SaaS Business Model: How It Works And How To Make Money With It
by Inna M. on Jan 3, 2023
Some software trends come and go, and some are here to stay. The concept of Software as a Service has been around for several decades and is still as fresh and popular among businesses and software vendors as ever. 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.
In part one of our investigation of the SaaS business model, we will talk about what SaaS is, what are its biggest benefits, and which ways to make money with a SaaS business idea there are.
What is Software as a Service?
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 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. In most cases, there are two ways in which SaaS products are created:
- The business owner has a software idea. They approach a SaaS vendor, describe their idea and other specifics of the future product, and have a custom SaaS solution developed specifically for them. Unless otherwise stated in the contract, the SaaS vendor can then modify and resell the product to other customers.
- The SaaS company develops a product based on its own business idea and then distributes it to the customers as-is or with any required modifications.
A SaaS 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.
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.
- 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.
- 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.
- 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 model, this process happens entirely on the customer’s side.
- 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.
- 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 SaaS companies
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:
- SurveyMonkey — an online survey tool with a market cap of $1.03 billion.
- Asana — a project management tool with a market cap of $5.07 billion.
- HubSpot — an inbound marketing company with a market cap of $14 billion.
- Shopify — an eCommerce platform with a market cap of $40.34 billion.
- SAP Concur — a travel & finance management tool with a market cap of $97.35 billion.
- MailChimp — an email marketing tool with a market cap of $119.23 billion.
- Adobe — a SaaS company that owns over 50 products with a market cap of $139.85 billion.
- Slack — a chat & collaboration tool with a market cap of $151.36 billion.
- Microsoft — a company with 100+ cloud products and a market cap of $1.83 trillion.
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Business benefits of Software as a Service
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.
Stable revenue stream
Developing a Software as a Service product takes time and money, but once you have it in your roster and acquire paying customers, you can continue getting revenue from that product with little involvement from your company’s side. Moreover, as Andy Ide from HorseRecords points out, SaaS companies are usually able to avoid the winter drop in sales that is common in the B2B segment by maintaining a loyal customer base.
Tapping into new markets
The affordability of SaaS products compared to traditional software, along with all-encompassing functionality and wide customization opportunities, make the SaaS business model perfect for tapping into new markets. You can try and distribute your product in foreign countries where the Software as a Service model is not as ubiquitous as it is in the Western market, or develop a completely new product that has no competitors but is able to find its own niche.
Easy maintenance and support
The architecture and design of a SaaS product allow the developers to introduce changes as they go without creating any disruptions in the usage. Moreover, upgrading and updating the software usually does not require the end user to do anything other than maybe restart the application once, which makes ongoing maintenance easier for everyone involved and provides wider improvement opportunities.
With Software as a Service, both vertical and horizontal scalability are significantly easier and quicker to achieve than with traditional software. Specifically, the user can request any number of new users to be added to the ecosystem, and the vendor will be able to quickly fulfill this request. Moreover, the software can be easily enhanced with new features, or some of the existing features can be removed, to fit the customer’s changing business needs.
Higher lifetime value
When you have a good product and can convert first-time customers into loyal users of your product, the lifetime customer value of a SaaS business will be higher than that of traditional software. A SaaS business survives on long-term subscriptions, so as long as the customers are happy with the product and the pricing, they will continue renewing their subscriptions and increasing the customer lifetime value.
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.
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 SaaS revenue models to consider.
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.
Under the freemium 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.
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.
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.
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.
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.
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.
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.
Good customer support is invaluable for any software product, let alone one as complex as a typical SaaS solution. 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.
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.
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 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.
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.
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.
u003cstrongu003eFrequently asked questionsu003c/strongu003e
u003cstrongu003eWhat is Saas?u003c/strongu003e
SaaS, or Software as a Service, is a software distribution business model where the owner hosts the application using cloud infrastructure and makes it available to the end users over the internet, whereas in the traditional software distribution model, the application is installed on the end user’s computer.
u003cstrongu003eIs SaaS always cloud-based?u003c/strongu003e
Although SaaS is often referred to as a subset of cloud computing, and a vast majority of SaaS solutions are based on cloud infrastructure, that doesn’t mean that all SaaS products are exclusively cloud-based. Sometimes, SaaS solutions are developed on a local terminal and only then shipped to the cloud provider. They can then be accessed via a web browser.
u003cstrongu003eWhat is an example of Software as a Service?u003c/strongu003e
There are some examples of SaaS that are mostly used in a corporate environment, such as ERP or HR solutions. However, the SaaS business model is now so popular that most of us use SaaS products on a daily basis. The most popular examples include Slack, HubSpot, Dropbox, Google Workspace, and MailChimp.
u003cstrongu003eWhat are the benefits of SaaS for the business?u003c/strongu003e
The Software as a Service business model has numerous advantages both for the customer and the provider. For the software provider, the biggest benefits include fast time to market and quick updates, 24/7 availability that works as a USP, and predictable revenue size with an opportunity to take quick measures to reduce the churn rate.
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