How do SaaS companies make money?

How do SaaS companies make money?

SaaS is now globally ubiquitous. For the lay tech user, one who’s digitally connected but may not understand the architecture of the internet and its many billions of innovative tweaks and developments, SaaS is just another acronym. But, the creation of Software-as-a-Service modelling and the rapid development and rollout of SaaS-built products and brands, has completely dominated the digital commercial space.

If you’ve used Netflix or Spotify, managed your company’s CRM through Salesforce, communicated with teammates through Slack, or bought something online from an independent shop, you’ve engaged with a company that uses a platform very familiar to SaaS.

The core component of SaaS – cloud-based services, offered via the internet, which are paid for through subscription fees – is only achievable and profitable when the online infrastructure and digital scaffolding can support it, and you have enough customers. 

Despite the SaaS business model having a presence within development and commerce teams since 2005, it’s only in the last few years, as latency improves and cloud-based storage and support expands to deal with the traffic, that SaaS has come into its own. 

Pre-pandemic, SaaS was a rising star within the tech hosting and support world. Now, with teams moving remote, e-commerce exploding, streaming services expanding at incompressible rates and underneath it all, huge datasets being created that are fuelling further investment decisions, SaaS has become a major crutch for companies undergoing digital transformation. 

The usability, scalability and critically the cost of SaaS platforms means it’s both approachable for agile start-ups and usable for enterprise companies at any stage of their growth journey. This, then, is the central conceit of SaaS: it provides affordability at scale, where traditional, legacy models of tech infrastructure work via outdated, slow, and expensive service support packages.

It’s truly an innovative two birds with one stone approach to providing managed services online for any number of industries and clients, and the sector continues to grow – global revenue from SaaS companies will hit $145.5 billion in 2021, and is predicted to hit $400 billion by 2025 with the global cloud services market hitting $800 billion.

The primary differentiator – the central reason why SaaS hasn’t been anchored as a large, enterprise-only business model – is cost. It’s affordable. 

The piecemeal nature of financial commitments to any SaaS platform – the subscription model of paying for services – means companies of any size can use it and customers at (almost) any financial level can access it.

Coupled with this is the nature of SaaS development itself. It’s hosted in the cloud, and as many in the tech space know, cloud services are provided by some of the world’s biggest and most established tech behemoths such as AWS and Microsoft – these companies provide ample access to cloud storage and the infrastructure to secure it, again for nominal fees.

Therefore, the two most critical considerations for developers within any tech field – can I make and support the service in the cloud, and can I charge customers a sustainable fee? – are answered with SaaS.

Consider Netflix. Netflix made $25billion in 2020. Netflix costs, in the UK, £5.99 a month, with parallel cost bandings globally. Netflix has 200 million customers. This is effective, mass-scale SaaS perfection, all powered and paid for by retained customers.

Netflix has changed the nature of media consumption and they’ve revolutionised how customers engage with both long and short-form content. Critically, their model has caused ripples of creative effect, and production houses, producers and directors around the world are scrambling to create content exclusively for this platform. 

All through shifting TV and Film from legacy systems (television and cinema) to streaming (SaaS), and pricing it sustainably. 

SaaS companies and SaaS-based products and services are cheap, compared to legacy tech costings – but how do SaaS companies keep their customer costs so low? How are start-up SaaS companies rapidly turning into tech unicorns when their customer-facing services remain competitively small… and why have some of the world’s largest tech companies about-turned to incorporate SaaS-first principles in their new product ranges?

How do SaaS companies make any money?

The economy of SaaS

To use, develop or include SaaS in your operations means you’re making an economic choice, as much as a creative, customer or operational one. 

There are always going to be benefits of having in-house IT professionals, especially at larger firms with sprawling networks and touchpoints. For most of these firms, especially the ones who require hyper-secure edge accessibility such as within MedTech, the priority is less on scalability, usability, or cost, and more about security and data collection and analysis. However, this is expensive. Skilled labour, not to mention the physical cost of replacing parts of maintaining server systems at this level, is pricey and completely unsustainable for smaller firms.

For the vast majority of service providers globally the SaaS model is a positive economic choice – the subscription model means you can budget more efficiently and know that the wide array of pain points within service management (systems outages, patching, security breaches etc) are managed by the vendor, not you. This trust in the vendor is a trade-off, but one that has changed the tech world. 

The economy of SaaS relies on two things – tiers of offer from the vendor and the flexibility to choose a package that suits your needs and retained customers. 

Tiers: tiers mean just that – various layers of service/SaaS offering by the vendor that are priced differently, to fit customer needs. This can range from “freemium” offers (customers can use your SaaS platform in a limited way, typically as a sweetener or sales tool to snare a potential buyer) all the way up to elite pay bandings (more in-depth SaaS offerings from companies with added features, offers and deals). Ideally, you want to curate a community of buyers who pay for the most expensive package. However, to force this point is to alienate your customer. This leads us neatly onto:

Retention: while getting new customers pushes potentially revenue higher, retention is the golden rule of SaaS. Retaining your existing customers means guaranteed income, financial security and, where appropriate, the opportunity to upsell higher-priced packages. Retained customers trust you and advocate for you. 

When you turn over customers, you lose money, and you lose advocacy of your platform and brand. This “churn” becomes a key metric in understanding the success of your SaaS product. Consider Netflix, remember? 200 million users, all paid, every month. Churn will be low, hence why they can spend billions making new shows and films.

“Companies with over $10 million in revenue have an average churn rate of 8.5%, and those below $10 million have a churn rate of 20%” – this quote alone should suffice to prove to anyone that lower churn rate means higher revenue.

Economy of Scale

Success or failure of SaaS services hinges on understanding economies of scale – what minimum customer numbers you need to maintain your service, and how and where those customers are more likely to purchase more from you. 

This takes savvy Sales, direct and focused marketing, and a development team able to be agile to customer needs. 

SaaS is expensive to develop and typically expensive to run – you profit when you hit a certain threshold of customers. This acquisition (or cost acquisition per customer) needs to be considered alongside your product’s long-term value. Your cost acquisition will only generate revenue once your customers have invested in you over the long term. 

The bottom line

SaaS is a highly intensive, expensive, and risky venture – but the potential revenue generated justifies the effort. Its unique model – affordability, scalability, and efficiency of cloud-based service provision – means with a well-curated Sales model and an attractive UX, customers can make a qualified decision on your product immediately, with a low-cost barrier to entry. Everyone wins!

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