Finance

Pros and Cons of the SaaS Business Model

The upsides and downsides of software as a service

You probably clicked on this article for one of two reasons: You’re curious about starting a SaaS company, or you wanted to know what a SaaS business model is.

If you're part of the latter group, subscription as a service (SaaS) is a business model where customers pay a monthly fee to access software. Companies like Netflix and Workday have made a fortune using this model, and the growth of the SaaS industry shows no sign of slowing down.

While a SaaS business model can lead to an incredibly fast-growing and profitable business, it isn’t without its drawbacks. Owning a SaaS can mean less upfront revenue, high maintenance costs, and intense competition.

Is a SaaS business model right for your company?

Pro: Fewer upfront expenses

Without a physical product, expenses related to shipping and manufacturing are non-existent. This is a huge advantage for growth, as a company pays a lot less per new customer than they would if they had to manufacture new products. The Saas business model is able to keep new customer costs relatively inexpensive due to multi-tenant architecture

Multi-tenant architecture, commonly referred to as multi-tenancy, is where a single instance of software runs on a server that services many different customers. In other words, a company does not have to create or alter their software when they acquire a new customer.  SaaS giants like Salesforce and Netflix use multi-tenancy. With this architecture, SaaS companies can increase revenue, and keep upfront costs minimal.

Pro: Fast Growth

Growth takes capital. Many companies can’t afford to manufacture more products or hire more employees to handle additional customers. Due to multi-tenancy, the amount of capital needed upfront for growth is lower. This allows a startup to focus its resources on staff, user experience and marketing, and leads to accelerated growth.

This lucrative industry is also growing. According to Bloomberg, the SaaS market could reach $600 billion by 2023. More people and companies are using SaaS companies, leading to high demand. This thriving industry attracts investors, and excited potential customers.

Appealing to customers

Have you ever seen an app promising a week free or a low monthly cost and signed up thinking, “why not?” By creating a low monthly fee, a customer doesn’t have to make a sizable initial commitment. Offering month-to-month services also signals to your customer that your company has faith that it’s software will make them want to continue their subscription.

Another reason SaaS companies are appealing to customers is because of a psychological phenomenon known as the Paradox of Choice.

The basic concept is that choice is overwhelming. This may seem contrary to common sense. Wouldn’t offering more options to my customer make them more satisfied with the product?

Imagine you’re deciding on a place to eat with friends. The options are endless, which usually ends in a back and forth conversation about who should choose. Having three solid options would make the process far more straightforward.

SaaS pricing models tend to follow the principles of the Paradox of Choice.

For example, ****tiered pricing allows customers to pick from a few (usually three) different subscription options at different prices. The more expensive packages appeal to users who value functionality over price. The less expensive option may be perfect for a customer who wants to try out the product or who only needs the basic aspects of the app. The choices aren’t overwhelming, yet they appeal to a wide variety of potential customers.

Tiered pricing works incredibly well for SaaS businesses and can decrease churn rate, as it allows customers to choose to downgrade their subscription rather than cancel it altogether.

The flexible, low-commitment pricing seen in the SaaS business model attracts customers and promotes brand loyalty.

Con: Maintenance costs

While Saas businesses are less expensive upfront, they can have significant and indefinite maintenance and hosting costs. It is important to vet your business model effectively and accurately assess the cost of maintaining your software. Causal allows your company to create adjustable forecasts for your expenses to evaluate if a SaaS business model will be profitable.

It may take years for a SaaS to generate positive cash flow, and a company must sustain these expenses until an adequately large customer base is acquired. This means customer acquisition and retention is key to the success of your SaaS startup.

SaaS companies are expected to continuously update and improve their software. In a Forbes article, the author discusses the expenses of the SaaS company, Monday.“If Monday stopped building after its product was “good enough,” it likely would have still experienced growth for a while, but other products would eventually outshine the company’s service and, as a result, customers would drop off.” The process of continuously creating new features and updates is both time consuming and expensive.

Emphasis on quantity of customers

With a subscription-based business model, your initial revenue will be lower than other business models. Expanding your consumer base is extremely important early in your company's development. To develop a profitable business, much of your income will have to be reinvested into customer acquisition and retention.

Early on, company’s face many issues that can lead to high customer churn. An SaaS will need to fix these problems as soon as possible or face startup failure. In order to decrease churn, a company will need to constantly improve their service, or lose their customers to more innovative competition. This can be a heavy burden for a newer company.

Significant competition

The SaaS business model is far from undiscovered, and offering competitive prices while still generating significant revenue can be challenging.

Market analysis can help examine your competition, pricing, and target market to see if entering this industry is the right choice for your business. Causal is the perfect tool for market analysis. Our models allow you to compare your company’s metrics to your competitors and analyze your customer base. With Causal, your partners, employees, and investors can understand your competition and create a service that stands out in a crowded market.

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