SaaS Business Model: How It Works And How To Make Money With It

Software as a Service (SaaS) business model is a cornerstone of modern business strategy. It has already transformed the traditional business software paradigm with its subscription-based, internet-delivered approach. With 99% of companies using at least one SaaS product routinely, the Software as a Service industry can be a very lucrative one to join.

Successful SaaS products are convenient, scalable, easy to adapt and maintain, invaluable when it comes to creating strong customer connections. 

Here, we will dissect the SaaS operating model, its financial dynamics and the biggest benefits. Most importantly — we will cover revenue models and the ways to make money with a SaaS business idea.

What is the SaaS Business Model?

Before we can talk about the specifics of SaaS development, monetizing SaaS products, and the biggest trends that will shape this industry in the coming years, let’s start with the basics: what Software as a Service business model is and how it works.

Software as a Service is a software distribution model where the application is hosted on a cloud service and the customer can access it over the internet, as opposed to the traditional distribution model where the application is installed on the customer’s computer and is not necessarily dependent on the internet to run.

SaaS is closely related to the cloud software industry, although they are not completely the same. SaaS software has a nearly endless variety of uses, both personal and business-related, and the complexity, functionality, and adoption rate of SaaS products continues to expand. Over the past 7 years, the SaaS industry has grown by 500% and is only expected to go up from here.

How does Software as a Service work?

SaaS companies develop applications on-site and distribute them over the internet. In other words, they are free of any physical distribution models. Some Software as a Service releases are a product of collaboration between two or more development companies. Here is how you normally build a SaaS business:

1. Discovery & ideation. The founding team (business owners) of the SaaS company identifies a key business problem that needs solving. Market research and competitive analysis leads to ideating potential software-based services with differentiating capabilities. User personas, pricing plans and go-to-market strategies are drafted.
2. Software development. The initial software application is designed, built and thoroughly tested based on the ideation phase. A MVP (minimum viable product) may be launched with critical features to garner early customer feedback for iteration. Ongoing agile development enhances platform capabilities.
3. Onboarding. Once ready, prospective customers can sign-up online via self-service model to choose the appropriate software plan. Onboarding tutorials and configuration guides ease the initial setup process.
4. Deployment & integration. The SaaS provider assists enterprise customers in launching the software by enabling integration with existing IT infrastructure through APIs for a unified interface.
5. Usage & support. Customers leverage the SaaS solution’s capabilities while technical support and expertise is provided 24×7 by the vendor to maintain systems and address feature requests.
6. Maintenance. Seamless updates, security patches, data backups and migrations are handled by the SaaS company without affecting client productivity.

Developing a SaaS product, a vendor can focus on different industries, decide to only work with enterprise-level customers or startups, and choose different distribution models and revenue streams — more on that later in the article. SaaS businesses often start with limited MVP offers, and later pinpoint the most successful features a particular model involves to create a SaaS that will capture users’ attention.

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The history of SaaS products

Software as a Service is commonly imagined as a product of the internet, but this type of software has been around long before the internet became widely available. In fact, most of the early SaaS customers used to access the necessary software using floppy disks. Here are more facts about the history of Software as a Service, from its early days to the current state of the technology.

1. The earliest known example of SaaS was called the Compatible Time-Sharing System. It was developed by MIT in 1961 to help companies that needed to use computing powers but did not want to invest in an expensive mainframe.
2. The next two or three decades saw a shift to computer hardware becoming more accessible and companies preferring to provide their employees with personal computers on-site. However, the same companies often struggled with the costs and effort needed to install and maintain the software on a growing number of devices, and software providers reported smaller margins due to high distribution costs.
3. The 1990s signaled the start of the dot com boom. During this decade, three important technologies were unveiled to later become the basis for the development of the SaaS industry: online marketplaces, online payments, and cloud computing. This is also where the predecessors to the SaaS model — ASPs, or Application Service Providers — appeared. The big difference was that ASP vendors had to manually create every user profile, while in the SaaS operating model, this process happens entirely on the customer’s side.
4. In 1999, the first Software as a Service product was launched by Salesforce. It was a CRM system built from the ground up. The new product was a hit from the get-go, and its popularity only grew following the burst of the dot com bubble, when companies were actively trying to optimize their expenses.
5. Two decades later, the SaaS business model is bigger than ever, with the world’s biggest software giants like IBM, Oracle, and Microsoft making a shift towards it. Although there seems to be a SaaS product for every customer and business need, now is still the perfect time to join the industry by releasing a competitive solution.

Popular and Successful SaaS businesses

Even though the Software as a Service market is a relatively new one, there are dozens of major players who, together, make billions of dollars annually. The United States is currently the leading country both by the number of SaaS companies (16,000) and by the total revenue generated by them ($389,3 billion). Here are the 9 biggest SaaS companies operating today by market cap, according to HubSpot:

1. SurveyMonkey — an online survey tool with a market cap of $1.03 billion.
2. Asana — a project management tool with a market cap of $5.07 billion.
3. HubSpot — an inbound marketing company with a market cap of $14 billion.
4. Shopify — an eCommerce platform with a market cap of $40.34 billion.
5. SAP Concur — a travel & finance management tool with a market cap of $97.35 billion.
6. MailChimp — an email marketing tool with a market cap of $119.23 billion.
7. Adobe — a SaaS company that owns over 50 products with a market cap of $139.85 billion.
8. Slack — a chat & collaboration tool with a market cap of $151.36 billion.
9. Microsoft  — a company with 100+ cloud products and a market cap of $1.83 trillion.

Do you have an example of a SaaS business even more successful than thees ones? No wonder! SaaS solutions use all the benefits of the digitalization, cloud computing and people’s FOMO to earn money.

Benefits of the SaaS Business for Customers and Vendors

The Software as a Service business model is understandably very popular among the end customers — most importantly, thanks to its flexibility, robust functionality, and reasonable costs — but it also provides numerous benefits to the vendor. Here are the biggest reasons to consider venturing into the SaaS business or adding a SaaS project to your existing project portfolio.

From the Customer Perspective

• Cost efficiency. Many SaaS business models often require lower upfront costs compared to traditional software purchases. This affordability makes advanced software accessible to a broader range of customers, from individuals to large corporations.
  
• Ease of use and maintenance. Customers enjoy hassle-free experiences as SaaS providers manage the infrastructure, updates, and maintenance. This convenience means users can focus on using the software rather than worrying about technical upkeep.
  
• Flexibility and scalability. The ability to scale services up or down based on current needs is a significant draw. SaaS also is appreciated for the flexibility of the SaaS pricing model that allows clients to adjust their subscriptions and features as their requirements evolve.
  
• Access to latest technologies. Following the latest innovations allows SaaS businesses to enable users to always have the latest version of the software, ensuring they benefit from the newest features and security enhancements without additional costs or effort.
  

From the Business Perspective

• Recurring revenue stream. The subscription-based pricing model provides businesses with a consistent and predictable revenue stream, which is crucial for long-term financial planning and stability.
  
• Market reach and scale. One of the key benefits of any SaaS business model is that it allows companies to reach a global audience with minimal distribution costs. The online nature of the service removes geographical barriers, opening up vast market opportunities.
• Data insights and customer engagement. Through SaaS platforms, businesses can gather valuable data on user behavior and preferences, enabling them to tailor their offerings and improve customer engagement and satisfaction.
  
• Reduced time to market. This SaaS operating model enables faster deployment and updates compared to traditional software models. This agility allows businesses to respond quickly to market changes and customer needs.
  
• Low risk of theft. If you are planning to make your software product available only on a paid basis, the SaaS model can ensure that only paying users can utilize the software. First, the customers don’t get access to the code, which means they are not able to steal it. Second, since the software is only accessible over the internet with authorized credentials, the possibility of the product being pirated becomes even lower.
  

Types of SaaS Companies

There are many SaaS companies, but the existing SaaS types are pretty limited. It all comes to how the client (B2B, B2C) interacts with the key SaaS features.

Low-touch SaaS. These products require little human intervention to deliver value to the customer. These are typically self-service offerings with automated signup, onboarding, and support. Examples of low-touch SaaS include cloud storage platforms like Dropbox and Box, online collaboration tools such as Slack and Asana, and marketing software like MailChimp.

High-touch SaaS businesses. They offer a customized service to each client, with sales staff directly working with customers to understand needs and consultatively sell the appropriate solution. The software still delivers key functionality but significant human effort goes into implementation, integration, training, support and account management. Good examples of a high-touch SaaS are enterprise resource planning tools like NetSuite and SAP, customer relationship management platforms such as Salesforce and HubSpot, and vertical market solutions tailored for specific industries.

Vertical SaaS. SaaS business solutions that are designed for specific industries or vertical markets such as healthcare, finance, retail, etc. They incorporate industry-specific capabilities, workflows, terminology and compliance needs. Examples include clinic management platforms and payment processing tools for ecommerce businesses. For better understanding of the SaaS business based on vertical model principles, check out Veeva Systems — specialized in cloud-based solutions for the pharmaceutical and life sciences industries.

Horizontal SaaS. These products focus on a specific business function and can be utilized across various industries, rather than tailored to any one vertical. This model is often used for email services, business intelligence, HR software and website builders. For examples, Slack is a classical horizontal SaaA operating model. 

Single-tenant SaaS. Each customer gets a dedicated instance of the software so they have more control, customization and security of data. Resource intensive but some enterprises prefer this model when custom workflows are required. Common for ERP, HRM and accounting tools.

Multi-tenant SaaS. Multiple customers share access to the same software instance and resources. Configuration allows some customization. Cost efficient for the vendor and can enable rapid scaling. Typical architecture for collaborative tools, e-signature and marketing software.

Enterprise SaaS. These platforms are robust, offering extensive functionalities and customization options to cater to complex business processes. Take Salesforce, for example. This enterprise SaaS is designed as a leader in customer relationship management, has myriads of features and caters for thousands of businesses including software companies worldwide. 

Micro SaaS. Niche SaaS products focused on solving a very specific business problem. Often built and managed by small teams. Pricing tends to be affordable and transparent. Appeal lies in the highly specialized value proposition.

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SaaS vs. other software business models

Although Software as a Service is arguably the most popular software distribution model on the market, it’s not the only one. Here is how SaaS compares to other in-demand software business models: PaaS, or Platform as a Service, IaaS, or Infrastructure as a Service, and XaaS, or Anything as a Service. 

SaaS vs. PaaS

Platform as a Service is a cloud software product that creates a framework for developers to build various applications upon it. Like SaaS, PaaS is also delivered to customers over the internet. Unlike SaaS, PaaS is not a software application itself and merely provides an opportunity to build an application according to the customer’s needs without developers having to worry about infrastructure, storage, operating systems, or updates. Examples of PaaS include Windows Azure, Force.com, and Google App Engine.

Platform as a Service creates a strong foundation for developers to create highly customizable applications and is a great option for multiple development teams or vendors working on the same project. However, it cannot fully replace Software as a Service because it does not include any ready-made applications.

SaaS vs. IaaS

Infrastructure as a Service provides cloud-based access to physical and virtual servers, storage solutions, and networking. IaaS products serve customers ranging from startups to enterprises who don’t want to purchase expensive hardware without knowing how much exactly they will need over a given period of time. IaaS is a highly flexible model, as customers can choose any amount of storage and networking they need, and scale up or down whenever they please. Some examples of IaaS include Microsoft Azure, Amazon Web Services, and Cisco Metacloud.

In recent years, Infrastructure as a Service has become a more modern and flexible alternative to data centers. The client can access their infrastructure facilities through an online dashboard, although APIs are also a popular way to deliver IaaS services. With the IaaS model, the customer can control a significant portion of the infrastructure, including operating systems, applications, and data. Still, the remaining parts are managed by the IaaS vendor, similarly to the SaaS model.

SaaS vs. XaaS

From the description of SaaS, PaaS, and IaaS models, it’s clear that these are not mutually exclusive solutions — thousands of companies successfully use two, and many enterprises combine all three in their operations. This is why now there is an all-encompassing term that refers to a product combining all three models — XaaS, or Anything as a Service.

XaaS solutions are always custom and built according to the customer’s needs. A comprehensive XaaS solution can cover all of the computing needs a customer may have. Moreover, the XaaS infrastructure is perfect for implementing robust functionality, connecting IoT devices, and overall significantly increasing the efficiency of work. That is why Anything as a Service looks like a particularly promising field to join right now.

SaaS revenue models

With some exceptions, the Software as a Service business model is created with profit in mind, meaning that the software product needs to generate revenue for its provider. The choice of the SaaS revenue model can be influenced by the type of software, size of the business, and other factors, such as the projected number of users. Here are the most popular types of SaaS business models to consider.

Free

The free SaaS revenue model is, well, free — you develop software and then make it accessible to users free of charge. This is a great way to introduce people to your product, hoping that at least some of them can then be converted into paying customers. One of the common ways to monetize free SaaS products is through advertising, while users who don’t want to see ads can upgrade their accounts to remove the ads.

Freemium

Under the freemium SaaS model, every customer gets basic functionality for free, while additional features are only available to paying customers. Additional features can include anything from more storage to the ability to save files in a specific format. This is one of the SaaS revenue models that resonate the most with customers, as they get to give the product a try for as long as they like before committing to paying for the service.

Flat rate

This SaaS revenue model means that the software product is distributed at a fixed price that includes all the functionality available within the service. The vendor can sell the product based on a monthly or annual subscription, or choose another way to obtain payments from the customers regularly. In some cases, the flat-rate solution can also be upgraded at an extra price.

User number-based

This is a model that is particularly popular among corporate SaaS product vendors, as here, the customer pays for each end user that utilizes the software. There is a fixed cost per user, so the customer is able to quickly calculate the amount of money they will need to pay for a monthly or yearly subscription that will cover the needs of the company.

User tier-based

In this case, the tier refers to the number of active users under the same subscription plan. The user tier-based model is another popular option for corporate SaaS vendors, especially the ones that aim at enterprise-level customers. Instead of having to pay for each new user added to the plan, the customer can choose a tier that fits their needs the most.

Feature-based

For SaaS products that include robust functionality, a feature-based subscription may be the ideal option. With this revenue model, the customer will pay only for the selection of features they need. This is somewhat similar to the freemium model, which also provides a bare minimum of functionality at the base level. However, the feature-based model is typically more flexible, with multiple tiers and different feature configurations available for choosing.

Storage-based

When the customer has increased storage needs, a storage-based subscription may make the most sense — for example, when the SaaS product deals with transferring and depositing files. In that case, there is typically a free storage limit, and if the customer wishes to go over the limit, they may choose one of several storage upgrade options. 

Ad-Supported

Under the ad-supported pricing SaaS model, users access the software for free, but the interface includes advertisements. It is an excellent way for providers to monetize free users while offering an option to upgrade to a paid, ad-free version. It’s a common approach in many consumer-focused apps where user volume is high.

Affiliate

In the affiliate model, the SaaS provider earns revenue by referring its users to other services or products. When users make purchases through these referrals, the provider receives a commission. It can be easily combined with different types of SaaS business products, complementing the core service offered by the SaaS platform, especially when those external products or services are relevant to the user’s needs.

Transactional Fees

Transactional fee models charge users for specific transactions processed through the SaaS platform. This is common in platforms like payment gateways or e-commerce services, where the provider takes a small fee for each sale or financial transaction made through the system.

White Labeling

It allows businesses to rebrand and sell the SaaS product as their own. This Software as a Service business model is popular among B2B providers, enabling clients to offer sophisticated software solutions without investing in development. It’s a win-win, with providers expanding their market reach and clients getting a tailor-made solution.

API Integration

In the API integration model, the SaaS provider charges for access to its application programming interface (API). This allows other businesses to integrate the functionality of the SaaS operating model into their own systems, enabling a wide range of custom solutions, benefiting from the core strengths of the SaaS product.

Hybrid models

Hybrid models combine elements of various revenue strategies. For example, a SaaS provider might use a base subscription model with added transactional fees or offer white-label versions alongside a standard offering. Tapping into multiple revenue streams and catering to a broader range of customer needs — just a perfect way to win the market today. 

As you can see, there is no one specifically successful SaaS business model that would cover all your needs and put your product right on top. In fact, SaaS sales growth depends on so much more than choosing a delivery model! How accurate your SaaS pricing is for your target audience? How saturated is a particular SaaS market today? Do you exhaust all the cost-efficient ways to sell SaaS products? While we can’t give answers on every single question in the scope of one article, let’s talk about SaaS business’s opportunities to use additional revenue streams. 

Additional revenue streams

In addition to the main SaaS revenue models, there are other ways to make money with a SaaS application. Here are the three most common ones.

Extended support

Good customer support is invaluable for any software product, let alone one as complex as a typical use the SaaS software solution requires. Basic customer support is usually provided for free, but if a customer has specific support needs — for example, 24/7 availability or support provided to each individual customer instead of the enterprise as a whole — it should come at a price.

Custom builds

Wide customization opportunities are one of the biggest unique selling points of Software as a Service, and some degree of customization can already be included in the revenue model. However, the customization needs of individual customers can often go beyond the standard amount. From specific security requirements to integrating the SaaS solution with the software the customer already uses — the possibilities for obtaining extra revenue are nearly endless.

In-app purchases

The functionality that a typical SaaS product offers is what attracts customers in the first place, and for many of them, it’s going to be more than enough. However, there are always customers who need more: more features, higher flexibility, more storage, etc. This is where in-app purchases come into play. With their help, you can provide a smaller group of customers with the features they need without overwhelming the remaining users.

Setup fees

Setup fees have been somewhat of a controversial topic in the SaaS business community: some vendors think that a setup fee can alienate customers who don’t want to pay additional money for something they believe should be included with the purchase. 

However, a setup fee can be a good way to increase revenue from a product in the low to middle price range, as well as to make sure only highly motivated customers end up purchasing the product. In that case, the setup fee should always provide extra value to the customer: for example, it can include creating accounts for the end users.

APIs

Selling the core product yourself isn’t the only way to make money with a SaaS application. Other software developers are ready to pay good money for an API of your product, provided that it adds significant value to their own application. An important thing to consider here is that APIs cost money to develop and require specific expertise, so it’s important to put a lot of thought into a winning idea and to have a dedicated development team you can trust.

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Top SaaS Metrics to Track

Stakeholders love SaaS metrics, investors love SaaS metrics, we all love the best SaaS metrics. Why? Because we can’t change, improve and effectively monetize what we can’t see and count. Growing your software business means not only creating a fitting SaaS pricing strategy, but also adopting a SaaS metrics tracking system that allows you always to keep abreast. 

Monthly Recurring Revenue (MRR)

MRR is the predictable revenue a business can expect every month. It’s crucial for understanding the company’s financial health and growth trajectory. Helps in forecasting revenue and planning for scaling the business.

Customer Lifetime Value (CLTV)  

CLTV represents the total revenue a business can expect from a single customer throughout their relationship. Understanding CLTV aids in determining how much to invest in acquiring and retaining customers.

Customer Acquisition Cost (CAC)

CAC is the total cost of acquiring a new customer, including marketing and sales expenses. Keeping CAC in balance with CLTV is vital for sustainable growth.

Churn Rate

This metric indicates the percentage of customers who cancel or do not renew their subscription within a certain period. A low churn rate is critical for long-term success, as retaining existing customers is often more cost-effective than acquiring new ones.

Net Promoter Score (NPS)

NPS measures customer satisfaction and loyalty by asking how likely customers are to recommend the service to others. High NPS can indicate strong customer satisfaction, a key driver for growth and retention.

Lead Conversion Rate

This metric applicable for most sales models tracks the percentage of leads that turn into paying customers. It helps in understanding the effectiveness of the sales funnel and marketing efforts.

Average Revenue Per User (ARPU)

ARPU measures the average revenue generated per customer. It’s useful for understanding revenue trends and identifying opportunities for upselling or cross-selling.

Expansion Revenue

Expansion revenue comes from existing customers, typically through upsells, cross-sells, or service upgrades. It highlights the potential for growth within the existing customer base.

If you measure even half of these for starters, you will surely find a way to optimize your SaaS revenue model. When we build SaaS business software products for our clients we always emphasize that the analytics should be set from the start. New SaaS solutions are made flexible and change-ready — just follow both quantitative and qualitative feedback from you team, and don’t be afraid to deviate from the initial SaaS business plan. 

To sum up

The Software as a Service industry has come a long way since its early days, and it’s not going anywhere any time soon. If you are thinking about venturing into the SaaS business, make sure to stay tuned for part two of our article, where we’ll discuss how to build a Software as a Service solution, which pitfalls you may encounter, and how to make sure your business grows exactly as you envisioned.