For customers, the benefits of the SaaS model are clear. It brought lower costs, lower commitment risk, and a try-before-you-buy model, which gave 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.
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 literally affected 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 time period, in exchange for the use of a software application or other tool.
The Three Phases of the SaaS Revenue Model
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, 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
SaaS Revenue Model 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.
SaaS Revenue Model 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 cancelled three, six — even 12 months later. They realized they couldn’t possibly 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.
SaaS Revenue Model 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 sells 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 even 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 time 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. See our related article on licensing for additional variations.
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.
In order to build a great SaaS revenue operation, there are three truths teams must accept:
- 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 in order to become great.
- Building a management structure that provides continuity and strategic consistency across these three phases of revenue will ensure the best shot at success.
- 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.
Now, that you know about the revenue models, let's get on board and start executing them in your business model. Let us know your views on the article in the comments section below.