SAAS Business Model: The Present and Future of Software

Software is an amalgamation of instructions that are fed to a computer to perform respective tasks. In computer science jargon, computer software is the information processed by various computer systems, data and programs. Software has been present ever since we have had computers. A computer is useless without a software.

Hence, it is the software that tells the physical components, known as hardware, of the computer how to perform different tasks. There have been different ways through which software has been distributed in the past and present. One such example is the SAAS business model. You may often hear about the term ‘SAAS’ in the news or on the internet. We will help you understand what it means and how this business model operates.

Software has been distributed primarily through two ways: as a product and as a service. Software as a product means that the software is sold with a license key. The consumer installs the software on the machine using the license key. The installed software is hosted/ran on the consumer’s computer system.

Similarly, there is another option. Software as a service (SAAS) is one of the new software distribution methods that is being adopted. In this example, the software is provided online and is hosted at a server owned by the software company. You need to pay for a subscription to use this service. This setup is similar to the relationship between a tenant and the landlord.

SAAS Business Model Enabler: Cloud Computing

We cannot talk about the SAAS business model if you are unaware about how cloud computing works. Cloud computing has made it possible for SAAS and other such services to exist. Cloud computing saw massive growth ever since the start of the dot-com bubble. Gartner reported that cloud computing industry grew by 18 percent in the year 2017 alone. It was worth $246.8 billion that year.

In simple terms, cloud computing is providing computing resources such as software, storage, database, networking, infrastructure etc. over the internet. Cloud computing companies charge their users on the basis of usage.

Cloud computing can further be divided into three categories: SAAS, IAAS, and PAAS.

What is SAAS Business Model?

SAAS deals with the service of providing software over the internet to its users. Hence, users and enterprises no longer need to buy licenses and install software on their computer systems. With SAAS, they can rent the required software over the internet and pay for how long they use it. Moreover, SAAS brings the ease to consumers that they no longer need to pay huge sticker price of software to use it for minimal time.

Examples of SAAS: Google Apps and Microsoft Office 365

What is PAAS?

PAAS stands for ‘Platform as a Service’. It provides a platform to its users that includes computing services such as operating system, web server, cloud server, database, and virtual environment for execution of programs etc. over the cloud. Furthermore, the platform can be used to develop software or deploy.

Examples of PAAS: Heroku, Google App Engine and Red Hat’s Open Shift

What is IAAS?

IAAS stands for ‘Infrastructure as a Service’. Companies providing IAAS host infrastructure such as servers, storages, networking, virtualization, and firewall etc.

Examples of IAAS: Windows Azure, Amazon EC2, and Rackspace

How Does the SAAS business model work?

There ae certain limitations in the ‘Software as a Product’ model. Those limitations are:

  • You need to purchase a license to use the software. Moreover, you need to pay to upgrade that software
  • Resources such as time and money are required to customize a software to your liking or needs
  • The data is stored locally. There is a danger of losing data in physical catastrophes
  • Updating the software can be cumbersome at an enterprise level. It wastes time and internet bandwidth

These are just the surface level problems that are faced when using the former model. Furthermore, adopting the SAAS business model has its definite perks as it minimizes the limitations that were mentioned above. To use SAAS, there is only important prerequisite, a good internet connection.

SAAS is hosted on the cloud. Hence, the developers can update the software and deploy the new version. This way, you no longer need to download or install the new update.

Moreover, SAAS business model makes for better scalability of projects as everything is on the cloud. Cloud computing makes it possible to host their services globally and allow users to connect from all around the world.

Understanding the SAAS Business Model

There are some important SAAS performance indicators that everyone should know:

CAC

It stands for customer acquisition cost. It is the cost that is incurred by a company to get one customer.

LTV

This is the amount of revenue that has been earned per customer.

MRV

It stands for monthly recurring revenue and it means the amount of fixed revenue that is retained every month.

MRR Churn

This term means how much revenue and customers are lost.

The Economic Side of the SAAS Business Model

SAAS uses a subscription based revenue model. It takes considerable time before profits are generated in a subscription based business model.

There are four kinds of costs that are incurred in this business model:

  • COGS
  • Marketing cost
  • R&D cost
  • General cost
saas business model

There is some negative cash flow in this revenue model because it can take some time before you break even with the expenses. In the earlier stages:

More customers = More CAC = Less Profits/Negative Cash Flow

saas business model

Moreover, the negative cash flow is minimized by charging the subscribers annually instead of monthly by offering enticing offers. Revenue starts to generate when the CAC has been met.

Customer Churn and LTV in SAAS Business Model

Customer retention can be a difficult task in this business model. Nevertheless, it is inevitable to lose some customers. Customer churn affects the LTV of the business model.

saas business model

Hence, to avoid this problem, entrepreneurs come up with enticing deals and ideas to attract more customers and to retain the existing ones. The marketing funnel ends up looking like this:

saas business model

This is the reason why SAAS offers various subscription options. Moreover, the addition of freemium makes it possible to attract new users.

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