SaaS Business Model: How SaaS Companies Grow

This post is for information only. You are responsible for reviewing and using this information appropriately. This content doesn’t contain and isn’t meant to provide legal, tax, or business advice. Requirements are updated frequently and you should make sure to do your own research and reach out to professional legal, tax, and business advisers, as needed. To sell products using the Shopify platform, you must comply with the laws of the jurisdiction of your business and your customers, the Shopify Terms of Service, the Shopify Acceptable Use Policy, and any other applicable policies.

Remember when software was a physical product? You bought a compact disc or two that you inserted into a slot on your computer and waited for the software to install.

Those days are gone, and most software now is sold virtually online, often as a recurring subscription. This is software as a service, a phenomenally fast-growing market that’s projected to expand from $315.68 billion in 2025 to $1.13 trillion by 2032. Let’s break down what you need to know about the SaaS business model, from its core definition to how SaaS businesses make money, how they measure success, and how they serve consumers.

What is the SaaS business model?

Software as a service (SaaS) is a cloud-based software delivery model where computer programs are licensed to users on a subscription basis. The software developer (or third-party service provider) hosts the application for the user who accesses it by logging in through a web interface on a desktop or mobile app. 

Suppose a business needs a robust email marketing solution and doesn’t want to manage the hassle of in-house deployment and infrastructure on its own servers. Customers like this match well with what SaaS applications have to offer. And there are a lot of them out there. In 2023, a whopping 73% of organizations were using SaaS apps.

The SaaS business model is popular because it eliminates the thorny brambles of managing licenses, software installations, data storage, and backups. The SaaS software company takes care of all that, providing frequent and seamless updates and maintenance. Shopify, for example, is an ecommerce SaaS provider that powers more than five million online stores.

SaaS may sound like something only businesses use, but consumer versions of it are ubiquitous. Netflix, for example, charges a subscription fee for consumers to use its platform and software to stream movies and other entertainment. 

Pros and cons of the SaaS model

SaaS comes with advantages and challenges to consider.

Pros

The benefits of SaaS solutions make them attractive to customers for the following reasons:

• Scalability. SaaS founders can scale fast by leveraging cloud computing, where users use the internet to remotely access programs stored on computer servers. This lets a business rapidly expand its user base and roll out new features without requiring a lot of costly infrastructure investment. 
• Consistent and predictable income. Subscriptions provide a stable and easy-to-predict income stream. The recurring revenue helps with financial forecasting, as well as long-term application development planning and product improvements.
• Global reach. Because the cloud hosts SaaS products, they are accessible worldwide, making it possible for small SaaS businesses to serve a global audience.
• Lower barriers to entry for customers. Customers can onboard quickly. Subscriptions are more affordable and pose less financial risk than buying a full software package. Many SaaS providers lower the bar further with a freemium business model, letting users test basic features during a trial before committing to a paid subscription. 
• Continuous updates improve customer loyalty. SaaS companies foster long-term retention as they continually improve their products, offer premium support options, and perform custom integrations.
• Appeal to diverse budgets.Most SaaS companies offer tiered pricing (e.g., free, standard, premium). This appeals to a wide range of customers, from budget-conscious solopreneurs to large enterprises.

Cons

Despite many advantages, SaaS growth strategies aren’t without challenges:

• Capital-intensive to start. Building a SaaS product often requires a significant upfront investment in software development, cloud hosting, and marketing. This can be a barrier for startups without a strong funding base.
• Complex maintenance and updates. A SaaS company must update products to meet demand and remain competitive. Its development team must be good at rapidly responding to bugs and feature requests.
• Cybersecurity challenges. Hosting sensitive customer data in the cloud is not without risk. SaaS products can be vulnerable to cyberattacks. Maintaining security measures in the cloud is a sky-high priority. 
• Subscription fatigue. While the recurring SaaS revenue model is a win for SaaS businesses, customers may feel overwhelmed by the product and cost, deciding it is too much for their needs, resulting in downgrades, cancellations, and increased churn rates, especially during economic downturns.
• Internet dependence. SaaS products won’t work without a reliable internet connection. This can be a problem for customers with unstable connectivity, and some may prefer applications that can work offline. 
• Slow customer acquisition. In a fiercely competitive SaaS market, customer acquisition can be a slow journey, especially when you’re up against free alternatives and more established brands.

Types of SaaS sales approaches

• Low-touch sales model
• High-touch sales model
• Hybrid sales model

Sales approaches differ based on how much a business interacts with its prospects. There are basically three SaaS sales models businesses can adapt to build the customer relationship:

Low-touch sales model

This subscription model is great for those on a budget because there’s little personal interaction with the sales team. It’s all automated, with tools like pre-recorded product tours, chatbots, how-to articles, and FAQ pages to guide prospects through the sales funnel. It’s a good way to get leads to try before they buy or upgrade. You do your marketing through various channels like content marketing (SEO, blogging), social media, email marketing, and affiliate marketing. 

High-touch sales model

In a high-touch model, the sales team works directly with prospects, from the very beginning to the end of the sales journey. They get to know their needs and lead them through demos and product tours. They generate leads through phone calls, emails, and advertising. 

The SaaS service’s team also helps with onboarding, setting up the software, and training. This sales approach is more suitable for larger businesses with more complicated requirements (like legacy system integration and unique security needs) than smaller clients, whose more basic needs don’t require as much hands-on attention.

SaaS companies that offer high-value, complex services rely on this more hands-on approach. They tend to have higher customer retention rates because the service is tailored to specific client needs, but it’s also more expensive. 

Hybrid sales model

This scalable approach combines the best of both worlds: low touch and high touch. When needed, you can get the hand-holding support of high touch, but for entry-level engagement, you can also opt for more efficient low-touch sales. Customers can choose the level of support that works best for them. 

Types of SaaS pricing models

• Tiered pricing
• Per-user pricing
• Per-feature pricing
• Usage-based pricing
• Flat-rate pricing

For a SaaS business to succeed, it must nail down a competitive pricing model. Here are some popular approaches:

Tiered pricing

Tiered pricing offers different subscription packages at varying prices, including entry-level, mid-level, and enterprise-level tiers, each with unique features, usage limits, and support. It caters to diverse customer segments and budgets, and it provides customers with more choices.

Per-user pricing

In this model, the price of the product goes up as the number of users grows. It’s easy for businesses and customers to understand, but it can get pricey when the user base expands, which might lead to customer dissatisfaction and losses. To avoid this, you could offer discounts for large user bases.

Per-feature pricing

For this approach, users pay based on the features they use. The price directly links to the value each feature offers. It’s a model suited to customers with different needs. 

Usage-based pricing

Instead of charging based on features, you could offer pay-as-you-go pricing. This means customers pay only for what they use. For example, you could charge based on the number of emails they send or the amount of server resources they consume. The more they use the service, the more they pay. 

Flat-rate pricing

This simple model charges a flat fee. It’s straightforward and easy to keep track of, but there aren’t as many chances to upsell.

KPIs of SaaS businesses

• Monthly recurring revenue (MRR)
• Customer lifetime value (CLV)
• Customer acquisition cost (CAC)
• Net Promoter Score (NPS)
• Churn rate

To thrive and grow in a tough market, SaaS companies need to keep a close eye on key performance indicators (KPIs) that show them what’s really going on.

Monthly recurring revenue (MRR)

MRR stands for the total amount of money a business makes from user subscriptions in a single month. It measures how effective a company is at attracting and retaining customers. Although it indicates growth, MRR doesn’t measure profitability because it doesn’t account for business costs. 

This information helps set goals for marketing and sales teams. If MRR is falling, it’s a clear sign the company needs to improve its products or revamp its marketing efforts. Here are some other recurring revenue types that you should keep an eye on:

• Annual recurring revenue (ARR) is the yearly version of MRR.
• Net MRR takes into account refunds and credits, giving you a more accurate picture of the company’s financial health.
• Gross MRR is the amount of money before discounts, returns, or taxes.

Customer lifetime value (CLV)

Customer lifetime value is the total amount of money a business can expect to make from a customer over the entire time they’re subscribed. This helps businesses figure out how much money they will make and how to spend their resources. Companies with high CLV usually focus on making sure their customers are happy and staying with them. 

Customer acquisition cost (CAC)

CAC is how much it costs to get a new customer. This includes marketing and advertising expenses. The ideal CAC value depends on your business and the market, but here’s a general rule: CAC should always be less than lifetime value. Knowing your CAC helps you plan your marketing budget and figure out how to price your products or services.

Net Promoter Score (NPS)

NPS is a simple yet effective way to gauge customer satisfaction with your SaaS product. It’s based on a standard question: “How likely are you to recommend our product to a colleague or friend?” This metric closely correlates with the quality of your product features, the effectiveness of your customer service, and the user-friendly nature of your interface.

Churn rate

Churn rate is the percentage of clients lost during a defined period (e.g., week, month, quarter). A lower churn rate makes it easier to forecast future SaaS revenue and indicates a healthy business. A high churn rate signals that the product may not meet audience needs, or that there’s tough market competition.