The SaaS market is booming just now—and it’s a market that’s expected to grow even bigger in the near future. 'We can expect an increase in worldwide software as a service (SaaS) market dominance over the next four years,' wrote Jarod Greene on the Cherwell website in May of this year. 'Leading research firm IDC predicts cloud software will grow to surpass $112.8 billion by 2019, at a compound annual growth rate of 18.3%.'
With figures like this, it’s no wonder so many people are keen to strike while the iron’s hot and get their own SaaS businesses off the ground. The problem is that there are multiple ways of doing this, multiple models to follow, and you might not know which one is the best fit for your company.
Let’s have a look at the various models and talk through the pros and cons of each so that you can make an informed decision on which way to go—or make the about-turn that your ailing business requires.
The Implications Of Choosing The Wrong Business Model
For a SaaS startup, choosing the right business model is the difference between success and failure. It’s as simple as that. 'Choose right and you grow smoothly from seed funding to A round to B round and beyond,' wrote Joel York of chaotic-flow.com in 2012.'Choose wrong and you spend precious cycles chasing your tail as cash runs out.'
It’s a pretty stark message, but it’s one that is echoed by other experts. 'Choose right and you’re quids in, but a wrong move here can see you returning to investors cap in hand, begging for funds,' writes Karan Vidal on the DueDil website.
The consequences of a poor decision early on, then, are clear: there is no gray area, no middle ground. Choose wisely or your business will struggle.
There’s No One Right Way
'If you’re walking down the right path and you’re willing to keep walking,' Barack Obama once said, 'eventually you’ll make progress.'
Never mind a right path, the thinking used to be that there was only one path to success for a SaaS startup. 'One of the commonly accepted myths of the software-as-a-service market and the broader cloud-computing environment is that it is inherently a high-transaction business,' wrote Jeffrey M. Kaplan in 2010 in the E-Commerce Times. 'This view has been fostered by the rapid growth of many commodity-oriented SaaS solutions and public cloud services.
'However, just as the overall technology and software industries have produced varying paths to success, so are the SaaS and cloud-computing segments evolving in a variety of directions, requiring varying sales techniques.'
Kaplan cites the example of Passkey, a provider of SaaS-based group-reservation systems to major international hotel chains. 'While many SaaS vendors pride themselves on offering free online trials to win over renegade workers in [the] hopes of securing a single-user subscription that may spread across an organization over time, Passkey starts at the top of the corporate ladder, presenting to CXOs face-to-face.'
The benefits of this are stark. 'Passkey is not only selling a high-priced SaaS solution, it generally makes multi-year deals that can be worth millions of dollars. Even more amazingly, Passkey is able to convince its customers to pay for these multiyear contracts up front. Of course, the company still must recognize the revenue on a month-to-month basis because of the accounting rules for SaaS. However, it doesn’t have to worry about the cash-flow challenges that plague many SaaS vendors who depend on more periodic payments.'
It can take a lot of courage for a startup to operate like Passkey, charging high prices and aiming their product at large, established corporations. Yet it could be exactly what your product requires. Open your mind and make sure you’ve considered all the options rather than going straight for a high-transaction model.
As Kaplan says: 'Bottom line: there is no longer one path to success.'
How To Pick A Business Model
Broadly speaking, there are three types of business model: customer self-service, transactional and enterprise. 'While a mature SaaS business may employ all three, a SaaS startup will have the resources to master only one,' writes York.
So, which one to master? Let’s have a closer look at the contenders.
This is also known as the higher-volume, lower-price method. It’s a method designed to achieve significant revenue at a low average selling price (ASP—more on that later), with a self-service model that uses free trials or freemium offers to lure customers.
'The ideal SaaS sales model is complete customer service,' writes York. 'However, this requires that your customers be willing and able to service themselves.' Companies who use such a method, like Dropbox and Yammer, acquire their customers online, most of whom are single users or small teams.
The transactional sales model is a scalable one, with solutions typically sold over the phone to medium-sized or large companies.
'As price increases, customers become less willing to part with their cash without at least knowing there are actual trustworthy human beings behind your website URL. Higher ASP brings higher expectations for the business relationship, such as signed contracts, premium SLAs, invoicing and the ability to speak to a human when problems arise.'
If your product is suited to it, the transactional method can give your business the best of both worlds. 'Products or services are usually highly configurable so that pricing can scale accordingly from annual contract values of thousands of dollars to [the] low hundreds of thousands of dollars,' writes Bocar Dia for LinkedIn.
Also known as the lower-volume, higher-price method, enterprise sales focuses on providing sophisticated, cutting-edge solutions that justify their high price tag. SaaS companies that use this method are defined by having sales teams in the field that explain the concept in depth in order to show the customer why such a high outlay is expected on their part.
'While most SaaS startups gravitate toward transactional sales or customer self-service, some SaaS startups have products that provide so much value per customer and are so complex to buy that their natural starting point is traditional enterprise sales,' writes York.
'Two good example categories are cutting-edge Internet marketing tools employed by big-brand consumer marketers… and feature-rich suites that automate strategic, core business processes for mid-to-large enterprises.'
It’s All About The ASP
So now you know what each one entails, which one do you choose? Joel York will tell you it’s all about the ASP. A low ASP means you are unlikely to be able to afford a direct sales force, simply because a rep would have to make a very high number of sales to cover acquisition costs.
Conversely, a high ASP will mean you have to close very few deals and can afford a field sales team that can afford to spend time and money wooing a client.
'The volume requirement implied by ASP flows back through the sales process to put pressure on every upstream metric,' writes York. 'Low ASPs require large target markets, more leads, more pipeline, higher conversion rates, shorter sales cycles, and so on, to deliver a high volume of customers.'
High ASP also means high risk. The greater the risk, 'the more your customers will desire a personal relationship,' writes York. 'It is the rare customer that will part with $50,000 through a self-service portal.
'Lacking the brand security of an established player like Google or Salesforce, a SaaS startup must put a human face on its service to overcome this fear. Luckily, high ASP pays for the sales and support labor required to create the personal relationship'.
Writing in Forbes, David Skok of Matrix Partners looks at a scenario in which a business sells a licensed product for an average of $18,000, with a customer-acquisition cost of $6,000. While traditional businesses can get that money up front, SaaS companies generally can’t.
'To be competitive, [a SaaS business] can’t charge $18,000 in the first year, but may be able to spread that sum over three years. That means $6,000 per year or $500 per month… In this scenario, it takes 12 months to get to breakeven, assuming a 100% gross margin… This means that, as the business adds more customers, their short-term cash flow actually worsens!
'But there is a bright side: once you get past the 12-month breakeven point, there’s a very exciting payment stream from each customer, assuming they don’t churn (quit your product). It’s this predictable stream of revenue that makes investors so excited about SaaS businesses.'
Complexity = Death
As so often in business, the key with SaaS models is to keep things as simple as possible for the client. 'The rule of thumb when addressing the sales model challenge is to remove as much complication as possible,' writes Vidal. 'Not only will this save you time and money but your business will grow by word of mouth, [through people] singing the praises of how easy your software is to use.'
An overly complex model isn’t just confusing for the customer — it’s curtains for your business, too, especially if you’ve chosen the customer self-service route. 'When complexity forces you into a SaaS sales model where the costs exceed your ASP, your business is destined for the SaaS startup graveyard,' writes York.
How Not To Blow It
Don’t Undervalue Yourself
Undervaluing one’s services is a common mistake made by many starting out in business, and one not confined to SaaS. 'In a misguided attempt to make a splash, B2B startups often set prices too low,' writes Steli Efti, CEO of Close.io. 'Have confidence in your services and charge for value. An active sales team can help educate your prospects and sell at non-discount rates.'
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Don’t Make Your Product Difficult To Buy
Once again, we return to the theme of simplicity. If a customer finds it difficult to buy your product, you’re going to struggle for business. 'Is your SaaS offering easy to find easy to understand, easy to try, easy to buy and easy to use?' writes York.
'Every hurdle that stands between your product and your customer reduces your sales velocity, decreases close rates, and increases your costs. The more complex the purchase, the more the prospect will need help. And the fewer choices you will have regarding your SaaS sales model.'
Don’t Just Find New Clients, Retain Existing Ones
The best way to for a SaaS startup to make the move from the customer self-service model to the more lucrative transitional model is by not only gaining new clients, but by persuading existing ones to stay loyal—and to upgrade.
'SaaS businesses have to keep their fingers in two pies when it comes to sales,' writes Vidal. 'A high premium needs to be placed on customer loyalty, as not only will they remain with you when new SaaS companies come to market but they’ll also be evangelists of your software.'
Don’t Give Customer Support Away For Free
The customer self-service model requires that customers know how to use the software themselves—but they often don’t know how to do so. Consequently, B2B startups sometimes offer customer support and training for free to those who need it as an incentive to buy.
Don’t do this. Charging for customer support is a great way to generate revenue and customers are generally happy to pay for quality, expert advice. 'Savvy clients will understand that, in order for you to provide quality service, they have to be able and willing to pay the costs associated with it,' writes Steli Efti. 'You’ll eliminate time- and resource-wasting users that never provide you with actual revenues.'
It has another value, too—it puts the kibosh on salespeople who are inclined to throw in a few too many freebies in an attempt to close a deal.
Choose your model wisely and your business will stand a far better chance of being successful as SaaS booms over the next few years.
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About the Author
A serial entrepreneur and digital nomad, Geoffrey has been running his own marketing consultancy for the past year.More Content by Geoffrey Walters