When businesses shop for software, there's a good chance they're not looking to buy a compact disc. For over a decade, software companies have been shifting toward a modern way to earn: the SaaS business model.
Software as a service (SaaS) is a business model in which companies host their software in the cloud and charge recurring fees for access. While traditional software is licensed out for a one-time fee — which largely limits the software company's earnings to new users — SaaS products can generate consistent revenue from existing customers over the course of months or years. As long as you maintain your customer relationships and offer value over time, implementing this model is your opportunity to grow quickly.
In this article, we'll explain how the SaaS business model works, then cover the SaaS metrics you need to track to make your company a success.
3 Stages of a SaaS Business Model
Entering the SaaS industry isn't as simple as charging a subscription fee. Businesses that implement the SaaS business model typically go through three key stages of growth, each of which comes with unique business needs you'll need to meet to keep your customer base and cash flow healthy.
1. Early Stage
When you first launch your SaaS solution, your startup is in the early stage of growth. You're taking your SaaS product — which can be a minimum viable product — to market with the help of a small team. In this stage, your SaaS business may acquire its first loyal clients, though you'll still mainly be funded by yourself, friends and family, small loans, or seed funding.
Early stage startups should focus on testing software functionality and identifying what your product uniquely has to offer in your market.
2. Growth Stage
The SaaS business model leads to rapid scaling once you get to the growth stage. At this point, a lot of new customers will start taking interest in and signing up for your product. Your job is to keep up.
You'll need to scale your entire business — including your team, data, bandwidth, and other key resources — at a rapid pace to keep your SaaS product as high-quality as when you were serving only a small amount of paying customers.
To get assistance in the growth stage, many business owners join startup incubators designed to help companies grow, or they start pitching to key investors (usually angel investors or venture capitalists).
3. Mature Stage
The most successful SaaS businesses operate in the mature stage. While your business should still be growing, you won't be growing as rapidly as in the growth stage.
Now, you need to focus on maintaining steady growth and loyal customers by proving your worth over time. Your team needs to perfect the processes that matter most to existing customers, like customer service and new feature development.
Potential customers are no longer drawn to your product for its novelty either. Your sales team must develop a proven SaaS sales process that they're constantly iterating on. Your pricing model should also be refined as needed — for example, you may start charging a monthly subscription per user instead of per company. Customer surveys and data from your sales CRM can help you make smarter decisions in the mature stage.
Salesforce, one of the first SaaS companies, is a widely lauded example of a business in the mature stage. It has long-established processes for lead generation, which includes offering a free trial, as well as following up with leads and engaging existing clients. Salesforce has also steadily scaled its own product over time to maintain a loyal customer base.
Companies like Zoom, Dropbox, and Slack have also had success with the SaaS business model, opting for a freemium model for lead generation instead of offering free trials. People can use their SaaS products for free for as long as they want. Then, as customers start to see the product's value, many start paying a monthly fee to access premium features or onboard more team members.
5 Key Metrics for SaaS Companies
No matter what type of business model you use or which stage of growth you're in, your SaaS company must track key performance indicators (KPIs). KPIs are metrics that tell you if your company is making headway toward its goals. Regularly tracking these five metrics will allow you to pinpoint where your company needs to make improvements or update its strategy.
1. Customer Acquisition Cost (CAC)
Customer acquisition cost measures the average amount you spend to gain a single paying customer. You can calculate this by dividing your total sales and marketing expenses (including social media ads, contractor fees, and more) by the amount of customers you gained in a specific time frame. Your CAC should always be lower than your per-customer revenue in the same time frame. Ideally, you should work toward decreasing your CAC over time.
2. Conversion Rate
Your conversion rate is the percentage of customers who enter your sales funnel then actually become paying customers. A low or decreasing conversion rate can tell you that you need to look into where people are dropping out of your funnel and adjust your sales process accordingly.
3. Monthly Recurring Revenue (MRR)
Monthly recurring revenue is the amount of money you expect to generate from all your revenue streams each month. A simple way to calculate MRR is by multiplying the average revenue per account (or the average monthly fee your users pay) by the number of monthly subscribers you have. This can tell you if your business is growing at a healthy rate or if too many users are downgrading or ending their subscriptions.
Some business owners also calculate annual recurring revenue (ARR) — which is your MRR multiplied by 12 — to get a broader perspective on their business growth.
4. Lifetime Value (LTV)
Customer lifetime value is the amount of money you expect to earn from the average client throughout the entire time they use your SaaS product. You can calculate this by multiplying your MRR by the number of months you expect the average client to stay (multiplying ARR by a number of years works, too). A strong LTV indicates that users are continuously getting value from your products, while a low one may indicate that you need to focus on developing new features, educating customers about your product, or upselling more clients over time.
5. Churn Rate
Your churn rate is the percentage of clients you lose over a given time frame. Simply divide the amount of customers you lost by the amount of customers you had at the start of the time frame. High churn can drive down both MRR and LTV, so it's important to know if customers are leaving.
Get Started With a SaaS Business Model
The SaaS business model can help your software business generate more consistent revenue, particularly after it reaches a mature stage of growth. But first, your team must develop a unique, quality product and maintain a strong infrastructure through a stage of rapid growth. Tracking key metrics can help you sustain a healthy business through any stage of growth.
To help you maintain strong customer relationships and maximize conversions, sign up for a free trial of ServiceBell and start connecting with clients through live video chat, straight from your site.