What is a SaaS business?

Original author: Patrick McKenzie
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Principles of work and growth mechanisms of SaaS companies

Software as a Service (SaaS) is a software payment and delivery model that is so superior to the traditional way of selling software licenses that it rebuilds the company according to its needs. Thanks to this, SaaS companies have gained a very special practical experience. Unfortunately, for many, this path is difficult: they repeat the already known mistakes - instead of carefully filling the bumps in new places.

It is unlikely that anyone will want to step on someone else's rake, so we will quickly look at the state of affairs in the SaaS business. In order to succeed in this sector, you need to learn to better understand the SaaS business model, be able to predict in which way the product should be sold (“with weak contact” or “with strong contact”), and - if you are already working in the SaaS business - be able to assess the state of the company and improve its work.

If you are a software developer and at the same time sell non-mobile applications (they have their own payment model defined by application stores of specific platforms), you need to thoroughly understand how the SaaS business works - then you can make more effective decisions regarding the product (and company) and see business problems lurking for months and even years before they become apparent. In addition, this understanding will help in negotiations with investors .

Translated to Alconost

How SaaS takes over the world

SaaS love it because it “just works.” To use the product, usually nothing needs to be installed. Equipment failures and operational errors — problems that often arise when complex machines are not serviced by professionals — do not result in significant data loss. SaaS companies achieve a level of performance (which can be expressed as a percentage of the time when the software is available and works correctly), significantly exceeding the rate that most IT departments of companies achieve (not to mention individuals).

Also, using SaaS usually seems less expensive than using software sold using other payment models. This is important, for example, for users who are not sure which software should be selected in the long run, or who need software for a short time.

SaaS like mainly for the delivery model, not the payment model.

Most SaaS are under constant development and use the company's infrastructure. (An important exception is SaaS in the corporate sector, however, with the vast majority of SaaS in the B2C and B2B sectors, users work over the Internet from servers supported by the software company.)

Historically, the development companies did not control the environments in which their code was run, and this complicated the development and technical support of customers. Any software deployed on client hardware is affected by differences in system configurations, interaction with other installed software, and operator errors. This must be considered when developing software and customer service. Companies that sell their designs both in the SaaS model and as installed software often note that in the case of locally deployed software, ten or more times support requests are received from one client.

Companies and investors SaaS is liked because the economic characteristics of SaaS look much more attractive than selling software licenses. SaaS revenue is usually regular and easily predictable, making cash flows in SaaS companies much easier to predict, which allows you to use this in your planning and even here and now sell investors cash flow in the future and, accordingly, quite generously finance the current growth. For this reason, SaaS companies are considered one of the fastest growing software companies in history.

SaaS Sales Models

If you do not go into details, there are two ways to sell SaaS. A sales model defines almost all other aspects of the life of a SaaS company and its product - it permeates all activities so that this may be a complete surprise for newcomers to the SaaS business. One of the most common mistakes SaaS companies can take years to resolve is the mismatch between the product or the market and the chosen sales model.

By the end of the article, it will become clear that the sales model for SaaS products determines the company's work in a much larger degrees than other differences: selling to individuals (B2C) or enterprises (B2B), the company receives support from venture capital funds or by its own means, what is the technological stack of the product under the hood and so on.

Low Contact SaaS Sales Model

Some products sell themselves.

The SaaS model with a weak personal contact is suitable for most customers and allows you to buy a product without constant personal interaction with representatives of the development company. The main sales channels in this case are the software website, email marketing and (very often) a free trial version, which they strive to develop in such a way that it can be very easily and quickly started to be used - and then just as easily become a regular user.

Sometimes such companies still organize sales units, but more often in the form of the so-called “customer satisfaction departments”, which are less focused on convincing customers to buy software and more so that users of free trial versions switch to constant use and began to pay for the service at the end of the free version.

Customer support in the case of products with poor contact is usually organized in such a way that it can be scaled: the product is designed in such a way as to avoid cases requiring human intervention - for example, training resources are being prepared that apply to the entire customer base. Human resources are the last to be used. At the same time, strangely enough, for many companies working on this model, customer support is simply excellent. SaaS economic performance depends on long-term customer satisfaction, so even a product that expects only one application (a separate interaction with the customer) for every 20 client months can significantly load the customer satisfaction team.

Weak-contact SaaS products are usually sold on a monthly subscription with a price range from about $ 10 for B2C applications to $ 20-500 a month for the B2B segment. This corresponds to an average contract amount (ACV, English “average contract value”) of 100-5000 US dollars. In companies operating according to the weak-contact model, the term ACV is usually not used - the monthly standard price indicator is used instead, but it is important for us to compare them with SaaS applications of the strong-contact model.

If you ask the owner of a SaaS company with weak contact about the most important indicator, you will be called the regular monthly revenue - MRR (English “monthly recurring revenue”).

A textbook example of a SaaS company with sales based on a model of weak contact - Basecamp . And Atlassian (on their account JIRA, Trello, Confluence and some other products) is perhaps the most successful public company using this approach.

Strong SaaS Sales Model

Some customers need to be told if certain products should be introduced and how to do it.

The SaaS model with a strong personal contact is intended for those cases when the human resource is noticeably involved: the employees of the development company convince customers to implement the software, help to successfully put it into operation and strive to ensure continuous use.

In this case, the organization’s heart is almost always the sales department, which is often divided into specialized units: specialists in the sales increase department (SDR, English “sales development representative”) find potential customers of the software that manage customer accounts (AE, English “account executives ”) manage sales for specific customers, and personal managers (AM, English“ account manager ”) are responsible for the satisfaction of individual customers and maintaining effective work with them.

As a rule, the sales department is assisted by the marketing department, the main task of which is to formulate for sales specialists a sufficient flow of suitable customers - to assess prospects and conclude a deal.

With this model, many high-quality products are sold, but in a first approximation for a SaaS business with strong contact, software development and the product itself are considered less important than the sales engine.

The organization of customer support in such companies can be very different, but it is usually assumed that the support service will have a lot of work: the expected number of requests for one client for a certain period of time is several orders of magnitude higher than in the model with weak contact.

According to the strong contact model, it is possible to work with individuals (for example, insurance services in the USA are traditionally sold through insurance agents), but it should be borne in mind that the vast majority of such companies work with enterprises that differ widely in the B2B sector and in terms of expected customer profiles, and ACV indicators (sometimes by this abbreviation is meant not the average, but the annual contract amount - English. "annual contract value"), and the complexity of the transaction.

In the lower price range, SaaS products according to this model are sold to small and medium-sized businesses (SMB) - here ACV is 6-15 thousand US dollars, but may be higher. There is no generally accepted exact criterion which companies are assigned to the SMB segment. In practice, this usually includes companies that can afford to introduce software worth $ 10,000: it is unlikely to be a local flower shop, but a private dental clinic with four doctors is quite possible.

The upper price segment - it is called "corporate" - targets very large enterprises and even governments. In a good way, contracts here begin with hundreds of thousands of dollars, and there is no upper limit. (For example, Inovalon's annual report there is a customer with a contract worth $ 70 million.)
If you ask the owner of a SaaS company with strong contact about the most important indicator, you will be called regular annual revenue - ARR (Eng. "annually recurring revenue"). (In essence, this is all of the company's constant revenue, minus certain irregular revenues, such as a one-time installation fee, consulting services, etc. The economic attractiveness of a SaaS business is growth over time, so one-time incomes, especially relatively low-profit ones revenue, business owners and investors are not particularly interested).

A textbook example of a SaaS company with strong contact is Salesforce (they literally wrote a book about this model). There are a lot of small SaaS companies working according to the strong contact model, but they are less noticeable than companies with weak contact, mainly because the latter attract new customers due to their visibility and popularity, and for the former this approach will not always be optimal. For example, many small SaaS companies calmly have hundreds or even millions of dollars a year, selling their services in a strictly defined vertical segment.

Mixed sales approach

Sometimes functionally the same product is successfully sold on both models. But in the case of the SaaS business, this is a rarity . Usually, the result of trying to use both models at the same time is the relatively successful application of one model, which interferes with the normal implementation of the second - as the approach to sales permeates all the activities of the company.

More often, only certain elements of the second are brought into one sales model. For example, in many SaaS companies with poor contact, customer satisfaction departments look almost like distance selling units if you look closely. Companies with strong contact usually borrow to a lesser extent: most often the product that the company does not sell, but distributes according to the model of weak contact, is the introduced element here, in order to attract potential customers to another product, the sales of which bring the main income.

The main formula of SaaS business

In the SaaS model, software is not sold as a product with a final cost, but, in fact, turns into a financial instrument with probably predicted cash flows, and in this context it is sold.

There are more complex approaches to modeling a SaaS business, but we will restrict ourselves to the version that does not require a diploma in economics, and make some assumptions that simplify the consideration (for example, we will not take into account the time cost of money) - mathematics at a level higher than high school will not be needed. The most necessary thing to know about the SaaS business is its basic formula: it is like a Rosetta stone for understanding the work of SaaS companies.

The basic idea is very simple: the long-term revenue is the product of the number of customers and the average revenue during the service of one client.

The number of customers here is a product of two indicators: attraction (how effectively potential customers are attracted to SaaS with weak contact or - in the case of SaaS with strong contact - how efficiently you find potential customers and contact them) and conversion rate (percentage of potential customers who start to pay).

Average revenue for the time of customer service (it is also called the customer’s lifetime value - LTV, Eng. “Lifetime value”) - the product of the amount paid by the client for a certain period (for example, one month) and the number of periods in which the service was used.

Average revenue per user ( ARPU ) is simply the average revenue per account for a given period.

Outflow is the proportion of customers who stop paying you; calculated for a certain period. For example, if in January 200 customers pay for your services, and in February - already 190, the outflow will be 5%.

The customer service time, if slightly simplified, can be calculated as the sum of an infinite geometric series - in this case it will be enough just to take the opposite from the outflow. If some product loses 5% of customers per month, then the expected service time is 20 months; if each client pays $ 30 per month, then the expected total revenue from the new customer will be $ 600.

Conclusions from the SaaS business model

Improving the performance of the SaaS company in several respects gives a multiplier effect.

A 10% increase in the engagement rate (for example, due to better marketing) and a 10% increase in the conversion rate (for example, through product refinement or more effective sales methods) will not give together 20%, but 21% (1.1 × 1 ,1).

Improving SaaS business performance is incredibly effective .

SaaS margin is very high, so a long-term assessment of the SaaS business is actually directly proportional to long-term revenue. Thus, an increase in the conversion rate of 1% means not just an increase in revenue by 1% in the next month or even in the long term - it means an increase company market capitalization of 1%.

Price is the easiest way to increase the effectiveness of a SaaS company.

Improving indicators of attraction, conversion and outflow often requires serious efforts of specialists from different departments. And to change the price tag, it is usually enough just to replace a smaller number with a larger one.

Ultimately, SaaS companies go to the limit.

With fixed attraction, conversion and outflow, there comes a moment when the company reaches the revenue plateau. This can be predicted in advance: the number of customers on the plateau is equal to the rate of attraction, multiplied by the conversion and divided by the percentage of the outflow.

A SaaS company that ceases to increase engagement, conversion and reduce outflows will stop growing with almost mathematical certainty. And if a company, having ceased to grow, does not manage to cover fixed costs (for example, salaries for developers), it will face a humiliating death - even if the management did everything right .

Significant capital may be required to grow a SaaS business.

For such companies, the initial expenses at the growth stage are increased, especially if the growth is dynamic; marginal costs per client are dominated by marketing and sales expenses, and often they account for the majority of all company expenses. The costs of marketing and sales associated with a particular client appear very early in his life cycle, and the revenue that ultimately covers these costs arrives later.

This means that a growth - oriented SaaS company will almost always spend more than a profit over a specific period of time. And the money for these expenses needs to be taken from somewhere. To finance growth, they often go by selling the company's shares to investors. For investors SaaS-companies they are especially attractive because their working mechanism is easy to understand: you create a product, fit into the market, spend a lot of money on marketing and sales in accordance with a relatively reproducible scheme, and ultimately sell your share in the business to someone else (it may be public markets , another company that takes over yours, or another investor who is looking for a risk-free business with good growth potential).

Margin - in a first approximation - does not matter.

Most companies seriously care about the cost of goods sold (COGS, English “cost of goods sold”) and the price that will satisfy a neutral consumer.

For some business platforms (such as AWS), material costs are a significant part of COGS, but for a typical SaaS company, the main source of value is software that can be replicated with an extremely low COGS. Typically, SaaS companies spend less than 5-10% of additional income on providing basic services to one client.

This allows SaaS business owners to almost completely ignore the economic indicators of a unit of goods, except for the cost of attracting one customer (CAC, English “customer acquisition cost”), which represents the marginal cost of marketing and sales per one new customer. If the company grows rapidly, this allows you to ignore expenses that do not increase in proportion to the number of customers (engineering costs, general and administrative expenses, etc.) - on the assumption that a significant CAC will exceed any other expenses column.

SaaS company growth takes some time.

The prevailing view in the press paints a picture of a rapid growth curve with a small initial section, but in practice it takes a very long time to gain momentum, grinding the product itself, approaches to marketing and sales, and only much later things start to go uphill. This phenomenon has a catchy name: the slow and long rise of SaaS to death .

In the SaaS segment, expectations for growth are very different.

Independent SaaS companies often need a year and a half to reach profitability, become competitive and give good money to founders. After reaching this point, a wide range of acceptable growth rates opens up; an annual growth rate of 10–20% can very, very please all interested parties.

In the case of SaaS companies with external financing, money is purposefully invested in growth, which means that they spend a lot of money in advance on improving the model of work, and there are almost no cases where it was not possible to spend a lot.

After the model is refined, it is scaled, which usually leads to an even more rapid loss of even larger amounts. For business, this is a successful result, which often contradicts the impression of those who follow the software industry. If the business is able to continue to grow, it can ultimately pay off any accumulated deficit. If there is no growth, the company will sink into the abyss.

There are many much less stressful business activities in the world than work aimed at the dynamic growth of SaaS companies, which is similar to flying on a rocket: you burn a huge amount of fuel in order to achieve the necessary acceleration ... but if something goes wrong - the rocket will explode .

In practice, for a successful SaaS company focused on dynamic growth, expectations for growth can be described according to the “3, 3, 2, 2, 2” scheme: starting from a sufficient base level (for example, more than 1 million US dollars ARR - regular annual revenue ), the company must triple its annual revenue for two consecutive years, and then double it for three consecutive years. A SaaS company with external financing, which at the beginning of its journey grows by 20% year by year, in the eyes of investors will most likely look unattractive.

Criteria to Know

One of the most popular questions that can be heard from the owners of SaaS companies is: “How do I know if I have good performance?”

It is surprisingly difficult to answer this question, since both the industry, the business model, the development stages of the company, and the goals of the founders are very different. However, in general, business-taught entrepreneurs use several practical valuation methods.

Performance for SaaS with weak contact

Conversion rate.

In most cases, SaaS companies with weak contact distribute a free trial version, and they use two opposite approaches: registration requires a minimum of data and during registration it is necessary to attach a credit card from which the subscription amount will be debited if the user does not cancel it. The choice here determines the nature of the free trial: if starting work with the software does not require special efforts from users, they may not be very careful about the evaluation of the software, so such users must clearly confirm their decision to purchase later; users who give a credit card number, as a rule, have already done some analysis in advance and, in fact, undertake to pay if they clearly do not express dissatisfaction with the product.

The difference in approaches leads to huge differences in conversion rates.

Conversion rate. для пробной версии SaaS-ПО со слабым контактом и без обязательной привязки кредитной карты:

  • Significantly lower than 1% - this usually indicates a poor fit of the product to the market.
  • About 1% - approximately corresponds to the basic level with skillful business organization.
  • Over 2% - excellent!

Conversion rate. для пробной версии SaaS-ПО со слабым контактом и обязательной привязкой кредитной карты:

  • Significantly lower than 40% - usually this indicates a poor fit of the product to the market.
  • About 40% - approximately corresponds to the basic level with skillful business organization.
  • Over 60% - business is booming!

In general, if you require credit card information in advance, the number of new users of the paid version increases (the conversion rate of customers from the trial version to the paid version increases more than the number of those who decide to try the free version decreases). This factor loses its significance if the company more purposefully and thoughtfully contacts the users of the trial version (trying to make sure that they use the software meaningfully) - as a rule, they improve user interaction with the product, send emails at various stages of the life cycle, and attract specialists customer satisfaction department.

Conversion rate. (относительно регистрации в пробной версии).

It is also necessary to measure the conversion rate between unique page views and the start of using the trial version, but this is not the most effective indicator for the company, and it is difficult to give good advice regarding expectations.

This conversion rate is highly dependent on how suitable visitors you attract. It may seem strange, but in companies that do better marketing, this figure is lower .

In the case of good marketing, the company attracts many more potential customers, among whom, however, are many unsuitable. Companies that have worse marketing experience catch the eye only of those who are already quite familiar with the market - and such people are usually much better as customers: they are so unhappy with the current state of things that they are actively looking for other options, are putting a lot of effort into it and are ready use products of unknown companies if their offer may be better than currently used. Other market participants are more likely to not actively seek an alternative right now; they can be satisfied with working with solutions from well-known market players or companies from the first page of Google’s issuance; they may not have an incentive to take risks by changing the provider of the right solution.

Percentage of customer churn.

In the case of SaaS with poor contact, most customers have monthly contracts, so the percentage of outflow is calculated per month. (Selling annual subscriptions is, of course, also a good idea: this allows you to get money in advance and reduces the percentage of outflows. However, in reports on outflows, annual subscriptions are usually converted to monthly figures.)

  • An outflow of 2% is a very attractive product that fits well with the market, and significant resources have been invested in reducing the outflow from it.
  • Outflow of 5% - somewhere from this figure usually begins.
  • An outflow of 7% - most likely, another seductive offer prevents the prevention of a voluntary outflow, or you work in a difficult market.
  • More than 10% is evidence of a very low compliance of the product with the market and a threat to the company's existence.

In some markets, the outflow will be fundamentally higher: if you sell the product to consumer producers or representatives of freer forms of business activity, such as freelancers, who have a high chance of leaving the business, this will significantly affect the percentage of outflow. More reputable companies fall apart much less frequently; in addition, they have much less need to save up to the last 50 dollars.

Higher prices naturally weed out the worst customers in the economic sense, so raising prices is more effective than they usually expect : raising prices by 25% can suddenly reduce outflows by 20% - simply due to a change in the distribution of customers who buy the product. This feature makes many SaaS companies with poor contact over time move to the upper echelons of the market.

Strong SaaS Performance

Strongly contacted SaaS companies generally differ much more in how conversion rates are measured (mainly because of differences in how a “potential deal” is determined) and what performance is achieved with similar definitions. The reason for this is different branches of work, sales processes, etc.
But the percent of the outflow is quite clearly divided: an annual outflow of about 10% is an acceptable indicator for the company in the first years of work. An outflow of 7% is an excellent indicator. It should be noted that even for mediocre SaaS companies with strong contact, the outflow percentage is essentially lower than even for the best representatives of the model with weak contact.

Companies with strong contact often measure two indicators: the so-called “outflow by firms” (when the client company as a whole is taken as the client, regardless of how many departments use the software, how many users there are, what they pay for, etc.) and outflow of income. In the case of SaaS with weak contact, this separation is less important, since these indicators are usually very similar.

Strongly contacted SaaS companies set prices in such a way as to increase revenue over the course of customer service - by selling additional quotas for users, other products, etc., so many of them track the outflow of net revenue , which represents the difference in revenue for a group of customers for the year. The generally accepted standard for such companies is the negative outflow of net revenue : switching to more expensive versions, expanding the contract from year to year and cross-selling to existing customers outweighs the impact on the revenue of customers who abandoned this software or reduced its use. (Almost none of the SaaS companies with poor contact achieve negative net outflows, since the percentage of outflows is too high to compensate for.)

Product Market Compliance

SaaS are not only figures of indicators. The most difficult thing in the early stages of a company’s development is to quantify the product’s compliance with the market (this term was introduced by Mark Andrissen, and informally it can be defined as the answer to the following question: “Will there be a group of people who really like what you developed for them?”
If the product I haven’t found my market yet, it will have relatively low conversion rates and a high percentage of outflows. Products with good market compatibility often have significantly higher growth rates, higher conversion rates and, as a rule, it is more pleasant to work with them.

SaaS business owners, who have more than one company behind them, can often describe the conformity of goods to the market only in this way: “Having achieved market compliance, you will know about it, and if you have doubts, it means you have not found your niche yet.” If you are not lucky, then each sale for you will be like rolling a stone up the hill, and if you are lucky, your product will literally be torn off with your hands.

Many SaaS who found their market didn’t get it right away ; sometimes it takes months and years of work. The most important thing is to communicate with customers, and a lot, and not rely on "feelings". Weak contact SaaS companies can justify their unwillingness to communicate with literally every who is registered in the trial version: economically at their prices this is unacceptable - however, the work of the SaaS company, when the product does not have its own niche, is also inefficient , so such communication is actually completely justified by the amount of information received.

Achieving product conformity with the market means not only accepting and implementing applications for new functions, but also carefully listening to the best customers, isolating the general in their requests and relying on it. With this approach, in order to focus on the needs of the best customers, you may need to change your marketing strategy, communication with customers, and even the concept of the product.

Which customers are considered "best"? Generally speaking, these are clients in those segments (by industry, size, user profile, etc.) where you have high conversion rates, low outflow percentages and (almost always) a relatively higher average contract amount (ACV). We can say with confidence that in the case of SaaS companies with weak contact, it most often happens that a product is launched that serves a wide range of users with a wide range of needs, and then a bet is made on one or two niches for the most promising users.

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