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Remember when software was a physical product? You bought a compact disc or two that you inserted into a slot on your computer and waited for the software to install.
Those days are gone, and most software now is sold virtually online, often as a recurring subscription. This is software as a service, a phenomenally fast-growing market that’s projected to expand from $315.68 billion in 2025 to $1.13 trillion by 2032. Let’s break down what you need to know about the SaaS business model, from its core definition to how SaaS businesses make money, how they measure success, and how they serve consumers.
Software as a service (SaaS) is a cloud-based software delivery model where computer programs are licensed to users on a subscription basis. The software developer (or third-party service provider) hosts the application for the user who accesses it by logging in through a web interface on a desktop or mobile app.
Suppose a business needs a robust email marketing solution and doesn’t want to manage the hassle of in-house deployment and infrastructure on its own servers. Customers like this match well with what SaaS applications have to offer. And there are a lot of them out there. In 2023, a whopping 73% of organizations were using SaaS apps.
The SaaS business model is popular because it eliminates the thorny brambles of managing licenses, software installations, data storage, and backups. The SaaS software company takes care of all that, providing frequent and seamless updates and maintenance. Shopify, for example, is an ecommerce SaaS provider that powers more than five million online stores.
SaaS may sound like something only businesses use, but consumer versions of it are ubiquitous. Netflix, for example, charges a subscription fee for consumers to use its platform and software to stream movies and other entertainment.
SaaS comes with advantages and challenges to consider.
The benefits of SaaS solutions make them attractive to customers for the following reasons:
Despite many advantages, SaaS growth strategies aren’t without challenges:
Sales approaches differ based on how much a business interacts with its prospects. There are basically three SaaS sales models businesses can adapt to build the customer relationship:
This subscription model is great for those on a budget because there’s little personal interaction with the sales team. It’s all automated, with tools like pre-recorded product tours, chatbots, how-to articles, and FAQ pages to guide prospects through the sales funnel. It’s a good way to get leads to try before they buy or upgrade. You do your marketing through various channels like content marketing (SEO, blogging), social media, email marketing, and affiliate marketing.
In a high-touch model, the sales team works directly with prospects, from the very beginning to the end of the sales journey. They get to know their needs and lead them through demos and product tours. They generate leads through phone calls, emails, and advertising.
The SaaS service’s team also helps with onboarding, setting up the software, and training. This sales approach is more suitable for larger businesses with more complicated requirements (like legacy system integration and unique security needs) than smaller clients, whose more basic needs don’t require as much hands-on attention.
SaaS companies that offer high-value, complex services rely on this more hands-on approach. They tend to have higher customer retention rates because the service is tailored to specific client needs, but it’s also more expensive.
This scalable approach combines the best of both worlds: low touch and high touch. When needed, you can get the hand-holding support of high touch, but for entry-level engagement, you can also opt for more efficient low-touch sales. Customers can choose the level of support that works best for them.
For a SaaS business to succeed, it must nail down a competitive pricing model. Here are some popular approaches:
Tiered pricing offers different subscription packages at varying prices, including entry-level, mid-level, and enterprise-level tiers, each with unique features, usage limits, and support. It caters to diverse customer segments and budgets, and it provides customers with more choices.
In this model, the price of the product goes up as the number of users grows. It’s easy for businesses and customers to understand, but it can get pricey when the user base expands, which might lead to customer dissatisfaction and losses. To avoid this, you could offer discounts for large user bases.
For this approach, users pay based on the features they use. The price directly links to the value each feature offers. It’s a model suited to customers with different needs.
Instead of charging based on features, you could offer pay-as-you-go pricing. This means customers pay only for what they use. For example, you could charge based on the number of emails they send or the amount of server resources they consume. The more they use the service, the more they pay.
This simple model charges a flat fee. It’s straightforward and easy to keep track of, but there aren’t as many chances to upsell.
To thrive and grow in a tough market, SaaS companies need to keep a close eye on key performance indicators (KPIs) that show them what’s really going on.
MRR stands for the total amount of money a business makes from user subscriptions in a single month. It measures how effective a company is at attracting and retaining customers. Although it indicates growth, MRR doesn’t measure profitability because it doesn’t account for business costs.
This information helps set goals for marketing and sales teams. If MRR is falling, it’s a clear sign the company needs to improve its products or revamp its marketing efforts. Here are some other recurring revenue types that you should keep an eye on:
Customer lifetime value is the total amount of money a business can expect to make from a customer over the entire time they’re subscribed. This helps businesses figure out how much money they will make and how to spend their resources. Companies with high CLV usually focus on making sure their customers are happy and staying with them.
CAC is how much it costs to get a new customer. This includes marketing and advertising expenses. The ideal CAC value depends on your business and the market, but here’s a general rule: CAC should always be less than lifetime value. Knowing your CAC helps you plan your marketing budget and figure out how to price your products or services.
NPS is a simple yet effective way to gauge customer satisfaction with your SaaS product. It’s based on a standard question: “How likely are you to recommend our product to a colleague or friend?” This metric closely correlates with the quality of your product features, the effectiveness of your customer service, and the user-friendly nature of your interface.
Churn rate is the percentage of clients lost during a defined period (e.g., week, month, quarter). A lower churn rate makes it easier to forecast future SaaS revenue and indicates a healthy business. A high churn rate signals that the product may not meet audience needs, or that there’s tough market competition.
Examples of SaaS businesses include Shopify, Zendesk, Zoom, and Slack. While these services are geared toward businesses, there are plenty of consumer-facing SaaS businesses, like Netflix and Canva.
Some Saas companies have grown exponentially, but here’s the catch: Scaling can also eat into profits if you don’t manage your key metrics well. When you’re growing fast, you need to invest in infrastructure, security, storage, and expanding your team. This can mean lower profit in the short term. But if you can keep your LTV/CAC ratio healthy and your churn low, you will be on your way to long-term profitability.
The Rule of 40 is a simple way to check if software companies are doing well financially. It says that the combined total of a company’s annual revenue growth rate plus its profit margin should be at least 40%. A startup might have a 40% growth rate and a 0% profit margin. A more established company might have a 20% growth rate and a 20% profit margin. A very mature company might have a 10% growth rate and a 30% profit margin.
