by Alex Ho
These are some concepts about SaaS that I learned from the daily work and some insightful articles.
(Image source: freepik)
- SaaS Intro
- What is SaaS (software as a service)
- Common characteristics for SaaS companies
- Advantages of SaaS
- For software company
- For customer
- For stock investors
- How can a SaaS company keep wining customer’s heart
- Common revenue streams in SaaS business model
- Subscription Fee
- Setup Fees
- Fees based on transactions amount
- Customer service or consulting
- Advertising
- White label licensing
- API fees
- Common Subscription Pricing Models for SaaS
- Flat Rate Pricing
- Tiered Pricing
- Usage-based Pricing
- Per-user Pricing (a.k.a Per-seat Model)
- Per-feature Pricing
- Important financial metrics for a SaaS Company
- Users (quantity of customers)
- YOY Revenue Growth Rate
- Annual Recurring Revenue
- Unearned Revenue (a.k.a Deferred Revenue)
- Remaining Obligation Performance
- NDR (Net Dollar Retention)
- ARPU (Average revenue per user)
- Customers Retention Rate
- Active Users & Churn Rate
- How to operate a SaaS company
- Other References
SaaS Intro
What is SaaS (software as a service)
- The software is delivered to clients over-the-air through internet. No need to download in install file to the local side of your computer and then install it (as the traditional way to purchase the whole software)
- The software itself and the related processing data are stored and managed in the cloud space.
Common characteristics for SaaS companies
- In order to keep clients satisfied and continue to pay, SaaS companies need to keep investing in improving and updating their products
- Thus it’s reasonable for a SaaS company to reinvest its profit into product development for future growth, acquiring new customers, market expansion
- Even though a young SaaS company might looks like “losing money” in some way, they might be aiming at becoming defensive and generating future revenue
- Many SaaS companies focused on revenue growth in their early years, and became profitable in the later phases
- Unearned Revenue (a.k.a Deferred Revenue 遞延收入)
- Even though customers might signed a contract for multiple years, the unearned revenue (to be paid in the future months or years) can not be included in the current financial report
- Fast expansion to acquire more users
- SaaS companies might spend much budget in marketing and business development
- Scalability
- SaaS companies can sell the same software to more and more clients, without investing more physical spending, it’s easier for SaaS companies to scale their business.
- And as the business is scaled up, the initial product development costs can be recovered. And thus the gross margin can go up.
- SaaS companies have to monitor if existing customers (i.e. old customers) maintain the subscription. See why they are still happy or why they are not happy anymore about the product
- For SaaS products targeting at enterprises, the products/systems can sometimes be very complex. SaaS companies might need to provide consultant services to onboard and guid the customers to use their products.
- This also means “do not only focus on acquiring the new customers
Advantages of SaaS
For software company
- Build the feature once, sell the product to many customers.
- Steady and predictable recurring revenue (as long as the customers do not cancel the subscription)
- SaaS company can digest the user data (in legal way) to find out area to improve its product.
- Customers can pay and start to use the software by their own (through website or mobile App). SaaS companies do not necessarily need resellers to sell their softwares.
- Some marketing spending can be saved.
- This could result in higher operating income.
For customer
- Start small, and scale up
- Customers do not need to purchase the whole software at once (with a chunk amount of money).
- They can start using the software with small amount of money right away.
- Practically, many SaaS companies allow customers to start using their product/service with a N-days free trial. They have to win customer’s heart during the trial and attract customers to become paid users after the trial ends.
For stock investors
- Because of the steady and predictable recurring revenue, it’s easier for investors to assess if a SaaS company has a bright future.
How can a SaaS company keep wining customer’s heart
- Well designed pricing model
- Figure out “what keeps the existing customer continue to pay for the subscription” ?
- In short, what is the value proposition of your product?
- Do not think in this way - “make everything free and think about revenue generation in the future”. Most likely you will regret from this in the future.
- Examples
- Trello.com worked on monetizing from paid users too late. Trello should have figure out way users use Trello (instead of other todo list Apps), what are the sweet points that they can charge users money to pay for premium features.
- Integration with existing major tools in the market
- No one can build all of the features that customers need.
- SaaS companies can build integration between their own product and other existing tools. And of course, you can charge your customers when they use the API integration features that you provide.
- Those ties also help to secure the existing customers (so that they cannot live without your product)
- Examples
- Shopify merchants can automatically upload their merchandises to Facebook Shop, Google Shop, Youtube Shop.
Common revenue streams in SaaS business model
Subscription Fee
- Customers pay monthly or yearly subscription fee to use the products
Setup Fees
- For most of the time, this only occurs when a customer “start” to use SaaS product for the very first time.
- And such setup fee is not charged repeatedly.
Fees based on transactions amount
- Taking Shopify for example.
- For a merchant to start to use Shopify system, he/she needs to pay the monthly subscription fee. (This is named as the Subscription Solution Revenue in Shopify’s ecosystem)
- Besides the subscription fee, Shopify also charges transaction fees and payment fees from merchant’s e-commerce transactions (This is named as Merchant Solution Revenue in Shopify)
Customer service or consulting
- Normally, for the purpose of scalability, most SaaS companies provide clear instruction guides or user manuals in the product for customers to solve the problems (when using your product) by themselves.
- However, as your product gets more and more complex (especially in the enterprise products), customers might want additional on-site support or consulting service from you so that they can solve the problems faster. Then SaaS companies can charge their customers additional fees from this.
Advertising
- Display ads somewhere in your product (e.g. in the backend console)
White label licensing
- For example. If your customers want to wrap up your product and sell it to their own customers, they might want to change the logo or the title of your product seen in the product backend console.
- For such scenario you can charge your customer licensing fee.
API fees
- E.g. Company_A charges Company_B when the later request for allowing the system integrations.
References:
Common Subscription Pricing Models for SaaS
In general, a good SaaS pricing model can help software companies to achieve these goals
- Maintain the future recurring revenue over time.
- Serve the right customers at the right pricing.
- Upsell customers to purchase more features or service
Flat Rate Pricing
A fixed price per month or per year. No multiple tiers available.
Pros
- (For Customers) Simple and straightforward for customers
- (For SaaS Company) Simpler product and pricing structure.
Cons
- (For Customers) There are no “levels” in this pricing structure. Customers might wonder “Do I really need to pay $XX to buy these whole things? Am I overpaying? for this”
- (For SaaS Company) Less room to tweak the price when needed.
Tiered Pricing
Different product/service level are offered for customers to choose
Pros
- (For Customers) Easier to start. All different kind if customers could find a tier suitable for themselves.
- (For SaaS Company) Acquire different levels of customers. Able to maximize the potential revenue from different customers.
Cons
- (For Customers) The complicated pricing models might overwhelm the customers and do not know which one to adopt.
Usage-based Pricing
Customers are charged based on the quantity of sth that they use in the product
Examples
- (For UX prototyping tool) Based on the maximum different files that you can create
- (For cloud storage service) Based on the storage space scale.
- (HR system) Based on the number of “employees who get paid (in customer’s company)”
Pros
- (For Customers) Customers can pay for the exact of amount of service that they truly need. And they can upgrade to buy more as their business scales up
Cons
- (For Customers) If there are low season and peak season for customer’s business, then for some time they do not actually need “that much of services”. Customers might want to ad-hoc adjust the service level to purchase
- (For SaaS Company) If customers might ad-hoc adjust the service level to purchase, it can be difficult for SaaS companies to predict there revenue
Per-user Pricing (a.k.a Per-seat Model)
- Customers are charged based on “how may users in their company are going to use this SaaS product”
- SaaS companies might have to work on the situations when a customer have huge amount of users (employees), as the price goes up badly.
Examples
- (For productive tools, collaboration platforms) Based on the number of users (in customer’s company) who need to manage one single Instagram account
Pros
- (For Customers) Customers can start from the cheapest option, and then upgrade to buy more as their team size scales up.
- (For SaaS Company) Gaining higher revenue when onboarding larger companies or enterprise.
Cons
- (For Customers) Larger companies need to spend huge amount of money (if there is no according well designed pricing structures for larger companies)
Per-feature Pricing
Example
- A SaaS product provides a few tiers for customers to choose from. But for some customers, they only need a certain feature instead of all of the features in the higher tier. Then they can purchase that specific feature only.
Pros
- (For Customers) They can buy exactly what they need.
- (For SaaS Company) More flexibility to upsell.
Cons
- (For SaaS Company) It makes the product and pricing setup more complex.
- (For SaaS Company) It might be more difficult to explain the full flexibility and combinations (to choose from) to the customers.
References
Important financial metrics for a SaaS Company
Users (quantity of customers)
- More users means:
- More recurring revenue
- Faster for a SaaS company to recover its investment in product development
YOY Revenue Growth Rate
- This is especially important for SaaS companies in the early stage, while they might not be profitable yet.
Annual Recurring Revenue
- Recurring Revenue of current year - revenue contribution from the lost customers + revenue contribution from the new customers acquired this year
- We can use this metric to assess if a SaaS company can keep wining hearts of existing customers and new customers
Unearned Revenue (a.k.a Deferred Revenue)
- Unearned Revenue means that a SaaS company has signed contract with customers already, but they haven’t fulfilled the service or delivered the product to customer yet.
- Unearned Revenue should be seen as a liability item in the balance sheet
- Because the SaaS company owes customers some service to be delivered in the future
- For example, a SaaS company signed a contract with customer A in 2022. The service will be delivered in 2023.
- The payment will be paid only in 2023.
- So the unearned revenue will be recognized in the financial report in 2023 in stead of 2022. But it can be included in the future guidance section
- Even though it is not calculated as “revenue“ yet, we can use unearned revenue to asses if a SaaS company is continuing to acquire new customers and revenue.
Remaining Obligation Performance
Remaining obligation performance includes
- Unearned revenue
- Un-billed unearned revenue (invoices not issued yet)
NDR (Net Dollar Retention)
Net Dollar Retention (NDR) = (Beginning ARR - Churn + Expansion) / (Beginning ARR)
NDR recalculates your annual recurring revenue(ARR) to incorporate growth and customer churn. NDR shows you how well your business keeps, engages, and upgrades your customers—demonstrating your business’s current health and viability. It’s also a critical SaaS metric for investors, as they look to determine an appropriate valuation based on your business’s growth rate and potential for long-term success.
ARPU (Average revenue per user)
- If ARPU goes up, it might means
- Product price increase
- Customers are happy with the product/service
- Existing customers purchased more product/features
- If ARPU goes down, it might means
- Company lowered down the product price (maybe because of the fierce competition in the market)
- Existing customers purchased less product/features (or canceled the subscription of certain features that they purchased before)
Customers Retention Rate
- DO NOT only focus on acquiring new customers and forget the old customers
- Your existing customers can continuously generating revenue for you.
Active Users & Churn Rate
- Some SaaS companies have lots of customers, but it’s likely that part of the users are not actively using the products or even not paying subscription fees anymore.
- Some companies still include those customers in the lump sum when they file the quarterly financial reports. It makes the investors feel that the churn rate is very low, while the truth might not be the case.
References
How to operate a SaaS company
(Below content is a brief summary from the article by
1. Set a clear “cadence” to operate a startup
- Put the 4 key functions in a SaaS company (Sales, Finance, Product, Marketing) on a quarterly calendar.
- Potential cadence to run repeated review meeting/discussions
- Weekly sprints focusing on specific objectives that help the team makes progress towards its larger and long term goals.
- Monthly review. Review metrics and performance to assess the overall health and direction of the business. Make corrections if needed.
- Quarterly planning. Set the goals and priorities for the next one or two quarters. Identify major initiatives/projects and assign responsibilities to the PICs.
- Focus on customer needs.
- Prioritize customer feedback.
- Drive product development.
- Improve overall customer experience.
Other References
Some materials that I haven't sorted out yet
About me
- Linkedin profile: Alex Ho
- Software Product Manager.
- 10 years of experience as software product manager in these areas: #ecommerce #SaaS #SoutheastAsia #delivery #MarTech #SuperApp #OnlineLearning
- Work experiences in Taipei, Singapore, and Shanghai.
- Currently based in Taipei City, Taiwan.