How does the SaaS business model work?

For both individuals and professionals, distributing software that is accessible online and marketed by subscription is now an obvious solution. So why does the SaaS business model seem essential and powerful, with just the provision of "Software as a Service"? Let's review its features and advantages, both for the SaaS and its users

1 - What is a SaaS (Software As a Service)?

"Software as a Service" companies are distinguished by very specific characteristics, both in terms of operation of the business and the customers.

1.1 - Definition of a SaaS

SaaS companies market software as if it were services. Their software is accessible via a web browser and is not installed "independently" on the user's computer (a model called On Premise). This is the main characteristic of the SaaS activity.

The consequence of this distribution method is that SaaS is sold via subscription, generally monthly or annually, which allows users to access an application hosted on the Cloud.

1.2 - From the On Premise model to the SaaS model

SaaS replaces the traditional model of selling software licenses. This classic mode called On Premise tends to disappear. It offers an unlimited period of use with periodic maintenance billing, unlike SaaS.

‍In the past, individuals and companies looking for software had to buy the license. Updates and version changes were not always free. As for maintenance, it was subject to additional billing, often three years paid in advance.

‍With the SaaS subscription, the customer uses the application without having to purchase the software or install it on their computer. Indeed, it is generally hosted on the Cloud, which makes access to the tool very easy (from anywhere).

1.3 -  Characteristics of companies that have adopted the SaaS model

This business model called "SaaS" now gives its name directly to the companies that practice it. We actually speak of SaaS every time to address these companies. These SaaS companies have the following operating characteristics:

• Their turnover is recurring due to the sale of subscriptions. We often speak of MRR, or Monthly Recurrent Revenue.
• They market access to a single version of the application, unlike On Premise software.
• They experience significant cash flow gaps between the costs of developing the service and the collection of cash from subscription sales.
• Their marketing and after-sales service strategy includes strong customer loyalty, because acquisition costs more than customer retention.

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2 -  Why is SaaS a powerful business model for its customers?

Having emerged in the early 2000s, SaaS has experienced exceptional growth in recent years. This reflects the many advantages that this model brings, first of all for its clients. Let's take a look.

2.1 - Lower cash outlay and subscription flexibility

SaaS users benefit from greater flexibility than in the case of On Premise software because they can:

• most of the time benefit from access to a free demo account, before making a purchase;
• then, access the software in a few clicks via their browser without having to install a program.

‍The subscription format also allows for a certain flexibility compared to the “irreversible” purchase of a license because the user can cancel at any time.

In addition, a SaaS subscription, especially if it is monthly, generally represents a fraction of the outlay required to purchase an equivalent license. Comparable to a rental rather than a purchase, SaaS therefore makes it possible to smooth out expenses over time and preserve users' cash flow.

2.2 - The benefit of software is that it's always up to date and constantly improving

By opting for a SaaS application, the user knows that they are benefiting from the latest version that is always up to date. The software is in fact continuously updated.

‍SaaS therefore makes it possible to develop the product for all users over time. It allows teams to iterate in real time to understand how to improve the service and bring more value to customers. This is the best way to reduce the churn rate and retain subscribers who may cancel at any time. Thus, it is a virtuous business model that focuses on customer satisfaction through continuous improvement of the software.

2.3 - No maintenance to pay in addition to the SaaS subscription

In the On Premise model, the purchase of a license was often supplemented by a paid maintenance contract. Indeed, the software was installed on the users' computer and thus required regular interventions to correct bugs and upgrade certain components.

‍For SaaS, no maintenance to pay: the software's evolution is ensured over time for all users, maintenance is included in the subscription. In addition, technical support is generally not subject to additional billing.

3 -  Why do SaaS companies benefit from a robust business model?

SaaS companies also find in this new business model multiple assets to develop their activity, whether in terms of recurring revenue or gross margin. ‍

3.1 - Recurring and therefore predictable revenue

The big immediate advantage of the SaaS business model lies in the predictability of recurring revenue. With subscription sales, the revenue is therefore embedded.

Its management consists in particular of monitoring key KPIs such as:

• the MRR (Monthly Recurring Revenue) and its evolution over time;
• the LTV (Customer LifeTime Value) as well as the LTV/CAC, i.e. the ratio between the total revenue estimated during the user's entire presence and the cost of acquiring a customer;
• the churn rate and the retention rate, in order to measure customer loyalty. ‍

3.2 - A SaaS business model with a high gross margin

This type of company has a significant average gross margin level with a rate that is generally around 80%. If most young SaaS companies are not profitable in the first few years, it is because they invest a lot in customer acquisition (CAC). Once the hypergrowth phase is over and CAC expenses are reduced, profitability comes around. It is still obviously necessary to monitor its cash runway and establish relevant, regular and automated financial reporting.

3.3 -  Strong growth capacity of SaaS

The SaaS business model consists of selling a service hosted on the Cloud and in the form of subscriptions. The distribution method is therefore largely simplified, all you need is a website. Nothing could be simpler for an Internet user than to create a user account to try the application online. ‍

For SaaS, this business model potentially generates strong and rapid growth. Of course, it requires allocating the necessary expenses to digital marketing and focusing on its customers to aim for the lowest possible churn rate.

‍The SaaS business model is becoming prevalent in the software sector. However, managing such a company involves relying on specific key indicators, particularly at the start-up stage and during growth. Fincome has made this its business.

‍We offer you 100% SaaS-adapted management tools thanks to our online platform.

‍Would you like to understand how we can concretely support the development of your SaaS? Nothing beats a demonstration with our experts!

💡 Complete your reading with the following articles:

• 3 common mistakes that kill SaaS startups
• Top tips for communicating with SaaS investors
• Automated reporting for SaaS: a quick guide
• KPI reporting at every stage of your startup
• Why is SaaS financial reporting still crucial for your startup in 2023?