How Do SaaS Startups Make Money? | SaaS Revenue Model

Software as a Service (or SaaS) is a new method for delivering software applications over the internet. It does not require any installation or maintenance of the software to avail of the services. The software is hosted by a third party and one can access it by paying a subscription fee.

The benefits of the SaaS model are clear. It provides lower costs, lower commitment risk, and a try-before-you-buy model, which gives customers a remarkable opportunity to assess a product before making a purchase. Indeed, the benefit is so clear that a 2017 study conducted by BetterCloud found that 86% of organizations estimate that 80% of their business apps will be delivered through the SaaS model by 2022.

In 2022, the SaaS market valuation is at $186.6 billion and has an annual growth rate of around 18%. It is projected to grow to $700 billion by 2030.

For software businesses, on the other hand, the SaaS model presented an entirely new way to build, distribute, market, sell, and support a software product. It affects every single part of a software operation. But the most significant change that the SaaS model brought — the one at the root of all the other changes — was the SaaS revenue model. The Software as a Service (SaaS) revenue model is associated with regular, ongoing payments over a defined period, in exchange for using a software application or other tool.

About SaaS
SaaS Revenue Model & Its Phases
Phase 1: The Initial Sale
Phase 2: Retention Revenue
Phase 3: Expansion Revenue
How to build a great SaaS revenue operation

About SaaS

SaaS is referred to as a software distribution model in which a cloud provider hosts applications and makes them available to end-users over the internet. In this model, an independent software vendor may contact a third-party cloud provider to host the application.

SaaS is one of the categories of cloud computing that include infrastructure as a service (IaaS), and platform as a service (PaaS). SaaS applications are mostly used by IT professionals, business users, and personal users. Products ranging from entertainment services, like Netflix, to advanced IT tools come under SaaS. SaaS products are mostly marketed to B2B and B2C customers.

As per recent McKinsey & Company study, technology industry analysts have predicted further growth in the SaaS market, and expect to see the market for SaaS products close to $200 billion by the year 2024.

SaaS Revenue Model & Its Phases

Before SaaS, the software revenue model was transactional and all that mattered was the initial sale of the software product. Big, fancy salesmen sold long-term deals for one, two, or even five million dollars a pop. Done. Hands dusted, gong rung, contract signed — all the revenue that was going to come from that deal had been generated.
Enter the SaaS revenue model. It swapped the single point of revenue with three essential phases: Initial sale → Retention → Expansion

There are three phases of the SaaS Revenue Model as listed below.

• Phase 1: The Initial Sale
• Phase 2: Retention Revenue
• Phase 3: Expansion Revenue

Phase 1: The Initial Sale

It still exists! And it’s still an essential part of the SaaS revenue model. “Closing” an initial sale includes everything from a simple self-serve upgrade to an annual contract shepherded by an inside salesperson.

If you play this phase well and show strong initial sales growth, you’ll get somewhere with your SaaS business. You’ll probably be able to raise some money, maybe even have a mini-brand — excellent! But these days, an initial sale brings in far less revenue than in the traditional SaaS revenue model. It’s still extremely important — you need a flow of new customers — but you also need to move on too.

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Phase 2: Retention Revenue

“You mean we have to keep them happy? Forever??” – Early SaaS pioneer

Quite so, Mr. Early SaaS Pioneer. There’s a new (SaaS) revenue model in town. Most early players, however, maintain the sales-first mentality even though they’re selling much smaller, month-to-month deals. They’re celebrating the initial sale disproportionately which is not correct for SaaS.

On the other hand, some SaaS companies quickly realized the importance of retention. Indeed, they saw that an initial sale didn’t matter much if a new account was canceled three, six — even 12 months later. They realized they couldn’t sustain growth if they churned the customers they brought in. These people know how to play the game of SaaS.

Today’s SaaS pros realize that retention is the biggest revenue opportunity in SaaS. An initial sale might get you $500 in the bank when you convert that deal. But retention, retention will bring in that amount times the number of months the account stays active. And why? Here’s some fast math on that point:

• 1 month (initial sale): $500
• x 12 months = $6k
• x 24 months = $12k
• x 36 months = $24k

Indeed, the revenue opportunity from retention is exponentially larger than the initial sale. Execute well in this second phase, my friend, and you will build a solid, sustainable SaaS business. Excellent! But wait — if you want to build a great SaaS business, crush the competition, and have a shot at an IPO, you’ll have to master the third phase of the SaaS revenue model: Expansion.

Phase 3: Expansion Revenue

Often overlooked, always important — this is where the true secret to SaaS growth lies. Savvy SaaS teams quickly realized that they could drive revenue growth by expanding existing accounts. Upsells, cross-sells, and any other sales that could generate additional revenue from existing customers became SaaS staples. And it worked earlier, mainly because the opportunity for second-order revenue was huge.

You understand the realities of the three phases of SaaS revenue. Excellent! But that’s only half the battle. The other half is executing against it. You’ll need to shift the way you look at adoption, customer service, sales, and marketing. Thanks to the SaaS model, the operations of software businesses are changing.

Customer relationships: In the SaaS revenue model, customer relationships are based on the ongoing delivery of customer value.

Marketing issues related to the SaaS/subscription model: Marketing strategies focus on growing subscribers through lead generation, branding, goodwill activities, and other efforts to create interest in the product or service.

Operational implications of the SaaS/subscription revenue model: Companies employing the SaaS/subscription revenue model should focus primarily on delivering cost-effective customer value.

Financial and strategic implications: In most cases, successful SaaS/subscription companies build up their subscriber base over a long period. In the interim, they require financing to develop delivery capacity as well as to support efforts to increase the user base.

Key metrics: SaaS/subscription companies consider key metrics to be customer retention and net new growth in subscriber numbers.

Modalities: While SaaS/subscriptions are most commonly thought of as single sales to individual subscribers, the SaaS/subscription model also works with bulk sales. Rather than selling one subscriber one subscription, a company can sell subscriptions in larger increments for a reduced per-user rate.

Costs and benefits of the SaaS/subscription model: The SaaS/subscription revenue model usually works best when a company is servicing ongoing and continuous customer needs. This means that customer relationships may span several years. It is often challenging to convince new customers to commit to long-term contracts, especially in the case of companies offering novel products or services.

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How to build a great SaaS revenue operation

To build a great SaaS revenue operation, there are three truths teams must accept:

1. SaaS revenue goes well beyond an initial sale. There are three essential phases of revenue and a SaaS business must execute well in all three phases to become great.
2. Building a management structure that provides continuity and strategic consistency across these three phases of revenue will ensure the best shot at success.
3. Product engagement is the key to winning the game of SaaS. Great SaaS operations understand this and find a way to bring this data to their team in the most actionable way possible. Great SaaS revenue models seamlessly integrate product engagement insights into every part of their customer-facing operations.

Conclusion

A good SaaS model provides lower costs, and lower commitment risk, and a try-before-you-buy model gives customers a remarkable opportunity to assess a product before making a purchase. For software businesses, on the other hand, the SaaS model presents an entirely new way to build, distribute, market, sell, and support a software product.

Now that you know about the revenue model of SaaS, let's get on board and start executing them in your business.

FAQs

What is SaaS?

Software as a service (or SaaS) is a way of delivering applications over the Internet - as a service. Instead of installing and maintaining software, you simply access it via the Internet, freeing yourself from complex software and hardware management.

What are the examples of SaaS?

Examples of SaaS are - BigCommerce, Google Apps, Salesforce, Dropbox, MailChimp, ZenDesk, DocuSign, Slack, and Hubspot. PaaS Examples: AWS Elastic Beanstalk, Heroku, Windows Azure (mostly used as PaaS), Force.com, OpenShift, Apache Stratos, Magento Commerce Cloud.

What are the three phases of the SaaS Revenue Model?

The three phases of the SaaS Revenue Model are:-

• Phase 1: The Initial Sale
• Phase 2: Retention Revenue
• Phase 3: Expansion Revenue

Is Netflix a SaaS?

Yes, Netflix is a SaaS that offers software to watch licensed videos. It follows a subscription-based model wherein the user can choose the suitable one as per its requirement.

Is Facebook a SaaS?

SaaS simply stands for "Software as a Service". Facebook is a consumer network product, not technically SaaS, but there's no other product that provides as many services as Facebook does.

Are mobile apps SaaS?

The new frontier for enterprise software as a service (SaaS) providers appears to be in mobile apps. While desktop platforms are still the backbone of any SaaS product, mobile apps are becoming increasingly important. Mobile apps and API connections are expected to add 0.71% growth to the SaaS Market Size.