Insight: SaaS (2) SaaS is a business model
This article is one of the articles in the series ‘Insight: SaaS’, and you can read the last article ‘Insight: SaaS (1) Why do I choose the US over China in the SaaS market?’.
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SaaS is the abbreviation of Software as a Service. Many SaaS companies have become well-known in recent years. Many entrepreneurs have started their own SaaS businesses as well. There are countless articles on the Internet that explain the benefits of SaaS. You can look for it on your own. This article will explain why SaaS is a successful business model, why it is magical, and why XaaS (Any as a Service) has yet to gain traction.
To begin, there are two essential components to SaaS:
- Recurring revenue
- Software
Note that lack of any parts is not a viable business model.
1. Recurring revenue
SaaS companies charge customers for subscriptions, not a large one-time fee, but a small number of recurring fees. Customers can choose to pay monthly or annually.
78 represents the SaaS company’s business model’s continuous income. Let’s say you get your first customer in January and he pays you $1 per month. If you continue to work in the second month and acquire a new customer, your income in February will be $2, which includes the old customers from the first month as well as the new customers acquired in February. By analogy, if you find a solid customer every month and you don’t lose customers every month, then your annual income is:
This is the allure of continuous income, as well as its predictability. Because SaaS products are often a tenth of the price of buy-out products and allow customers to cancel subscription plans at any time, the customer acquisition cycle is shorter, and the number of new customers acquired each month is predictable. This is why the capital market prefers SaaS companies because their revenue is backed by a large customer base and their earnings and growth are predictable.
We’ll assume a perfect scenario here, in which the customer renewal rate is 100%; if it’s 90%, the situation isn’t looking great.
Assume that the annual new sustainable income grows by 20% each year, but that the old customer retention rate is only 90%.
This means that a SaaS company’s growth rate is similar to that of a traditional company with a 20% annual revenue increase. Seeing as you can’t keep old customers, the company’s growth rate is mainly determined by the rate of new customer acquisition. The magic of SaaS businesses has faded.
SaaS companies take the approach of allowing retained customers to pay more in order to offset customer losses. SaaS offers better products, assists customers in achieving their goals, and allows customers to upgrade their plans or purchase new cross-products.
If Net Dollar Retention(NRR) > 0, the increased purchase portion is greater than the lost portion, assuming the NRR is 5%:
In comparison, a company with a 20% growth rate is very ordinary, and an excellent SaaS company’s Net Dollar Retention Rate can reach 120 percent.
2. The SaaS business model relies heavily on software.
Even the SaaS model is not so healthy when it comes to cost. Customer acquisition costs (CAC) are now rising season after season, finding it challenging for many SaaS businesses to break even. Given that the marginal cost of software is gradually decreasing, if SaaS evolves into XaaS, Anything as a Service, with a large number of retained customers, the cost will rise in tandem with the growth of MRR, as shown in the graph below:
Retaining customers will result in increased revenue and costs. With the exception of software, only products with a lower marginal cost can be + as a service. Not everything can be turned into XaaS.
SaaS charges 10% to 20% of traditional software in exchange for a steady and predictable income stream. If a service for commodity X is added, it also requires a significant price reduction; X’s gross profit margin must be extremely high. Otherwise, the company’s long-term evolution cannot be guaranteed. SaaS products have a gross profit margin of around 80%. If X’s commodity gross profit margin is negligible, a significant price cut will result in a predictable loss in subscription revenue.
SaaS companies are more valuable as the percentage of recurring revenue grows.
Consider two companies: one is a general software company A, and the other is a SaaS company B.
The one-time fee for customizing software for customers is A’s main source of revenue, while subscription income from SaaS products is B’s. Company A must increase the number of engineers and AM in proportion to the increase in customers. The cost of management and the ability to acquire customers are both being put to the test. When compared to A company, B company’s customer acquisition ability and efficiency are superior. Customer acquisition capabilities are easier to standardize training for because B is a standardized SaaS product, and customers can be acquired in batches, allowing for more customers with less CAC investment. This is why having a recurring source of income is preferable to having sporadic sources of income.
The next article ‘Insight: SaaS(3) The core metric of SaaS — — NDR’ is published. Simply send me some claps and feedback if you enjoyed my article.
