Software-as-a-Service (SaaS) is a business model that delivers a software product through the cloud. With a subscription-based model, SaaS deviates away from traditional business models that solely rely on one-time purchases. The SaaS business model is unique in such a way that if taken advantage of, it can lead you to high growth and high profits — who doesn't want that?
Working with SaaS companies, we’ve learned a thing or two about this business model and we’re excited to give you some tips to help you make the most out of your SaaS company.
The subscription-based model of SaaS creates a predictable revenue model based on your current monthly and/or annual contracts. Since consumers and clients only have access to your product for a certain time period, they will have to continuously renew their contract to use your solution. This is one of the biggest strong suits of SaaS; you have an idea of what your company will look like based on subscriptions renewals.
Unlike traditional business models that do not know how much revenue they will make in the future or what their customer base will look like, the recurring revenue component in SaaS allows for accurate and predictable revenue forecasts. Being able to look ahead with greater degrees of certainty is a huge advantage when it comes to making informed business decisions in the present.
SaaS subscriptions operate on monthly and annual contracts. This makes recognizing revenue tricky. Revenue is a whole different ball game when it comes to subscriptions. Even if a customer pays up front for one year, all that cash cannot be recognized as revenue from the start. Only once the product has been delivered can that cash be recognized as revenue. Until then it is considered deferred revenue.
For example, say a client buys a one-year subscription for $12,000. After one month of the product being delivered to the customer, you can recognize $1,000 of that payment as recognized revenue. The remaining $11,000 is deferred revenue. After six months, $6,000 of the payment is now considered recognized revenue. The remaining $6,000 is still deferred revenue.
Make sure to recognize revenue according to GAAP regulations. Even if your customer pays up front for the year, you haven’t technically “earned” the cash until after the product or service has been delivered at the end of each month. There is always a possibility a customer terminates their contract early and if you have already spent deferred revenue, you’ll be in some cash trouble.
*Here’s just one more accounting tip: mostly all SaaS businesses get huge tax and cash flow benefits by using accrual accounting over cash basis accounting.
Metrics always matter regardless of what industry you’re in, but SaaS has its own unique metrics to measure a company’s financial health and sustainability. You’ll want to keep track of metrics such as churn, LTV:CAC ratio, magic number, and more. For more in depth explanation of these metrics and more, check out our Metrics that Matter e-book.
Finding the right metric for your company is important, but it can be tricky. But, here at KPI Sense we organize and cleanse your metrics and show you the data that really matters.
Because SaaS products are delivered through the cloud, you won’t have to deal with actually physically producing, storing, and distributing a tangible product. All the stressors of supply-chain management like material sourcing, manufacturing, shipping, and delivering are a thing of the past. You only have to focus on your software, so investing in an efficient development team is necessary for smooth sailing.
The absence of inventory means it's also easier to scale your company. The software platform and delivery through the cloud allows your product to reach your customers quickly and basically anywhere in the world without the aforementioned geographical limitations. Cloud delivery opens your company to a much wider audience than traditional business models.
Additionally, the absence of inventory means your cost of goods sold (COGS) is much, much cheaper since you don’t have to take into account material costs, labor costs, distribution costs, etc. Lower COGS means you’ll have more money leftover from your revenue which leads to a higher gross margin and higher profit. The SaaS industry is notable for its high gross margins.
Most SaaS companies have an 80% gross margin because of its software platform — if you can achieve this, you can reinvest your profits back into your company to grow and scale.
Clearly, the SaaS business model is teeming with benefits. Another perk? Running your company on a leaner team. By removing the need for a traditional brick & mortar store, you also eliminate the need for any management and retail employees.
With less employees and less retail space needed, your general & administrative (G&A) expenses will be reduced. You’ll be able to spend less on traditional expenses such as rent, utilities, and salaries and refocus those margins back into your business.
Sales and marketing play a huge role in SaaS. In order to scale, you need effective marketing campaigns that will bring in new leads and an efficient sales team that can close deals.
Converting leads into paying customers falls entirely on your sales department. From generating outbound leads that resemble the ideal buyer persona to presenting to the potential customer, an efficient and experienced sales team is necessary for growth. You’ll also want to keep your sales cycle low and perfect your sales process as much as possible.
Your marketing team is in charge of producing inbound leads through effective marketing campaigns and advertisements that will educate audiences about the value of your product. Aside from lead generation, your marketing team is also in charge of retaining your existing customer base through communication and content creation to keep churn low.
The SaaS industry is pretty saturated at the moment - that’s where effective sales and marketing channels come into play. The key is to differentiate your company. Your product needs to show why it's the best solution available in the market. Spend time discovering your audience’s pain points and build a narrative that shows the product’s value.
Unlike traditional business models, a SaaS software purchase is a huge commitment (with a nice, high price point to match) that needs effective sales and marketing to convince the buyer that your product is worth it.
The software your company offers is the fruit of labor from your research and development (R&D) team. Not only does the R&D team create the product, but they also are there to fix any glitches or bugs that may arise during customer usage. Having an experienced and adaptable team of developers on deck should be a priority on your checklist.
One of the biggest opportunities in SaaS is the revenue expansion available through your existing customer base — this is where the real profitable opportunities are. You’ll want to have an array of additional products and features available for your existing customers. For this, your R&D team should be able to keep evolving your software to develop new features and create user-friendly experiences.
The recurring revenue component of SaaS is what makes SaaS so attractive. You know that customers will keep paying for your product into the future. But what happens if they decide not to renew? This would be considered a churned customer and something that you want to avoid at all costs. It’s your customer success team’s responsibility to provide great customer service, guarantee renewal, and keep churn low.
It’s the customer success team’s job to assemble a loyal customer base. It’s also their responsibility to generate expansion revenue from upgrades and add-ons. Expansion revenue doesn’t have any acquisition costs so profit margins are even higher. Maintaining good customer experiences and generating expansion revenue will keep your company afloat, especially once growth starts to stabilize.
The SaaS business model has high growth and high profitability potential. Because of this, the SaaS industry is more saturated than ever and keeps evolving as more and more traditional businesses transition over to a software platform.
Having an efficient sales and marketing team, R&D team, customer success team, and product will differentiate your company from your competitors.
Make sure to take advantage of SaaS’s revenue model, metrics, and customer expansion opportunities that will lead you to growth and profitability.
Metrics and models are our speciality here at KPI Sense. We build custom KPI dashboards, tailored financial models, and do just about everything else SaaS. To learn how we can help your company click here.