Running a SaaS business may seem easy on paper, considering the surge of its popularity in the past decade. However, many SaaS businesses struggle with sustaining themselves past the five-year mark (sometimes, earlier) despite an initial run of success. For a market sector that is one of the fastest growing in terms of economy, there are many challenges that SaaS providers have to contend with to maintain their foothold in the market.
While the SaaS model is built for success, setting a business around it requires a shift in perspective and the understanding that such business cannot be run along the same lines of a traditional online venture.
So, what challenges do SaaS businesses encounter?
Lack of Market: As we’ll see later, one of the key goals of a successful SaaS business is finding the right product/market fit for your business. Most businesses jump into the fray, hoping to solve an existing or perceived problem, without taking the time to figure out if there is a viable market that will sustain the product. The lack of a market can either be due to:
- The existence of well-established solutions that already serve that purpose
- The market that benefits from it is too limited and exclusive to sustain the product’s long-term success.
Fast Adoption: Failure to identify and eliminate barriers to fast product adoption is yet another pitfall that many SaaS businesses fail to avoid. This includes implementing seamless and friction-less billing, on-boarding and other customer nurturing tactics. Companies are often laser-focused on acquiring new customers, especially in the beginning, when they should be focused on customer retention, as well.
Cost of Customer Acquisition: The cost of customer acquisition often exceeds the revenue generated from closed customers, especially for start-ups. The time it takes to break even and start recovering costs can have a long-term impact on the business’s overall success.
In this article, we take a look at the factors that define the SaaS business model, and what strategies are paramount in making it a success.
Defining the SaaS Business Model
From the perspective of the vendor, the success of the SaaS model can be defined and determined by three primary aspects:
The objectives of any business model include the direction which the business plans to take, the milestones that determine the success of the business, and most importantly, the strategies that will help it grow organically over time. The SaaS business model is defined by three main dimensions:
- Profitability, measured both on the customer and product level and defined through KPIs such as Customer Acquisition Cost (CAC), Customer Lifetime Value (LTV) and workforce productivity
- Revenue, centered on indicators like Monthly Recurring Revenue (MRR), CAC, and
- Growth, which determines the market-growth potential of the business, tracking metrics like the total number of Product Qualified Leads generated, the Average Number of Customers, Average Revenue per Customer and Churn Rate.
The product-market fit establishes the point where the purpose of your SaaS product aligns perfectly with the needs and requirements of your target market, thereby making that market capable of sustaining your business’s growth in the future.
The cloud-based nature of the SaaS model allows you to establish product-market fit much quicker than traditional software vendors. The near-constant connection between vendor and customer can help SaaS providers to understand their market much more easily through tactics such as:
- Establishing a constant feedback loop during product development with customers at every iteration, soliciting their suggestions to improve the product
- Integrating feedback channels within the product itself that allow customers to be directly involved in improving the product
Strategic advantage encompasses the features and capabilities that can contribute both to present and future success over the competition. These capabilities should be hard to imitate and have a huge application potential in multiple niche markets.
The capabilities that give the SaaS product its strategic advantage are generally:
- Core features that make the product stand out from others in the market
- Branding and messaging that lead consumers to perceive value in the product over its competitors
SaaS Revenue Models
When it comes to deciding what revenue model to build a business on, two questions must be answered:
- Does the model allow for a scalable way to acquire new customers?
- Does the model allow you to monetize these acquired customers at a higher rate than the cost of their acquisition?
Based on the above two questions, we count five sustainable revenue models on which a SaaS business can thrive:
1. The Recurring Revenue Model
Most SaaS businesses are built on the recurring revenue model: the revenue is acquired through repeated payments over an extended period of time – more specifically, the customer’s lifetime – determining the LTV.
If the customer finds value in the SaaS solution and is able to attain their business goals through the product, they will stay on, opting to renew their subscription. The longer the customer stays, the higher will be the ROI on the customer acquisition cost (CAC).
The only drawback of the recurring model is that the revenue will be slow-going at the start, and depending on how quickly customers adopt and gain value from the product, will take time to get to the point where the business can see a significant return on investment.
The sustainability of the business’s cash flow in this instance is centered on two key guidelines:
- LTV:CAC ratio, which should ideally be greater than 3; implying that the lifetime value of a customer should at least be 3 times greater than the cost of acquisition for that customer.
- The time required to recover the CAC, which should ideally be less than 12 months.
SaaS businesses can opt for two types of recurring contracts:
- MRR (Monthly Recurring Revenue)
- ARR (Annual Recurring Revenue)
The overall/net recurring revenue is, therefore, contingent on three factors
- New MRR (or ARR) which is the revenue added from new customers added during the month (or year)
- Churned MRR (or ARR) which is the revenue lost due to customers who have exited during the month (or year)
- Expansion MRR which is the revenue generated from existing customers who renewed their subscription.
2. Viral Customer Acquisition
This is an effective revenue model since it doesn’t require any marketing investment, and is entirely contingent on the existing customer base and the power of the internet. When a business is able to successfully monetize the customer acquired through virality, they’ll have a good revenue model on their hands. In terms of the two key variables CAC and LTV, when true virality is achieved, it can result in high returns on CAC with low churn rates.
Unsurprisingly, though, only a very few companies have been able to successfully build their business through viral growth. True viral success is dependent on two main parameters:
- Viral Coefficient – denoted by K – which is the percentage of referrals that convert into paying customers, which should be ideally greater than 1.
- Viral Cycle Time, or the total time elapsed from the point where a customer sends out a referral invite to the point where the invited customer signs on to use the product. The shorter the time, the higher the effect on the growth.
Unlike the recurring model, the success of this model is highly dependent on the true efficiency of the SaaS product to deliver value to its customers. The more efficient it is, the higher its shareability, and consequently, its virality. Marketing can only take you so far in this case.
3. Free or Freemium Model
This model centers on acquiring customers by offering a free product or service. The key to achieving success with this model is ensuring that the free product you’re offering is of value to a customer’s needs to the point where they’re willing to try the rest of the product or convert to paying users.
4. Field or Direct Sales
This model uses direct sales facilitated by salespeople who go out into the field, face-to-face with customers to sell the product. This model has a much longer sales cycle than the other models mentioned above, and consequently a higher ramp time before any discernible results can be seen.
5. Channel Sales
This model uses additional sales resources from channel partners to sell the product; it, therefore, allows the SaaS company to take advantage of the channel partner’s existing customer relationships to acquire customers of their own. However, like direct sales, this model has a sales cycle that is not entirely controlled by the SaaS vendor and results in higher customer acquisition costs and marketing investment.
Defining SaaS Growth Goals
Any good SaaS marketer worth their salt loves data and relies on data analysis to identify growth opportunities and unearth any problems within their current strategies. It follows that marketers must structure the growth goals around data metrics that determine a business’s performance.
With that said, a SaaS company’s growth goals can be structured around five main KPIs:
Acquisition: Increase the Total Number of Customer Acquisitions
KPI: Number of new customers
This goal centers on increasing the number of successful conversions from qualified leads to customers. This is, admittedly, a broad metric that tracks a customer’s journey from a visitor to a Market Qualified Lead to a Sales Qualified Lead, and finally to a customer.
Activation: Increase the Average Transaction Value
KPI: Average revenue per new customer
This goal is about increasing the average revenue generated per new account or customer. Strategies that are implemented to achieve this goal include product improvement and improved and targeted buyer personas.
Other metrics that can be tracked during this phase include:
- Daily Active Users
- Monthly Active Users
- Average Onboarding Time
Retention: Increase the Frequency of Repurchase
KPI: Monthly revenue churn rate
This goal centers on increasing a customer’s lifetime and reducing the churn; in other words, it centers on successfully retaining acquired customers through proper nurturing and retention strategies.
Profitability: Increase Monthly Recurring Revenue
KPI: Monthly Recurring Revenue
The SaaS business’ profitability is contingent not on the revenue generated by new customers, but on the revenue generated by its existing customer base. Therefore, the Monthly Recurring Revenue is a crucial indicator of a business’ ability to recover the costs of acquisition and other marketing investments.
Virality: Increase Customer Referrals
KPI: Viral Coefficient
As previously discussed, virality is the ability to grow on the merits of referrals from qualified customers who have successfully used the software and gained value from it. The virality is defined by the KPI known as the Viral Coefficient, which is discussed above.
Understanding SaaS Pricing Strategies
Free trials are a crucial component of most SaaS pricing strategies: the concept being that offering a prospective customer a time-limited free trial of the product allows them to assess it without the prospect of paying hanging over them. Once they gain a sufficient benefit from the product, it gives them the incentive to upgrade to the full version when the trial period ends.
Most free trials are time-limited, but some SaaS companies choose different restrictions on the product such as number of usages or number of users per account, for example.
According to Lincoln Murphy of Sixteen Ventures, choosing the right pricing structure is not a one-size-fits-all proposition. The right pricing depends on a number of factors including:
- The type of customer the business is targeting
- The business’s current standing within its market
- And most importantly, the product itself
More to the point, a pricing structure is never, and should never be static; it will change over the course of the company’s growth. With that being said, some of the pricing structures that SaaS businesses often use include:
- Flat Rate Pricing which includes a single, usually monthly, flat price for a single set of features
- Usage Based Pricing, which bills the customer according to how often and how much they use the product. The more they use it, the higher the pricing.
- Tiered Pricing, which is the most popular pricing structure used by SaaS businesses. This one allows companies to offer multiple packages that are priced differently based on the features and restrictions available on each tier.
- Per User Pricing, where the pricing scales the number of users per account. The more users within a company account that use the product, the higher the price.
- Per Active User Pricing, a more flexible version of the previous structure, where the customer is billed only for the number of active users within the account.
- Freemium Pricing, is typically part of the tiered pricing structure, and where the tiering starts with a free entry-level tier.
Each of the pricing structures above has their pros and cons, and businesses need to weigh them along with factors such as their target audience and product type to determine the pricing structure they are going to use.
Customer Retention Strategies
According to forEntrepreneurs, 70-95% of revenue comes from upsells and renewals. This little factoid underscores the importance of implementing effective customer retentionand nurturing strategies to derive more value from them. These include:
Upselling involves selling to an existing customer base, with the aim of increasing the revenue generated from them. This could include product add-ons, package upgrades or even, independent services that can add value to the customer’s experience.
Upselling techniques can accelerate a business’ growth and profitability if done right. The difference between upselling and product marketing is, of course, in the target: your existing audience doesn’t need aggressive selling tactics since they already know the value of the product. Upselling tactics are generally subtler and less on-the-nose.
Advocacy involves encouraging and incentivizing an existing customer base to promote and refer the product to their peers and acquaintances, with the aim of gaining potential customers (and additional revenue). SaaS businesses can identify potential advocates through online surveys or feedback forms and then target those users for referral programs and incentives Successful referrals can be incentivized and rewarded by special offers or deals that will encourage them even further.
Predictive Marketing and the SaaS Model
The nature of the SaaS model gives providers unfettered access to a large volume of data acquired through the CRMs, customer feedback forms, billing system, etc. It is this data – big data – that forms the basis of any SaaS marketing strategy.
Predictive marketing is one such strategy that allows marketers to predict a business’ future performances through analysis of data from the past and the present. The predictive marketing model establishes and analyzes patterns in the data to determine:
- What happened in the past
- Why it happened
- What is happening now
- What might happen based on the patterns established in the past and present
- What will likely happen
The predictive model becomes increasingly accurate as more data is accumulated, and patterns and trends are further established. Using predictive analysis and metrics such as ROI, LTV, and COCA, you can create highly efficient and incisive marketing campaigns with higher success rates.
The SaaS model is one of the most successful business models, to date, and one that is likely to sustain its dominance over the years to come. Especially, in this age of big data and information, it is tailor-made to thrive on strategies that are built around data mining and analysis.