaS Companies Make Money: The SaaS Business Model

How SaaS companies make money: the SaaS business modelEver wonder how SaaS companies make money? Or have you wondered how exactly to utilize the SaaS business model to generate revenue from a tool you created?

Maybe this is you: Not too long ago, you were sitting at your day job, frustrated by an inefficient process. You realized that as a software developer you could come up with a solution, so you created a product. You went through several iterations and completed beta testing until you were finally happy with the current version. In talking with others, it turns out they were dealing with similar issues and suddenly there is interest in your SaaS product. Friends and acquaintances are contacting you because they realize they could benefit from using your SaaS product. What are your next steps? How will you roll out this offering to a broader audience? How will you transition this online business idea into a revenue-generating service?  

The SaaS Business Model Explained: How they Generate Revenue 

Understanding how SaaS companies make money and setting up the right SaaS business model from the outset is key to long-term success. Doing so will benefit you in many ways: You’ll have a fee structure that best aligns with your customers’ needs, you’ll set yourself up for long-term income generation, and you’ll also ensure your business is in the strongest position possible should you need funding in the future. 

Anna Popovych from Clockwise Software summarizes it so: “The SaaS business model is a source of uninterrupted recurring revenue. Once you have all the functionality up and running, the processes set up and repeat clients, revenue is guaranteed. This fact is significant for 2 reasons: Stable income is the top goals of every company. After you are introduced to SaaS revenue models and employing one for your needs, you can reach this goal and take your business to a new level. By demonstrating your SaaS business model example and proving you have a stable income from your business, you will attract more investors to contribute to your product growth. Your business will be profitable in terms of finances and overall company development.” 

Two key things to consider before determining your business model are your customers and your long-term goals. 

Who are your customers? 

Selecting the right SaaS business model will appeal to your customers and lead to positive results for your company, but it can be helpful to take a step back and think about your customers or the customers you want to attract. 

When asked what brought SaaS online business success, the founder of Appointlet, Rami El Chamaa said, “It was not a magic wand, but rather a magic ear. Basically, talking with customers and better understanding their problems and needs. The thing is a big portion of your customers are talking and giving feedback so things can get out of hand. The key is in focusing on those few voices that would have the most impact on your business. Those little voices that come from people that are innovators in their own way. Listen, filter and take action.” 

Listening to your customers and taking note of their feedback will help your product in the long run. If your target audience are young startup companies, then you will want your pricing model to be within a feasible price range for those types of businesses. For example, a customer just starting out with a limited budget will be hesitant to commit to a product that only offers a yearly subscription.  

Customer retention is an important consideration for every business but it’s even more crucial for SaaS businesses. It takes significantly more effort and energy to acquire a new customer than it does to nurture a current one. If you have an appropriate business model, have high-quality customer service and you roll out regular product updates, you will likely have satisfied customers. These customers will often recommend your SaaS offering to others and they will be interested in upgrading their service.  

What is your goal?  

When you are creating a SaaS business, you will want to determine what your goal is. Do you want to maximize revenue today or maximize lifetime value? Yes, generating revenue is important but when you are creating a SaaS business and determining the price point for your product, lifetime value matters most. LTV calculates the amount of revenue you will receive from a customer over the lifetime of their account with your product. The higher your products LTV, the more valuable each customer will be to your SaaS business. This metric helps you know exactly how much you can expect to bring in from a customer. 

For example, if you are Microsoft, you will happily pay $100,000 to Salesforce annually on a 3-year contract. Why? Because the product has proven lifetime value for your company. It also helps that Microsoft is a stable and successful business that can afford Salesforce’s fees. Salesforce knows its customers and target audience. They offer different options to meet the needs of businesses of varied sizes and maturity levels. 

Now, if you tried to sell Salesforce’s services to an entrepreneur who just started his bootstrapped venture, you wouldn’t expect him to pay a high dollar amount and you wouldn’t expect him to sign an annual contract. That is why Salesforce offers different pricing models depending on which services your business needs. If you are a small business owner, you will not pay the same high-ticket price as Microsoft because you would not require the services that they do. We will go in more depth about Salesforce and their unbelievable customer service and how this relates to their business model success later in this article.  

Which Business Model is the Best Fit for your SaaS Business? 

Unless you are launching a brand-new process in a new space, you have enough competitors in the market to compare pricing and offerings and identify the appropriate pricing for your SaaS product. High end? Low end? Why? Why would someone pay more for your product? 

When asked tips on how to grow a SaaS business, experts collectively said, “Experimenting with pricing plans can have a huge impact on how fast your business grows. Price your software in a way that enables you to provide insanely over the top customer support and service. Your early customers will love you for it and will tell other people in their industry.” 

Monthly recurring subscription 

In this revenue model, a customer pays a recurring fee monthly to use the software, as is the case with Adobe Acrobat. If you are just starting out and not yet a household name, it is more realistic that customers will sign up for a monthly, lower-cost subscription, with the goal of eventually turning them into customers who are so happy with the product that they want to sign up for a yearly subscription.  Yearly recurring subscription

In this revenue model, a customer pays a yearly subscription fee to use the software. An example of this is Microsoft Office 365. In this pricing model, SaaS companies often offer a discounted price for those who commit to using the product for a year. 
Usage based

In this revenue model, a customer pays depending on the amount of software they are utilizing. There are often different pricing tiers including a Freemium model, a basic plan, a premium plan or a deluxe plan. SentryKit, an app that uses artificial intelligence to monitor the state of your FBA business, uses a usage-based model.  

Hybrid model

With the world shifting increasingly to the online space, most SaaS companies have learned to adapt their pricing models to the changing of the times. This has caused most SaaS businesses to implement what is known as a hybrid pricing model, where they will offer different renditions of each pricing plan depending on the needs of the customer. For example, some companies will use a combination of a monthly subscription fee and a usage-based model. The user pays a set amount each month plus they pay for usage that they use. Call Tracker, a call tracking software company, uses a hybrid model where users pay a set fee monthly and pay an additional fee for minutes used and the number of phone numbers designated to their account.  

Freemium model

A freemium model means the consumer can use the application free of charge. You can use the app forever, for free. These types of plans are often offered on a usage-based model and the consumer will never be charged for usage within the free limit. Two notable examples of the freemium model are Spotify and Zoom. With Spotify, users can listen to music for free on the app but must endure ads occasionally. With Zoom, users can take advantage of many of its features free-of-charge, however, certain features (like meeting hosting for large numbers of attendees) are reserved for users with a paid subscription.  
The freemium model is a wonderful way to get customers to sign up and chances are they will pay for an upgrade once they have become hooked and are truly satisfied with the service. Customers who choose to stay at the freemium level can only use a certain amount of usage. Although they do not pay a fee, the consumer is considered a customer.

Free trial model

A free trial, such as the one offered by Philo, gives the user a chance to try out the product free of charge for a certain allotted time. Once the free trial is over, the customer is invited to participate in a demo where the user will be walked through how the app works and the value it will add to their life. The user has a short window of time to decide to join. 
The goal here is to convert customers from the free trial to paying customers. The consumer is not considered a customer until they have signed up for a subscription.

SaaS founders will often mix-and-match the three when creating pricing plans for their business. They do this to create options that are suitable for the unique needs of their customers.

If you have 100,000 customers (about the seating capacity of the Los Angeles Memorial Coliseum) and you are only offering them one set plan, chances are you aren’t meeting the needs of every customer. It is difficult to justify charging every customer a set price because everyone has different needs and should only pay for as much as they are utilizing the app.

Things to consider when making decisions on pricing tiers 

  1. If you are launching a SaaS business, chances are there is someone doing something similar or comparable to you. The question to ask yourself here is: Where do I want my SaaS business to be placed in the market? If you were to launch a company like Netflix, you wouldn’t have people pay $50 a month for a subscription. Look at the market and your competitors and find out what you can realistically charge your customers. Then ask yourself: Can I be profitable charging this price?
  2. Next, you want to ask yourself how you can be different from all the other players in the market? If you have not discovered what gives you a competitive edge, we suggest you go back to the drawing board and figure this out before drawing up your pricing plans.  

Some SaaS founders will start with a lower price and offer more usage to allow a customer to see if the product is something worth sticking around for. Although companies lose money in the beginning this way, they end up gaining traction once they have hooked customers. The goal here is to get a customer accustomed to using more usage so when the time comes and pricing models change, they do not convert down to a lower usage tier.  

Important Metrics to Note 

While creating your pricing strategies and developing your company’s competitive edge, make sure you are paying attention to the following metrics. Be careful not to get caught up in what Viktor from Product Mint called, “KPI overload, the act of tracking too many metrics which deteriorates focus and stalls growth.” Pay attention to the following metrics but do not get weighed down so much by them that you are not able to move forward.

Customer acquisition cost

CAC is how much money it will cost you to acquire a new customer through sales and marketing efforts. Bringing on new customers is pricey, make sure you factor this in when developing your pricing plans.

Monthly recurring revenue or annual recurring revenue

MRR or ARR will predict the amount of revenue your company can expect monthly or yearly.

Retention rate

This is key for any SaaS business. Retention is how well your company retains customers or how well they retain revenue. These two metrics have the opposite effect of churn and it is important that you pay close attention to both when evaluating the strengths and weaknesses of your company’s business model. Just because you have good customer retention, doesn’t always mean you will have high revenue retention. For example, you could retain all your customers on an app but if they downgrade to a lower price tier, you will have 100% customer retention but a much lower rate of revenue retention. You want to watch out for changes to customer retention and revenue retention, as both can have significant implications for your business.

Churn rate

Churn metrics show how many customers stop paying for your service over time. The key to any SaaS business is to prove the value of the product and make sure that customers believe that using your product is worthwhile and benefits their business. You want to make sure you focus on reducing your churn, or better yet, making it negative.

If the business you operate has a high churn rate, your next step should be to look at your customer acquisition costs and channels. This will give you an idea of how much it might cost to replace lost users and whether you are taking advantage of all the channels available to you, such as organic and paid search, affiliate marketing and outbound marketing.

When a SaaS company only offers one monthly plan, they often create churn. Let’s say you offer a monthly plan for $50 a month with customer service from 9-5 but your customers would rather pay $75 a month for extended customer service hours. In this scenario, your customers may look to bring their business elsewhere. This would create churn. To retain customers, you would want to create different tiered pricing options that would accommodate the needs and wants of your customers. Offering tiered pricing plans enables you to craft offerings to suit your diverse types of customers instead of creating a blanket product that would benefit some but not all.

Keep this in mind when building your pricing plans and be strategic about which models will keep your customers around for the long haul. It’s not a bad idea to request feedback from current customers or potential customers to make sure that you are spot on with your business model offerings.

You want to create a software offering that is so critical for your customer base that they will do everything in their power to remain a customer. Two great ways to bring new customers into the fold are through offering a freemium model or a free trial model. I’ll walk through these options below.  

Real-world Success Stories 

Whether you are in the pilot stages, the growth stage or the mature stage of your SaaS business, it is important that you never lose sight of your end goal: retaining customers and generating revenue. Here are a few real-world examples of SaaS businesses who have succeeded in doing just that: 
Model used

Per use per license, billed annually 
Why they have succeeded

Mike McCann spoke to the companies success, “When Salesforce first entered the market, competitors such as Oracle and SAP charged expensive fixed monthly or annual rates for hardware, software, upgrades and support. Salesforce shifted the pricing paradigm by introducing a per user fee, billed annually. Since then, more cloud-based business applications have made the switch to per user license fee, clearly proving that Salesforce is a leader in its field.” 

What you can learn from Salesforce

Adapt to your customer base and research your competitors. Create processes that help those who are just starting out and those who have are industry leaders. This will create a dynamic that your customer base can trust and rely on.  

Model used

Monthly recurring subscription, single app price, all app price  
Why they have succeeded

Adobe had a different strategy when becoming a successful $95 billion SaaS company, “Adobe’s winning strategy was being intentional from the beginning and thinking long-term. Their very first product, PostScript, was a huge success and there was no need for Adobe to add more revenue streams at that time. But the leadership knew that remaining a one-product company wasn’t a smart financial decision in the long-term. That’s why they started building out apps that could target new users and bolster PostScript’s revenue, even though they weren’t immediate cash cows.”  

What you can learn from Adobe

It is imperative that you adapt your SaaS business over the years. If you notice trends in the market, adapt to them. Do not let a tendency to be stubborn keep you from riding different customer waves as they come.  
Model used
Freemium, monthly recurring subscription 
Why they have succeeded

Dropbox treats everyone as equal. Ian from Press farm explained, “It didn’t bother Dropbox that the several million users who signed up to use this 2GB of space weren’t paying because they were aiming to attract as many users as possible and then up-sell more services to businesses. This approach sent a clear message to the users that these freemium customers were just as important to the company as their paying customers. Offering free space was such a simple strategy, but it helped build an audience of millions which it could then market its paid subscriptions to. In fact, many of their paying clients converted from the freemium model to get more storage space.”  

What you can learn from Dropbox

A non-paying customer on a basic subscription is just as important as a paying customer on a plus subscription. Customer retention matters and it is important that you treat every customer equally.  
Model used

Free trial, usage based, monthly recurring subscription 
Why they succeeded

ScraperAPI have succeeded because they have structured their app and their pricing plans around the needs of their customers. Their unique plans offer something for everyone and they have custom plans that fit niche needs as they arrive. Every plan includes 24/7 professional support and unlimited bandwidth. They also offer a 7-day refund policy if a customer is unhappy with their service. The customer is their number one priority.

What you can learn from ScraperAPI

Dedicated customer support is key and creating a pricing structure that allows your company to offer quality customer service is so important. ScaperAPI have attentive account managers and a direct support channel with their engineering team to make sure that the software is meeting all your scraping needs. They will never leave a customer hanging with any issues that they have.