SaaS Business Models Explained

Apr 08, 2019
Share
SHOW CONTENTS

Software as a Service, otherwise known as SaaS, is one of the fastest growing business models as it attracts new entrepreneurs and wily veterans.

With the internet comes a staggering amount of options for building a business. Inside each of those business models are dozens of options and strategies for pricing and obtaining customers.

SaaS as a business model appeals to a massive demographic of entrepreneurs as almost anyone with knowledge or skill can contribute to building a SaaS company. Gather a team that includes a coder, a designer, and anyone from any part of the business world under the banner of an idea for a software that can be sold as a service and all of the sudden you have a potential business.

What is SaaS?


SaaS is a newer business model. Traditional software companies have the need to build out a complete infrastructure and have a customer pay upfront to have the ability to download the software. At that point, the company would need to host the software on their infrastructure and the user would be able to access it from their computer.
what is saas
Nowadays the option to pivot from that is available with the massive boom in cloud resources. SaaS businesses host their product in the cloud. Instead of building out massive infrastructures, companies can just pay a cloud service to host it for them. This allows customers to jump on a web browser and access the software from there.

Rather than paying a large upfront fee, a customer can just pay a monthly subscription and have access to the software. The way a business can actually obtain a customer and decide to make money from them varies greatly. We will go into more detail in the SaaS business models section.

More and more software companies are going the SaaS route as it takes a much smaller amount of money to reach a minimum viable product. However, it isn’t all rainbows and sunshine with SaaS products. Problems do arise.

Positives of SaaS Products


There are always pros and cons to weigh with any business model. SaaS is not for everyone but these positives speak to a large population of entrepreneurs.

Short-Term Cost Savings

Avoiding the initial expenses of tackling a software infrastructure is a game changer and is something the modern internet has recently made possible. An IT infrastructure is expensive and the ability to avoid those initial fees is the most attractive aspect of the SaaS business model.

Scalability

If a SaaS business gains initial traction, server space is not an issue. In traditional software companies there would need to be a plan in place to increase server capacity. A lot of successful software companies experience a brief crisis to build it out. In the SaaS business model, the only hurdle is upgrading the hosting service.

Accessibility

Every company has a specific market but the SaaS business model expands that market. Anyone that can access a browser through the internet has the ability to use the software.

Upgradeability

A recurring theme presents itself: not having to deal with infrastructure is a huge positive. The hosting service provider will have to deal with all upgrades concerning hardware and software.

Resilience

If a top-tier hosting service is used with built-in redundancy with backups in place then a SaaS business becomes resilient. In a self-hosted infrastructure, contingency plans are expensive. Leaving this up to the hosting service saves time, money, and resources.

Negatives of SaaS Products


With the SaaS business model comes less upfront cost and simplicity from an infrastructure standpoint. The positive side of SaaS comes with sacrifice.

Security

When outsourcing server space and other infrastructural needs you are also outsourcing security. This isn’t always a bad thing but if there is a security breach with a cloud service that is being used the blame will still fall squarely on the shoulders of the SaaS company.

Outages

Outages happen with any server infrastructure. With a SaaS product and an outsourced cloud infrastructure, outages will be completely out of the company’s control. Any outage is problematic but if there is an outage that is longer than normal, extra resources will have to be deployed towards damage control.

Compliance

Depending on the industry category a company falls under, compliance can be a factor in the decision of hosting providers and any other vendor used. Using a third-party vendor can even be off-limits in some industries.

Performance

There will be customers that complain about performance with a browser-based software. These same customers will have a slow internet connection and a 2003 version of their internet browser downloaded.

Capital Intensive Scaling

The amount of money needed to hire more designers, more developers, and other parts of the team is high. All of the money made in the initial stages of a SaaS business needs to be reinvested. This also includes capital for more security and storage.

Different Types of SaaS Business Models


The options are endless with how to reach a customer and then charge them in any industry. There are a handful of proven ways in the SaaS industry to do both.

Two Main Categories

Low-touch SaaS and high-touch SaaS companies are the two overarching models. The former focuses on an individual customer whereas the latter focuses on enterprise-level sales.

types of saas models

Low-Touch SaaS

More often than not, low-touch SaaS companies rely on somehow sending a potential client directly to their website. Usually, the potential user will be enticed with a free trial.

The goal is then to have the free trial user love the product and then actually purchase a subscription to the software. In most cases, there will be multiple levels of the service which the consumer can choose from.

The products under the low-touch category should not be difficult to use. There are apps that can be learned intuitively or with an automated onboarding operation.

These products rely on a lot of people signing up for them as low-touch software is usually less money than high-touch software. A normal day-to-day consumer would pay for this product out of pocket. Low-touch SaaS relies on smart and efficient marketing more than direct sales.

Mailchimp is an example of a low-touch SaaS business that brings in a high number of users through marketing. The company also offers a free version of the software so people can become users before paying. Once the user outgrows the free version they upgrade to the paid version.

High-Touch SaaS

High-touch SaaS companies do everything the opposite way a low-touch SaaS company would do it. Rather than sending a potential customer to a website in order to be pulled in with a free trial, direct sales are often made with large companies that want to and can pay a lot of money for the service.

Sometimes the company will use the software to manage a process or they provide the software to an existing user base (their employees).

Since high-touch SaaS companies deal with enterprise level potential customers, the specific needs of each potential customer need to be met. I

This means that resources need to be put towards the relationships built with customers. It also means that customer support is more personal and turns into managing an account rather than supporting customers when they need help randomly.

Pricing Models


Some pricing models are more common than others. We describe the most common to the least common pricing models in the SaaS industry. Some of these pricing models can be used together for hybrid pricing models.

pricing pyramid

Per-User Pricing

Per-user pricing is the most popular SaaS pricing model when applicable.

How it works

Per-user pricing is a pricing model that can be used in a hybrid model with tiered pricing, freemium pricing, and others. The general concept is that a customer will pay one price if one person at their company is using the software and if a second person wants to use it then they have to pay for that privilege.

Discounts are often offered if the amount of users reaches a certain number.

Pros

There is a reason that per-user pricing has been used since the beginning of software. It is an extremely direct model and makes it easy to calculate monthly costs for users and monthly revenues for the software company.

Cons

Many thought leaders are calling for all companies to stop using per-user pricing as it limits adoption throughout a company. Monthly active users is the king of SaaS metrics and when there are limits on who can use the software in an organization, monthly active users will plummet.

Example

Per-user pricing is being used in concert with tiered pricing more and more as time goes on. For example, Shopify offers tier pricing but the different tiers determine how many users can be on the account.

shopify pricing

Tiered Pricing or Per Feature Pricing

Almost every company starts with a tiered pricing strategy as it is straightforward and allows the potential for upsells and increased value. The tiers can be decided by amount of certain features can be used as well as features available in general.

How it works

A company will offer their service at a handful of different rates. The lower the rate the less features a customer will get. This allows a company to provide different levels of value while appealing to different levels of user.

Pros

With the tiered pricing approach, the market immediately expands to people with varied budgets. It also allows new users to test the product out at the lowest level and upgrade depending on their needs.

From a marketing perspective, the easiest person to make money off of is an existing customer. The ability to upsell to an existing customer base is a huge benefit of tiered pricing.

Cons

The biggest con against tiered pricing is trying to appeal to too large of a market. If everyone is your customer then no one is your customer. Other downsides include confusing potential users. Offering easy to understand pricing tiers is important so decision fatigue does not set in and impact a potential customer.

Example

Almost any web hosting service utilizes tiered pricing to a high degree. Companies like HostGator offer three tiers where users can decide which one fits their needs the best.

hostgator shared web hosting pricing plan

As you can see, this presents HostGator with the opportunity to recommend one of their plans and potentially upsell their customer down the line.

Freemium Pricing

Freemium is one of the most well-known pricing models because of high profile success stories. What people don’t see are all the freemium model companies that died via server costs that couldn’t be paid.

How it works

The freemium pricing model pulls users in with a free version of the software. Once a customer likes it or needs more functionality they need to pay to get the full use of the software.

Pros

Free software is much easier to gain users for. If the market you have targeted values the service then it will be much easier to sell them on the premium version of the software if they already enjoy the free version.

Cons

Upfront costs that have no incoming revenue to pay for them is the biggest issue with this model. Free users also will take up other resources such as the support staff.

Example

There are a handful of great examples but one of the earliest companies to pull this off successfully is Dropbox. With the free version of Dropbox you can use up to 2 GB of storage space. This brings users in forcing them to upgrade to a paid version once they fill their 2 GB. The freemium model is always going to be a hybrid pricing model with another one on this list.

Usage-Based Pricing

In the old days, the only usage-based pricing model applicable was a pay-per-view movie or fight on cable. This pricing model has become trendy in the SaaS world due to the widespread appeal.

How it works

A user will only be charged for how much they actually use the software. This can be seen in many industries with the actual use factor being data or transactions processed. The more data used, the more the bill will be or the more transactions processed, the more the bill will be.

Pros

The biggest pro of this pricing model is that companies can scale their expenses with their revenue. The companies that use the software a lot will have received direct value from the product.

Cons

Depending on what the SaaS product is being used for, a customer could be upset to find out how much they owe the company at the end of a month.

Well-Known Examples

Almost every cloud server platform, such as Google Cloud, offers a usage-based pricing model. Depending on how much data is used and other factors, charges from these types of services are based completely on how much you use.

Per Active User Pricing

Per active user pricing is a direct variant of active user pricing.

How it works

Per active user was created as an improvement on per-user pricing to allow companies to use a software without having to pay for users that would not actually use the software. This improves a sales proposition for software companies as well, making the case that if no one wants to use the software then the potential customer won’t have to pay a cent.

Pros

As mentioned, it is a much easier sales conversation and companies will not have to pay for users that aren’t actual users. It also remedies the negatives associated with adoption for the original per-user pricing model.

Cons

It is harder to make money off smaller businesses with this pricing model.

Example

Just like with the active user pricing model, the per active user pricing model can also be used in a hybrid pricing plan. Slack uses a freemium pricing model but once a customer decides to pay the pricing is decided per active user.

slack pricing

Flat Rate Pricing

Without many real-world examples of a flat rate pricing model, it is hard to tell how a  successful truly flat-rate priced SaaS software would do with many successful companies using other models.

How it works

Rather than messing around with different pricing tiers or offering different levels of service, a company offers its service for one price.

Pros

In the SaaS world, a lot of companies have extremely confusing pricing models. There is no confusion with flat rate pricing. It is extremely easy to communicate the message to potential customers. A company can point to what someone would get if they decided to use the software and then point to the price needed to pay to use it.

Cons

The problem with flat rate pricing is that there are not many industries where this won’t lose a company a huge amount of money. Large companies are able to pay much more money for software. If a small company is paying one amount, there will be a lot of missed revenue if a large company is paying the same amount.

Well-Known Examples

Any software that starts out flat priced eventually pivot to a different pricing model. This is because once more knowledge is gained from a customer base, flat rate pricing makes no sense. Some customers need fewer features or use the software less and it becomes apparent where more value can be offered to a customer which will come at a different rate.

Resources to Learn More


The best place to learn more about the SaaS business model and the SaaS industry, in general, is from experts in the field. Andreessen Horowitz has a podcast called a16z Podcast that talks about SaaS in general, the big SaaS news of the week, and interviews with high-level players.

a16z Podcast – A podcast from Andreessen Horowitz that talks about SaaS in general, touches on the big SaaS news of the week, and showcases interviews with high-level players in the industry.

Andy Chung’s SaaS Story – A great step-by-step story on a SaaS businesses road to their first customer.

Data from KeyBanc Capital – Industry surveys and resources full of data and takeaways are available from KeyBanc Capital.

InsightSquared SaaS Resources – InsightSquared has put together the 77 best SaaS sales resources including many amazing blogs like A Smart Bear, written by Jason Cohen, who is one of the founders of WP Engine.

Share

Our research

What is SaaS?Positives of SaaS ProductsNegatives of SaaS ProductsDifferent Types of SaaS Business ModelsTwo Main CategoriesPricing ModelsPer-User PricingTiered Pricing or…

What Kind of Growth Do SaaS Companies Need?Why Do Companies Switch to SaaS?Are Organizations Really Making the Switch to SaaS?The…

Organic Search Marketing vs. Paid Search MarketingWhat Is Organic Search Marketing?Pros and Cons of Organic Search ResultsWhat Are Paid Search…