SaaS Business Model: Key Stages and Pricing Strategies

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The SaaS business model is a way of delivering cloud-based software to users over the internet, usually on a subscription basis. 

As exciting as this model sounds, executing it isn’t a walk in the park. The average traditional business survives if it grows at 10% to 25% annually. Unlike this, a SaaS startup growing at 20% is 92% likely to fail. Worse, 60% growth still doesn’t guarantee success. 

So, how can you survive despite such terrible odds? 

A great product idea is an excellent start. But to ensure the level of growth needed for survival, you have to do the right things at the right developmental stages. For instance, you don’t want to market when you should focus on product-market fit. You must also determine the right revenue model for you.  

Thankfully, you’ll understand both elements by the end of today’s guide. 

How Does the SaaS Business Model Function?

The SaaS (software-as-a-service) model has some peculiarities that differentiate it from other business models.

For one, the software is hosted on the cloud. So, users can access the service over the internet – most likely via a web browser.

It is also subscription-based. This means users pay a recurring subscription fee—say, yearly—to use the software.

Here’s where it gets tricky. 

Since SaaS delivers a service, determining what counts as revenue isn’t as straightforward. For instance, your customer commits to an annual subscription; in return, you’ve received some cash upfront. It might seem like revenue at first glance, but it’s akin to a commitment to providing ongoing value. Until you’ve provided the service promised, the cash upfront is a potential refund waiting to happen.

That aside, the success of SaaS business models relies heavily on customer retention. You can only stay in business when paying customers renew their subscriptions. That’s why the customer success team is even more involved in the SaaS sales process to cultivate customer relationships and prevent churn.

Finally, SaaS products thrive on consistent updates. This is essential in offering the best user experience. It also helps to reduce the chances of cyber attacks.

SaaS Business Model Examples 

Below are three great examples of companies that have adopted SaaS as a business model:

1. Right Inbox

Right Inbox is an online gmail extension, primarily for sales engagement and email productivity: 

The platform automatically tracks email opens and clicks in real time, making it easier to monitor your email marketing success. 

The tool is available on a tiered pricing subscription basis, starting at $5.95 monthly for teams and $7.95 for professionals. 

Plus, Right Inbox understands that users are less likely to leave if you give them what they truly need. So, to boost retention, it has a dedicated feature request page where users can suggest and vote on features. Then, it implements the features that align with its business goals. 

You’ll need something like this to collect feedback on your software product. Pick feedback that resonates the most with your vision for the product and include it in your roadmap.

2. Writer

Writer is a generative AI platform. It allows brands to integrate generative AI tech into different business processes, like creating sales and marketing assets.

One of Writer’s customer retention strategies is targeting enterprise-level customers, who are less prone to churn than SMB businesses.  

Writer has also gone through a series of updates over the years. For instance, it transitioned from just an AI writing platform to a full-stack gen AI solution. From the screenshot above, you can also see they’re introducing a new feature called “Voice” through a banner at the top.

Again, product updates and new features are essential in the SaaS business model.

3. Shopify

Shopify is a SaaS e-commerce tool targeting online stores. It offers a no-code solution that helps entrepreneurs create online stores. With Shopify, any retailer that wants to sell anything online can do that without hassle.

Shopify’s subscription is also available in tiers, ranging from $32 monthly (basic plan) to $399 monthly (advanced plans). 

In addition, as a SaaS company, Shopify is quite heavy on updates. If you look at its public changelog, you’ll see it pushes updates every other day. 

Finally, Shopify has a community where users can share their thoughts and problems. Its quick response to user feedback and remarkable marketing campaigns are some of the reasons why Shopify is one of the most recognizable eCommerce solutions.

Growth Stages of SaaS Businesses

Successful SaaS businesses are built in three stages: early, growth, and mature. Doing the right thing at each stage determines whether you’ll move to another successfully.

Let’s look at each one below:

1. Early Stage

The early stage is one of the hardest for SaaS companies. This is where you focus on nailing down your product-market fit (PMF). So, you’re busy conducting targeted surveys and interviews and using the feedback to develop and adjust the software for better PMF.

It can be tempting to implement every feature customers request at this phase. That’s a bad idea. Doing so can lead to feature bloat and distract you from your core goals. 

Prioritize feedback that aligns with your big vision for the product.  

In terms of customers, business owners at this stage try to find loyal early adopters, mostly through word-of-mouth. These customers are usually tech enthusiasts who love trying new products.  

But bear in mind that your product is still not fully developed. That means there isn’t much brand awareness, and you also don’t have any convincing customer success stories. This makes it much harder to attract customers early on.

One way to solve this issue is to give potential customers a special deal to get them interested. For instance, providing a lifetime software license to specific potential users to gain initial traction. However, this is only advisable if you have a low marginal cost for serving each user.

Junno, software that lets customers create digital signage in a browser, is an example of a SaaS brand leveraging a lifetime deal.

At the early stage, SaaS businesses are still seeking their first pre-seed round. Because of the high risks involved, funding is typically very limited at this stage. That’s why you should run a lean team and keep your burn rate at a minimum. Some founders also opt to bootstrap their businesses through this initial phase. 

Metrics to monitor

  • Burn rate
  • Burn multiple
  • Runway
  • Net promoter score
  • Net dollar retention rate
  • Number of active users

2. Growth Stage

Software companies at this stage have found a functional product market fit. They’re now growing with a positive cash flow and meeting the SaaS rule of 40.

Raising funding is easier during this time than in the early stage because you now have a proven PMF and growth. Investors see your business as less risky and with potential.

Some investment avenues you can consider now are venture capitalists, angel investors, and accelerators.

Scaling becomes a priority here. So you can start thinking about growing your team. You must also start investing heavily in marketing and other growth strategies. Check out this article to see how much SaaS companies spend on marketing.

SEO is a smart and cost-effective marketing move to consider at this stage. A great SaaS SEO strategy will help drive qualified leads to your website. It’s also more cost-effective long-term than other campaigns like PPC. 

Let’s use Writer, the AI writing platform, as an example. Their primary goal was to attract high-intent and qualified traffic. So, they aimed to rank higher on Google for relevant high-volume search terms, such as “grammar checker,” which has a monthly search volume exceeding 450,000 in the US.

Through strategic link building, we helped them secure a top-three ranking for this keyword. The keyword currently attracts over 1.2 million qualified web traffic every month.

Besides SEO, social media advertising, referral programs, and email marketing are other effective SaaS marketing strategies you cannot overlook.

Metrics to monitor

  • MRR (monthly recurring revenue)and ARR (annual recurring revenue)
  • Churn rate
  • Customer acquisition cost
  • Customer lifetime value
  • LTV to CAC

3. Mature Stage

SaaS companies entering this stage are very well established. They have a predictable ARR of over $20m. Your KPIs are also stable here. Plus, you now have a strong foothold in the market and are well-known in your industry.

Now, your focus is on becoming a market leader and building a cult following. This is where more expensive marketing strategies come in—for instance, annual conferences like Inbound for HubSpot and MozCon for Moz.

Unlike in the early stage, you’ll also attract all types of customers, i.e., technical and non-technical users. The latter needs more training. That’s why educational resources like ebooks, courses, training webinars, and guides become essential.

For instance, Writer frequently hosts Webinars, inviting industry leaders to share their insights. You can replicate this idea as well.

Mature SaaS companies might also seek more funding. But this time, it’s for bigger goals. For instance, breaking into new markets. 

Also, consider acquiring companies with working products to improve your software. For example, what HubSpot acquired Performable. Or buy out your competitors like how Atlassian acquired Trello.  

Lastly, similar to mature-stage brands like GitLab, you can start considering going public (IPO). However, to achieve a successful IPO, you must maintain a growth rate exceeding 25% and an ARR of at least $100 million

Metrics to monitor

  • Customer lifetime value
  • The average revenue per account
  • Churn rate

SaaS Pricing Models

Monetization has the most impact (12.7%) on your bottom line, compared to retention (6.71%) and acquisition (3.32%). This means choosing the right revenue model for your product is crucial. 

Here are five models to consider.

1. Freemium Pricing

Freemium pricing is a strategy in which you offer a basic version of the software for free but allow users to upgrade to a premium version for more advanced features. That’s what Airtable does, for instance.

Pros of freemium pricing

  • Free access entices a larger user base, increasing brand visibility.
  • Users become comfortable with the product. If excellent, they’re more likely to upgrade.
  • Users can experience the product’s value before committing financially.

Cons of freemium pricing

  • The free version might lack critical features, limiting user experience.
  • Providing support to free users can strain resources.

Best for: Startups that want rapid user adoption and those with a clear upgrade path. 

Dropbox is an excellent example here. The company initially offers users free 2GB of storage. Anyone who exceeds this capacity must upgrade their plan to access more space. 

With this strategy, Dropbox amassed over 700 million users while generating $1.91 billion in annual revenue. Although not all free users convert to paid customers, they can still become valuable brand advocates, thereby boosting visibility.

Unfortunately, users can get pretty comfortable with the free product, leading to low conversion rates. To tackle this, Dropbox adopted a full-featured free trial. 

This trial helps users experience the full breadth of the tool. Thus, they’ll understand the value they stand to gain from upgrading, ultimately motivating them to take a step toward the paid plan. 

2. Flat Rate Pricing

Flat rate pricing involves offering the software at a fixed price, regardless of usage or features accessed. Check out IxactContact, for example:

Users pay a fixed amount, either monthly or yearly.

Pros of flat rate pricing

  • Straightforward pricing makes decision-making easier for customers.
  • Easier to sell.
  • Customers know exactly what to expect in terms of expenses.
  • Simple billing and invoicing process.

Cons of flat rate pricing

  • Some customers might not use all features, leading to a perceived lack of value.
  • Limited room for customization based on individual user needs.
  • May not be okay for businesses with rapidly fluctuating needs.

Best for: Simple software products with limited features.

3. Tiered Pricing

Tiered pricing involves offering different levels of service at varying price points. This could include professional and personal versions with different features, prices, and capabilities.

See how Right Inbox does this:

Pros of tiered pricing

  • Scales well to accommodate diverse customer needs.
  • Customers can choose a plan that aligns with their requirements.
  • Encourages users to upgrade for additional services.

Cons of tiered pricing

  • Managing multiple tiers can be administratively challenging.
  • Customers might struggle with decision paralysis.

Best for: Platforms with a broad customer base and varied usage demands. For example, you can implement tiered pricing to cater to small teams seeking basic features and larger enterprises needing advanced features. 

4. Usage-based Pricing

The usage-based model charges customers depending on how much they use the product. 

Zapier is a good example. Its usage-based pricing is structured around tasks. Users can select a plan based on the number of tasks they intend to complete each month with the tool. The starter plan allows a choice between 750 or 1500 tasks per month, for example.

Pros of usage-based pricing

  • Customers pay only for what they use, ensuring fair value.
  • Can attract customers with diverse needs, ranging from heavy to light users.

Cons of usage-based pricing

  • Tracking and monitoring usage can be challenging for both customers and providers.
  • Overestimating potential usage can lead to unnecessary costs.

Best for: Product targeting enterprises with fluctuating and unpredictable usage demands.

5. Per-User Pricing

Per-user pricing charges customers based on the number of users accessing the software. That’s what Writer uses:

Pros of per-user pricing

  • A clear understanding of expenses based on user count.
  • Users enjoy unrestricted access, promoting adoption.
  • Straightforward billing and tracking of user counts.

Cons of per-user pricing

  • Flat pricing per user might not reflect varied usage needs.
  • Restriction on user counts may hinder scalability.
  • Some users might not fully engage with the software, affecting value.

Best for: Companies seeking predictable MRR and catering to a stable user base.

What are the Disadvantages of the SaaS Business Model

Here are some of the major issues facing the SaaS business model and their potential solutions:

1. High Upfront Costs

Establishing a SaaS business involves significant initial expenses – software development, infrastructural development, etc. You’ll probably spend more than you’re earning in the early stages.

Possible solution:

Outreach.io faced this issue during its initial years when low traction and high expenses were draining its finances.

Its response? The company decided to pause its marketing efforts for two to three years. Instead, it focused on refining its Product-Market Fit (PMF) to create a product people actually want.

Today, Outreach is one of the billion-dollar SaaS companies. 

Essentially, before you market your product, make sure it’s something people want. That way, you’ll attract more users and quickly break even on your upfront costs. 

It’s also essential to keep your overhead costs low. For example, you can set up a remote team and use cloud services to save on costs.

2. Increased Competition

People can create a SaaS product today with $0. This low barrier to entry means more players are entering the field, making it more competitive.

Possible solution:

The first solution is to differentiate your offering to gain a competitive edge. Find an underserved problem in your niche and solve it.

Before Zendesk, most SaaS customer relationship management tools had a steep learning curve. However, Zendesk understood this issue and developed a product with almost no learning curve. This unique approach was one of the right steps they took to help them gather a $1.3 billion ARR.

You can also consider the freemium model. While it might seem odd to give away a product you made for free, it can help you get noticed. It worked for Dropbox, helping it secure over 700 million users. 

Finally, consider acquiring your competitors. As mentioned earlier, Atlassian and Trello are great examples. But you should only do this when you’re in the mature stage. 

3. Customer Churn

Customers can cancel their subscriptions for various reasons. For instance, a major competitor promises them a better value-for-price. This can be a huge issue because: 

One – Churn is one of the things VC firms consider during business valuation. 

Two –  Boosting retention by 5% can increase your profit by 95%. Imagine that 5% of those customers get churned. That can be a massive profit loss. 

Possible solution:

For starters, enterprise-level clients have a lesser annual churn (6% to 10%) than SMBs (31% to 58%). One reason is that enterprise clients often have more stable and long-term business needs. Plus, they are at lesser risk of closing down than SMBs. So they’re less likely to stop using the tool shortly after adoption. 

Moreover, larger businesses typically invest more time and resources into evaluating and implementing software solutions. Thus, it’s not easy to switch providers frequently. 

So, consider moving upmarket from SMBs to enterprise clients if you want to reduce customer churn

Also, track user behavior to find out why they quit. This could be a difficulty in using a feature. Then, find a solution to the issue. By doing this, you can upgrade your product experience like Groove and reduce churn by 71%.

Finally, Mention also reduced churn by 22% simply by constant communication with customers. So, get your customer success team involved to conduct and act on customer churn surveys.

4. High Costs of Hosting and Maintenance

As you enter the growth stage, you may face issues with high hosting and maintenance costs. That’s because you now need to accommodate a larger user base and handle increased data demand.

Possible solution:

If you haven’t already, consider switching to cloud software hosting and server-less architecture. 

PipeLyft, for instance, partnered with Amazee to switch to cloud-hosting solutions. This move helped the company save up to $70,000 on hosting and maintenance. That’s because they now only had to pay for the storage spaces and computing resources they needed.

Next, instead of starting with proprietary tools and technologies, consider using open-source options for some parts. For example, Wave has free libraries and frameworks to help you build an advanced user management system.

The beauty of open source is that the community takes care of the maintenance, so you won’t need to worry about those costs. 

As a final tip, optimize your resource management by running a lean system until you close your next funding round.

SaaS Business Model FAQs

1. What does a SaaS business do?

A SaaS business provides software applications over the Internet using a subscription model. Users can access and use these applications without installing or maintaining the software on their devices.

2. What are some SaaS business model examples?

Some good SaaS business model examples include HubSpot, Zapier, and Mailchimp. These SaaS companies charge users monthly and annual subscription fees to access different features.

3. What is SaaS business model?

A SaaS business model delivers cloud-based software solutions to users over the Internet, usually on a subscription basis. Writer and GetResponse are good examples of SaaS business models.

In Closing

The SaaS business model has become so popular in recent years. However, understanding the model is essential to give your software company the best shot at success.

In this article, you’ve learned the key stages in this model and what happens in each. You’ve also seen the different pricing models and their pros and cons. Finally, we’ve taken you through the major challenges SaaS companies face. 

Hopefully, this guide will help you make informed decisions in building and scaling your SaaS company.

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