Most people still remember the days when software applications were distributed mostly through CD-ROMs and floppy disks. While some companies still maintain CD distribution methods, it’s safe to say that the SaaS distribution or “SaaS revenue model” has taken over.
In this guide, we’ll explore what this SaaS Revenue Model is, why it’s so popular now, and some tips to help you make the most of it.
What Is The SaaS Revenue Model?
The SaaS (Software-as-a-Service) revenue model is a software delivery method where users pay recurring fees at regular intervals to access cloud-based software applications.
In the SaaS model, the software provider typically hosts the application and all of its data in the cloud. You pay a subscription fee to access the software and the data over the Internet. There is no need to set up your own infrastructure, data storage, or anything of the sort.
The SaaS model grew out of the fact that once the software was on demand, the provider could roll out updates continuously.
It no longer needed to deliver a physical product occasionally. So, software companies needed to establish a model that was scalable and allowed them to profit from the applications they developed for as long as they remained valuable to other businesses or people.
Why Is The SaaS Revenue Model So Popular?
Most software companies are moving toward a SaaS-based revenue model. For those that haven’t switched to SaaS, it’s often a matter of time, more than anything else. Below are some of the benefits of a SaaS business model.
Continuous and reliable revenue stream
This is perhaps the most important benefit. By adopting a SaaS model, software vendors can receive payments throughout the lifetime of the product instead of a one-time fee from a physical product. Therefore, it’s easier to predict revenue and focus on growing your product.
Scalability and ease of distribution
The traditional model of printing CDs or installing software physically required an entire operational component, including purchasing of CDs, printing, and managing physical distribution networks — the whole works.
With a SaaS model, vendors no longer have to worry about these complex components. Instead, they can channel all efforts into developing and improving the existing tool. Users simply need their login credentials and an internet connection to use the software.
In addition, vendors no longer have to develop for different operating systems and devices, since the product can be accessed through any web browser irrespective of device type.
This makes it even easier to scale and distribute applications to end-users.
Frequent updates to the user experience
Because users expect ongoing value in exchange for their subscription, software vendors need to provide an ongoing top-notch user experience.
A regular income stream from SaaS revenue provides the funding for companies to continually invest in improvements and always deliver a relevant product.
For users, a SaaS model offers the following benefits:
Continuous updates
A user always has access to the latest version of a SaaS product because the software is regularly updated and maintained. Unlike other software, they often don’t need to install updates, since they’re accessing it live via a web browser.
Many tools also have publicly available roadmaps or community forums where users can upvote their most desired features and report bugs, so the overall development objectives are always in line with users’ needs.
Lower prices and upfront costs
With on-premises applications, users had to pay a lump sum for the tool upfront and maintain servers to support the software. With SaaS, users do not have to worry about maintaining any underlying infrastructure, which can often be less costly in the long run.
Testing before use
One of the biggest selling points of the SaaS model is that it allows users to try a tool first before they fully commit to it from a cost perspective. Some tools even operate on a freemium model where users have free access to basic features of the product as long as they maintain an account.
Convenience
For the user, there’s no complicated software to install. All they need is a username and password to access an always up-to-date tool.
They don’t need to take time to install every new update or read through pages of technical manuals to figure out how to install the software.
The onboarding process is also smoother compared to traditional methods. Since the software is completely web-based and independent of the user’s operating system, onboarding directions are clearer and easier to follow.
Most tools also have dedicated customer service teams available to guide users in real-time if they run into any trouble.
Components Of The SaaS Revenue Model
If you’re considering the SaaS revenue model for your business, below are the components you need to be aware of.
Access, authentication, and tiering
In a SaaS model, people pay for access to the software/product. So each user requires authentication before they gain access to the tool.
Their access is also usually limited to the features covered by their monthly subscription package.
Tiering packages and the authentications required can be a substantial engineering lift. These three variables are central components of any SaaS platform.
Cloud technology
The development of cloud technology was instrumental to the success of the SaaS model. It’s a lot harder to charge a subscription for a CD that users buy to download a program onto their computer.
With the advent of the cloud, users can access the software remotely and conveniently so it’s easier to control access and charge a monthly rate.
Continuous value
The ability of the software to continuously provide value is a key component of SaaS. Consider a company that uses AR technology to rebuild a factory floor so that factory managers can optimize their space usage for production.
Since the service is probably a one or two-time affair for which the company charges implementation fees, the business is not continuously providing value.
However, if the vendor re-architects the software so that factory managers can remotely access the tool and work with it regularly, then a SaaS model could apply.
Types Of SaaS Sales Approaches
Here are three SaaS sales models that modern companies use.
Low-touch sales model
Low-touch sales refers to a sales approach in which there is little personal interaction between a sales team and a prospect from the moment they start exploring the service through the moment they convert.
Common characteristics of a low-touch SaaS model include:
- Prospects and sales team members have minimal direct contact.
- The sales process relies heavily on automation to move prospects along the sales funnel. These include pre-recorded product tours, chatbots, and FAQ pages.
- The process also relies on providing the prospects with the information they need to make a purchase decision, including referrals, reselling partners, affiliate marketing, content marketing (SEO, social media, and blogging), and email marketing.
- It is commonly used by SaaS businesses that provide low-cost subscriptions.
- Leads are encouraged to try the product out for free to gain a deeper understanding of how it works.
- When satisfied, customers can upgrade to the paid edition of the software right within.
- A lot of self-service is involved too, such as How-to articles, Help pages, detailed documentation, and other guides.
- A detailed pricing page helps the lead understand the product without having to contact support.
- While it is a low-cost approach, it tends to have higher churn than a high-touch or hybrid sales model.
This approach is almost the opposite of a high-touch approach, as you will see below.
High-touch sales model
A high-touch SaaS sales model involves a lot of direct interaction between sales and prospects from introduction to conversion.
Here are some highlight features of a high-touch sales approach:
- The sales team typically works with prospects to identify their needs and value proposition, then provides in-depth demos and product tours.
- The lead generation pipeline involves cold calling, cold emailing, advertising, lead qualification, and conversion.
- The sales team also assists with onboarding and implementation.
- This model is often employed by companies offering high-value subscription services (and a price tag to match).
- Often, the products involved are also complex to integrate, operate, and optimize – and require quite a bit of hand-holding to get started right.
- Onboarding involves providing tailored guidance and training to the new customer, setting up accounts, software customizations, etc.
- This funnel often involves many touchpoints before the sale is made.
- And even after the deal is reached, the sales team often appoints an Account Manager to provide ongoing consultation to help the customer reach their goals using the software service/product.
- High-touch models offer dedicated support, monitor customers’ usage with the intent of helping where needed, and personalize the experience to boost customer satisfaction and loyalty.
- Customer retention rates are higher with this approach than with low-touch models, even though it can be quite resource-intensive throughout the customer lifecycle.
Some companies also use a combination of the two SaaS sales models with success.
Hybrid sales model
Hybrid SaaS sales models combine low-touch and high-touch approaches to selling the same product.
This approach has several highlight features:
- It offers the best of both worlds, providing customers with personalized, high-touch support when needed while also leveraging the efficiency of low-touch sales.
- For that reason, a hybrid approach is more scalable than a high-touch sales model.
- The approach streamlines the onboarding process, providing customers with personalized guidance while still allowing customers to find their own solutions.
- It also gives customers the flexibility to choose the level of support they receive, allowing them to tailor their experience to their needs.
- The hybrid SaaS sales model often offers custom pricing or requires customers to get a custom quote.
We have highlighted the different sales models. Now, here’s a quick breakdown of the sales models that SaaS companies typically use to increase their customer retention and recurring revenue.
Types Of SaaS Pricing Models
Adopting the right SaaS pricing model is key to profitability when switching to a SaaS revenue model. Here are some of the most popular pricing models:
1. Tiered pricing
Most SaaS businesses operate a tiered model where they offer different packages of the product at different price points. The goal is to appeal to more customer segments and provide more options for the user.
There are usually three broad tiers: entry-level, mid-level, and enterprise-level tiers. Examples of businesses that adopt this model include Hubspot and Google Workspace.
2. Per-user pricing
This is by far the most popular pricing model adopted by SaaS businesses. In this model, each user pays to access the software, so the price of the product increases as users increase.
The benefit of this model is that both the end-user can keep track of cost while the business can reliably predict revenue. The downside is that this model can become expensive as the customer’s user base grows so they may be more likely to churn.
To curtail this, companies usually offer incentives to customers with a large user base, such as offering a discount per specific number of users or only charging per active user.
3. Per-feature pricing
In this model, users are charged based on the features they access, so the price of the product is tied directly to the value provided to the user. The advantage is that users only pay for what they need.
This can be a great option if your users have a variety of different needs. They can pick their own set of features.
4. Usage-based pricing
This model is also called pay-as-you-go pricing because usage of the service correlates directly with cost. Most cloud providers such as Amazon Web Services offer cloud services using a pay-as-you-go model.
Examples of usage-based metrics include the number of emails sent, API calls made, or server resources used. The higher the usage, the higher the price the user pays. This model works best for products with flexible demands and very low costs.
5. Flat-rate pricing
In this model, companies charge a flat rate irrespective of user numbers or usage level. An example is Basecamp, which charges $99 per month for organizations of all sizes no matter their usage levels.
The advantage of this model is that it’s easy to understand and cuts down decision-making time for prospective buyers. The downside is that users with custom needs are left out and you forfeit any upselling opportunities.
You may need to combine two or more pricing models to create one that works for your business.
For example, tiered pricing is often paired with per-user or per-feature pricing. So, each tier may be limited to a specific number of users and the price per user will differ between tiers.
Tips For Choosing A SaaS Revenue Model For Your Business
Consider the following nuggets.
Get crystal clear about your bottom line
Do some self-discovery to uncover the value that your business brings to your customers and the cost of delivering that value. Work backward from there and choose a model that aligns with your product.
The goal is to ensure your chosen model scales with your costs and the value you deliver. So, the more it costs you to deliver a particular feature, the more the customer pays. And the more value your customers get, the higher the price they pay.
Be careful not to discourage the behavior you want to create
For example, charging per user could discourage organization-wide adoption because the cost of the tool could increase exponentially as the customer’s user base increases. So, if your goal is to have as many users as possible, you may consider a feature or usage-based model since usage patterns may vary per user.
Understand your unit costs
This could be your cost per feature, customer, or other important metrics. This will help you choose a pricing model that scales with your costs. For example, if you’re a payment platform, understanding your cost per transaction is critical to ensure profitability.
What Are The Most Important SaaS Metrics To Track?
SaaS companies can track the health and performance of their businesses using a range of metrics. The following SaaS metrics are often the most crucial at any stage of the company.
Monthly Recurring Revenue (MRR)
This is a measure of revenue that a SaaS company generates from subscriptions or memberships every month. It is one of the top SaaS value metrics to track. Revenue that is generated yearly is referred to as Annual Recurring Revenue.
Net monthly recurring revenue is MRR minus any refunds or credits given. Gross monthly recurring revenue is MRR before any discounts or taxes are applied. Net MRR gives a true picture of a SaaS company’s monthly revenue and overall financial health.
Active Customers
With this metric, you can find out how many users are actively using the product during a given period. It can be measured monthly, quarterly, annually, or however works best for your SaaS business.
Measuring active users can provide insights into your retention rate and customer lifetime value. It can also help you identify areas you can improve, such as where users are dropping off.
Customer Acquisition Cost (CAC)
Your CAC measures the total amount you spend to acquire a single new customer. It includes marketing and advertising costs.
The CAC can help show you how much money you need to invest in acquiring new customers. You can also use CAC to identify areas where you can reduce costs to boost profitability.
Also, knowing your CAC can help you plan your marketing budget and determine where to focus your efforts. Additionally, it can help you optimize your SaaS pricing strategy so you maximize the return on your advertising costs.
Lifetime Customer Value (LCV)
The LCV refers to the total amount of revenue that a customer generates for your SaaS over the entire period of their relationship with your company. It can help you determine how much profit you gained from this particular customer and see how long it takes to recoup your CAC (CAC Payback Period).
Churn
Churn refers to the number of customers who cancel their subscriptions, memberships, or business relationships with your SaaS company during a given timeframe.
The churn rate refers to the percentage of customers who churned during a specific period. The Retention rate is the percentage of customers who remain.
Churn may indicate that customers are dissatisfied with your product, service, or customer support. It may also be that your product does not meet their needs. Finding out why will require customer research. It may also be necessary to adopt a more high-touch SaaS sales model to help customers learn how to use the product effectively.
Cost of Goods Sold (COGS)
COGS is the cost of producing and delivering a SaaS product to the customer. It includes direct costs such as materials and labor, and indirect costs such as marketing and distribution. COGS is an important factor in determining pricing and profitability.
Could you be overreporting your COGS and reporting weak margins? Check out our SaaS COGS guide to find out what metrics to measure and more tips.
Gross Margin
This refers to the difference between sales revenue and the cost of goods sold (COGS). Gross margin reflects profit after all costs have been taken into account.
A company’s gross margin often indicates its profitability, overall financial performance, and whether it is running efficiently.
Pricing your SaaS products and services has a huge impact on gross margin as well. To learn more about protecting and improving your profitability, check out our guide to SaaS pricing here.
Unit price
Measuring per-unit costs is a relatively new method of assessing the costs associated with delivering a single SaaS product or service. A good example is cost per customer or cost per feature:
In this way, you can make data-backed decisions about setting competitive SaaS pricing while protecting your profit margin.
This concept is known as SaaS unit economics, a powerful way to optimize your SaaS business’s operations as you scale.
The above SaaS metrics are based on customers, sales, and revenue. Check out our SaaS metrics guide for more metrics to monitor. And, for a look at some of the most important SaaS metrics from an engineering perspective, see our guide to cloud metrics for SaaS companies.
Better yet, learn about The Rule of 40 for SaaS here or The SaaS Magic Number here.
What Are Some Of The Crucial Tools That SaaS Companies Need To Grow?
Several key tools can provide a significant boost to a SaaS business’s revenue generation and maximization potential. We’ve shared a comprehensive list of the 60 best SaaS tools for software companies by category here. But here is a critical handful.
Marketing tools for SaaS businesses
SaaS brands can use these tools to automate marketing and sales processes, ensuring a working mix of low-touch and high-touch results. Examples of sales and marketing platforms include HubSpot, ActiveCampaign, and Pipedrive.
Collaboration tools
In addition to promoting teamwork between different teams and departments, these tools also enable remote working and online project management. Examples include Slack, Jira, ClickUp, Asana, Basecamp, and more.
Billing software
SaaS billing tools are crucial for generating invoices, processing real-time payments, and automating payment reminders. The best ones also help with tracking revenue, reporting billing errors, and more features in one platform. Examples of billing software for SaaS businesses include Chargebee, Recurly, Stripe, Chargify, and Zuora.
Data analytics tools
SaaS analytics tools are crucial for SaaS companies because they help identify product performance and customer usage patterns across all stages of development, sales funnel, or sales lifecycle. Examples of SaaS analytics platforms include Kissmetrics, Userpilot, Amplitude, and MixPanel.
Customer retention tools
A customer retention tool is software that helps businesses identify customer churn and churn prevention strategies. In some of these tools, you can track user and product usage to gauge where customers are dropping off, so you can address the problem. You can use tools such as Autopilot, Delighted, SurveyMonkey, ProfitWell Retain, AutoPilot, Copper, and more to better retain customers.
Cloud Cost Management tools
This refers to a tool that helps you visualize, analyze, and optimize your cost of delivering SaaS products to customers over the internet.
Cost tools are not made equal, though.
The best cloud cost management tools offer real-time cost allocation, report unit costs, allocate 100% of your cloud costs, enable Engineering-Led Optimization, and more.
Understand Your COGS, Improve SaaS Revenue, And Maximize Profit Margin With CloudZero
The cloud is an essential component of SaaS, and your cloud costs make up a significant portion of your total costs.
Building a profitable business requires understanding the cost of running your products and features in the cloud. However, most cloud cost tools are clunky, inaccurate, and focus too much on total and average costs (instead of unit economics).
CloudZero is different. With CloudZero, you make better decisions about everything from pricing and packaging to maximizing renewals by giving you granular visibility into your costs per feature or customer.
With CloudZero’s cost intelligence platform, you can:
- View unit costs such as Cost per Customer, Cost per Team, Cost per Environment, Cost per Feature, and more (12 out-of-the-box and more custom metrics).
- Identify your most profitable segments using Cost per Customer insights, and increase your profits by targeting them more effectively.
- Set competitive pricing and discounts while protecting your profitability with accurate and context-rich cost insights.
- Be able to analyze your per-unit costs at different stages of your growth, such as when you onboard a certain number of new customers or deploy a new feature. Excellent for budgeting and forecasting!
- Allocate 100% of your cloud spend no matter how complex your environment is.
- Make informed decisions about pricing, discounts, and cost reductions with real-time cost allocation.
- Accurately collect and report costs for tagged, untagged, and untaggable resources (even in shared architecture). No perfect tags are required.
- Take advantage of real-time cost anomaly detection to prevent cost overruns that can eat into your revenue, margins, and market value.
- CloudZero’s Engineering-Led Optimization can help your engineers understand how their actions affect your bottom line so they can build cost-effective solutions from the start.
These and other capabilities have helped CloudZero customers slash their cloud costs by 18% to 40%, including Drift (over $3 million), Demandbase (36%), and NinjaCut (40%). Other companies like Remitly now understand how much they spend per customer, while MalwareBytes and Obsidian are reducing their cloud cost management time by 6-10 hours weekly. Yes, you can, too.
to experience CloudZero for yourself.
The Modern Guide To Managing Cloud Costs
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