SaaS is a cloud model where software is hosted and provided to customers over the Internet. Such businesses quickly cover the market, developing new products almost daily. As of 2023, the SaaS market is worth nearly $200 billion, which makes it one of the most popular models. Entering such a fierce and fast-paced environment might be challenging, to say the least. Besides, SaaS constantly evolves by implementing new strategies, monetization means, etc.
Hence, the idea behind the article is to guide you through all the intricate behind-the-scenes aspects of the SaaS business model. In this piece, we will cover not only the SaaS business model definition but also the development phases, handy metrics, tools, and examples.
Stick around if you are excited as we are!
What is a SaaS business model?
Quite self-explanatory, SaaS as a business model stands for software as a service. SaaS business model is a software delivery method where software is licensed on a subscription basis and centrally hosted by a third-party provider. This business model generates revenue by providing software solutions to single or enterprise-level users.
For more understanding, SaaS product always aims to be the key to solving specific problems. For instance, Zoom and Slack eliminate the remote work disadvantages by providing convenient messaging and video meeting features.
Notably, these products are cloud-based. Thus, they heavily rely on cloud computing to offer rich functionality and store the data somewhere. In return, users don’t have to download anything as the product usually works on the web. This distinctive and SaaS-exclusive feature makes the model stand out among others.
SaaS business models types
As the market evolves, new SaaS-based business models appear. However, there are several that are proven to be effective. They can be met in numerous products we use regularly. Let’s take a look.
Notably, freemium is a wordplay based on the words ‘free’ and ‘premium. This model is common in SaaS business thanks to the flexibility it offers to users. This model has a relatively simple strategy.
Generally speaking, the SaaS development company offers two ways to use its services with this model. The first is a free product with basic functionality available to the user. Often, its functionality is limited, but it is enough to try out the app and see if you like it. The free version of the product is typically enough to attract a solid customer base but not comprehensive enough to satisfy the needs.
Another way opens when the user gets satisfied with the free functionality and decides to stick with the premium version of the content. Accordingly, users can subscribe to gain access to more advanced features, paid upgrades, or an ad-free experience. Here’s a visualization of the flow in the freemium model.
Overall, the freemium model has several solid advantages. It allows SaaS companies to acquire a sufficient user base to expand their presence in the market efficiently. Besides, the freemium model is a reliable revenue generator because it is highly customizable in time and pricing.
Nonetheless, implementing the model requires thorough planning to ensure two core aspects:
- To attract customers and give the feeling that there’s more to discover, the free version of the product has to be compelling enough.
- The premium version has to be immersive enough to keep the existing users entertained and satisfied. Besides, it has to be regularly updated with the content (if applicable) and responsive to user suggestions or reviews.
The flat pricing model represents a pricing strategy where a SaaS company offers its software for a fixed price for a specific time period. In a nutshell, customers have to pay a flat fee and can use the software without limitations and additional charges. More importantly, the number of users covered with the subscription and the amount of usage don’t matter.
This model is quite popular among companies because it's streamlined and reliable. It is preferred in companies that offer a specific kit of features or functionality instead of customizable options. Flat pricing is transparent and trustworthy, which allows it to attract more customers and increase conversion rates.
BaseCamp, a project management tool, features a wonderful implementation of this model. It is often referred to as the “one-size-fits-all” model, which clearly describes the idea of it. The same is with Basecamp, as they offer everything for a transparent price which you can adjust to paying monthly or yearly.
The only notable drawback is that flat pricing may not suit all SaaS businesses. Any product with a complex pricing strategy or custom options won’t benefit from the straightforward method this model provides.
Usage-based pricing involves charging users based on the amount of content or resources they use. Hence, the more users consume, the bigger the final bill. Usage-based pricing is not quite popular in SaaS, but certain companies still use it. It may not be popular since monetizing certain types of content is impossible based on the usage volume. It would be inappropriate for Netflix to charge users for each episode they watch. You get the idea.
This model is used in utility-minded services and apps. For instance, it is commonly used in API-providing companies that charge users based on the number of API calls they make. Here’s an example of how OpenWeather allows different numbers of API calls depending on various subscription options.
In a nutshell, the scheme is pretty simple. Depending on your chosen plan, you have limited API calls available. Consequently, the more expensive options offer more calls.
Nonetheless, usage-based pricing can be suitable for products that offer custom usage patterns. Customers pay for what they need rather than the predefined features they might not want. Basically, this concept sounds quite comfortable, as users can have changing needs. Thus, they only benefit from the value and transparency.
On the one hand, the provider is obliged to create high-quality content, efficiently use the resources and keep the platform optimized.
On the other hand, the customer has to effectively use and manage the resources given and avoid exceeding the limits or waste. Thus, usage-based pricing mediates qualitative cooperation between users and SaaS providers.
SaaS business model pricing is designed to generate revenue based on the number of users accessing the software. In this matter, the SaaS-providing company changes a fixed price for each customer who uses the software. Usually, they operate on a monthly or annual basis.
Typically, this pricing model is the most common among companies heavily relying on teamwork and online collaboration. Thus, the per-user pricing model is very profitable yet flexible in terms of scaling itself. For instance, it can be adjusted to offer a single-person or enterprise-level subscription. Teams also benefit from this model as it allows them to scale their usage of the software as they grow while also providing predictable costs that can be budgeted.
At its core lies the idea of providing different pricing plans where each plan has a different set of features and functionality depending on the price threshold. Typically, pricing caps are organized in tiers, each offering a progressively higher level of service. In this matter, the cheapest versions provide everything for comfortable usage covering all the basic functionality, yet with minor limitations important to some users. Here’s the most common implementation of this model by DocuSign.
The main advantage of tiered pricing is that it offers users a variety of choices that best meet their needs. Thus, thanks to the flexibility, this model allows SaaS companies to cover a much broader audience and quickly cover attention.
This pricing model is often an amalgam of all listed above. Normally, it combines two or more different pricing models into one. For example, a product can offer a base subscription fee for a certain service and add more paid options along the way. For instance, game publishers can make their games free but add in-app purchases. Also, they can allow players to access online mode via subscription.
It’s worth noting that the hybrid SaaS business model quickly spreads its narratives all over the SaaS market. Why? It is highly customizable. Most modern apps are quite flexible, combining numerous features and services. Thus, applying a hybrid model allows them to effectively monetize the content leaving room for the customers to choose what they want.
Main phases of SaaS business
Same as every other product, SaaS startups have their own life cycle. Understanding the entire way your business has to undergo may be very helpful in choosing the right model. It’s worth noting there are many steps in it, but let’s make it convenient. Instead of listing a dozen of stages, let’s highlight three major ones.
This stage includes a lot of phases as it’s where the whole product is born. Normally, it is discovery, product design stage, development, and testing. Often, there must also be room for maintenance and ongoing support to release new features and updates.
During the growth phase, companies choose the business model and test it. Consequently, they develop the model they chose to perfection to acquire a solid customer base and gain a foothold in the market.
It’s also worth mentioning that, at this point, companies usually have a small team and quite limited resources. Hence, establishing a product-market fit becomes a main mission to survive in the market. Accordingly, the startup focuses on developing and launching the product. Besides, it has to acquire a solid amount of customers and interest in the product to move on to the next stage.
Once the product has found its place in the market, it may still seem unstable. Thus, active growth is all about expanding your product on the market, attracting new customers, and returning the initial investment.
For the active growth phase, companies set goals to scale the team and infrastructure and increase revenue while maintaining customer retention. Once the company matures enough, it moves on to the next stage.
During startup scaling, the business model aspect is the most crucial. At this stage, it becomes obvious whether or not the choice has been right. Besides, there’s always room for improvement. For instance, teams accurately monitor the performance, and once something goes wrong, they adjust the model they choose to fit ever-changing needs.
At this point, the SaaS startup ought to be stable and already have a huge customer base. Its focus also shifts. For instance, companies shift from a growth to a profitability perspective. Why? Probably because maximizing shareholder value is one of the good ways to take root in the market.
Nonetheless, for successful SaaS companies, the sky’s the limit. Exploring new markets, revenue streams, or even new products became a reality. Having sturdy ground to stay on, businesses also take care of their product, regularly innovating and improving it to meet customers’ changing needs.
SaaS business model metrics
Tracking SaaS products’ performance is a vital part of the whole business. There are numerous helpful metrics to evaluate different aspects of your app. Some of them are users’ interest, churn percentage, and retention rate. Thus, understanding how to work with them may open new ways for improvement and potential updates.
Lifetime value (LTV)
The lifetime value metric is an essential component of long-term revenue planning. Generally speaking, it calculates the amount of revenue a customer can generate throughout the entire usage time.
Besides, it works fairly simply. You can calculate LTV by multiplying the average revenue per user (ARPU) by the customer’s average length of time they stay subscribed to the service. Analyzing LTV helps SaaS companies to predict customer acquisition costs and compose viable pricing strategies.
Customer acquisition cost (CAC)
This metric calculates the total cost a business incurs to obtain one new customer. Why there’s a need for CAC? If the company has an estimate of how much it costs to attract one, then it will be easier to figure out how much investment is required to obtain 1000 new customers. Thus, CAC can easily scale and become a resultative tool with the right analytical approach.
Typically, you can calculate CAC by dividing the total cost of acquiring new customers by the number of new customers acquired during a specified time period. For more understanding, let’s imagine a SaaS business spent $10,000 and acquired 100 new customers over this time period. Thus, the CAC would be $100.
Monthly and annual recurring revenue (MRR and ARR)
MRR and ARR are essential metrics for measuring a SaaS business's performance. MRR stands for the amount of recurring revenue that the company earns on a monthly basis. It is calculated by normalizing your recurring revenue into a monthly amount.
On the other hand, ARR is the annual recurring revenue normalized in a year span. Obviously, ARR is calculated by multiplying MRR by 12.
Why is it useful?
Predicting how much your company can generate with the current customer base in a month and a year can significantly simplify the planning process. Moreover, regularly tracking both ARR and MRR can help identify trends and people’s reactions to updates. The latter, in turn, allows you to make data-driven improvements.
This measurement defines the percentage of customers who stop using a service during a period. Churn rate is so far the most popular metric, thanks to its simplicity. For instance, a 10% churn rate occurs when the company has 100 customers and loses 10 of them during the month.
As you can see, each part of the churn rate equation is a variable that can be fed with different numbers and time periods. Thus, its flexibility allows analyzing your customer base's likings and their reaction to the content of your SaaS product.
Besides, it is a fundamental metric to be acknowledged, as the churn rate is one of the most crucial aspects of successful growth.
Related reading: 10 Biggest Problems for SaaS Companies and How to Solve Them
The exact opposite of the churn rate, the retention rate represents the percentage of users who keep using a product over a given period. Calculating the retention rate is also fairly simple. Normally, analysts define a specific time period, take the total number of users from the beginning of the period, and see how many of them continue to use the product by the end of the chosen period. This metric is especially useful to identify the loyalty and satisfaction of your users.
Proper retention rate treatment can do wonders with your startup. It’s an extremely important metric to take advantage of, as it’s very helpful in managing your audience. Besides, it is even more crucial in a SaaS environment because most software solution companies rely highly on their audience.
Understanding the combination of all metrics listed above can seriously improve your startup's progress. Moreover, regular analysis can reveal the lacking points of your product in their forming period. Hence, you will have enough time to eliminate them.
SaaS business model examples
We have already covered various pricing models, SaaS business lifecycles, and metrics you should consider. Regarding examples, looking at successful cases can help you compare your idea to others. Moreover, you can study practical cases and observe how the business model fits the product, how it generates income, and what potential points are there to improve. So, let’s take a look at companies that took the most from the models we listed.
This software is one of the most popular online collaboration tools available in the market for free. It is designed to organize teams' work into tickets neatly placed on customizable thematic boards. Trello’s functionality is highly adjustable, as many useful details may come in handy. As a result, over 2 million teams all over the globe use Trello to manage their workflow.
At its core, Trello takes advantage of the freemium model we mentioned earlier. In Trello, the lion’s share of the functionality is free. Only advanced and customization features are available with the subscription. Besides, it also has tiered pricing where users have a choice depending on their needs.
What is more interesting, Trello has an in-built per-user pricing for the enterprise-level subscription. Such a decision allows teams to manage the expenses depending on the number of users, which is really a next-level play by the Trello team.
It is a solution that provides marketing solutions for companies. It is designed to establish communication with your clients, organize marketing campaigns, and work with the analytical side of the process. Currently, MailChimp holds 66% of the market share, making it the absolute leader in the market.
As a SaaS business model example, Mailchimp offers quite flexible hybrid pricing.
Notably, they offer a free version, allowing users to test the functionality first. Also, they combined tiered and per-user pricings into three comfortable types: unlimited ‘premium,’ ‘standard,’ and ‘essentials.’ For instance, the latter is relatively cheap yet offers a pretty neat set of features.
At Codica, we had a chance to work on the SaaS solution to eliminate administration hustle from the creative environment and business relations. Thus, we developed a highly performant and reliable SaaS platform for bakery business.
In our work, we adhered to the best development practices, which resulted in catchy UI/UX design, optimized performance, payment security measures, and advanced third-party integrations. Let’s admire a little, shall we?
Regarding the mission of the startups, we decided to stick to a minimalistic approach in business model choice. Hence, we developed two-tiered pricing with two purposes: to give users a choice and not overwhelm them.
As a result, a combination of a free trial and only two subscription options became a no-brainer and greatly simplified customers’ acquaintance with the platform.
Essentially, Slack is a messaging app for business purposes. It is designed to organize teams’ workspaces and establish effective communication within them. Slack offers various features to simplify the working routine, including huddles, clips, and third-party integrations. Obviously, such a comfortable product did find its place on the market. Only between March 2020 and April 2021 Slack generated over $900 million in revenue.
Speaking of monetization, Slack business model is fairly simple. Apart from the time-limited free version, it offers three plans. The ‘Pro’ plan is the most common, providing everything needed to organize efficient teamwork. The other two are ‘Business+’ and ‘Enterprise Grid.’ While ‘Business+’ provides additional features to scale your company’s communication, the latter is designed to cover enterprise-level needs.
Helpful tools to optimize SaaS business model
Nowadays, one of the strongest advantages of the SaaS business model is the number of tools available. In fact, there are so many startups that it gets overwhelming to choose the right tool to suit your business’s needs. Let’s cover a few we take advantage of at Codica.
This name stands for customer relationship management. It is a tool that simplifies interactions with customers on behalf of business owners. Normally, it is used to track customer interactions and keep records of all communication with customers. It includes phone calls, emails, or conversations. CRM software can also be used to manage sales leads, automate marketing campaigns, and provide analytics on customer behavior.
At Codica, we do our best to implement a CRM system in every software product we create. As a result, it allows our clients not only to own the business but to observe metrics and take part in its analytical aspect. We also make emphasis on this feature’s flexibility. Hence, our clients always receive a customizable dashboard that can be adjusted to analyze the ever-changing activity on the platform.
This service represents a set of tools that can help you track your startup. To cover such a gigantic tool, let’s break it down into several benefits you can get from properly using it.
- Increase retention. With provided tools, you can predict potential churn risks. Thus, tracking user behavior may reveal patterns that result in canceling the subscription. Thus, it is crucial to take proactive steps to satisfy your clients before it backfires on your business’s performance.
- Identify opportunities. Analyzing your audience's likings can help you identify product improvement areas. For instance, you can detect opportunities when users form a trend about some aspect of your app. Alternatively, when they search for a specific feature you currently don’t offer, it’s a green light for updates.
- Understand user behavior. With the tools Google Analytics provides, you can detect various activities your customers are into. For example, their navigation patterns, preferable content, the average time of how long they stay active in the app, and many others. These metrics can then be formed in complex research, which may show you the path for future improvements.
Product discovery role in business model choice
Each startup begins from the idea glimpse. The road from the idea to its implementation is the most thorny and requires thorough planning and analysis. Besides, the proper business model choice can highly affect your startup and make it either successful or mediocre.
At Codica, we built a serious expertise in consulting our clients with the best business model choice and the whole way of transforming prospective ideas into successful businesses performing a product discovery. With our thoughtful approach, you can enjoy all the various benefits of the SaaS business model we choose to build your project on.
Every project we take starts with product discovery. Essentially, it allows us to evaluate, monetize, and build the brand around the idea. This process allows our clients to test their ideas and save costs in case they are inefficient or nebulous.
Depending on the project specifics, we can easily modify the team who performs this task. Moreover, inviting experts from different areas allows us to look at future projects from all possible angles. For example, our software engineers, design team, project managers, DevOps specialists, and QAs usually participate in the process by providing their expertise.
Summing everything up, the business model choice for your startup is a very important step. After looking at various business model types, helpful metrics, and examples, it is clear that the success of your business highly relies on the monetization you choose. Hence, this step requires thorough planning and analysis to make your way to the market efficiently.
In this matter, Codica is always up to becoming your reliable partner. Over the years, we developed strong expertise in consulting our clients in various fields. Apart from SaaS development, we are keen on building marketplaces, PWA solutions, mobile apps, and MVPs. If you are excited as we are, feel free to check our portfolio.
Finally, if you have an idea to start your SaaS business and shake the market – embrace the challenge. You will have to go from the idea glimpse to a fully operating company on your own. However, entrust this matter to professionals and contact us if there's even the slightest doubt.