How to Build a SaaS Business Model
The SaaS Business Model
SaaS businesses have two enviable advantages over other business models: fast iteration and low capital requirements. This allows a SaaS business to evolve quickly as it learns. The cycle of hypothesize, test, learn, and revise in the SaaS Business Model governs many facets of the business, not only the product. Rapid iteration is used to find the best means to operate key aspects of the revenue engine: target market, value proposition, sales strategies, pricing and go-to-market.
The book, Business Model Generation by Osterwalder, was a revelation in creating a common framework to describe a businesses strategy. The Business Model Canvas is a powerful tool for both aligning the team around one unifying plan, and guiding the iterative growth strategies from pre-revenue through expansion. We'll use the Business Model Canvas to explore the operational and strategic choices to grow a SaaS business.
The SaaS Business Model Canvas Overview
The Business Model Canvas is a visual framework for organizing key components of a business. The Canvas divides the company into nine parts, each responsible for the most vital business elements of every organization.
When growing a business, focus your efforts on the right half of the model. The right half covers how you grow revenue. I've ordered them here in the order of impact to a SaaS business. Until you master the first two, the rest are of much less importance.
- Value Propositions
- Customer Segments
- Revenue Streams
- Customer Relationships
- Key Partnerships
- Cost Structure
- Key Activities
- Key Resources
The Business Model Canvas Prioritized for SaaS Businesses
1. Value Propositions
The Value Proposition is the most important element for success of any business. It is the reason a customer will pay for your product. The entire purpose of a startup business is to discover the Value Proposition. Once the Value Proposition is clearly known for the target Customer Segment, it becomes the North Star for the business. Until this is clear, throwing money at customer outreach is tremendously wasteful.
A good Value Proposition is a unique combination of benefits that will either solve a customer’s problem or bring them value. Often the value proposition delivers a successful answer to this test: Does it make your customer more revenue, save them money, improve their lives, or entertain them?
2. Customer Segments
Your customers are the most important aspect of your business. High growth companies need to keep their laser sights on the customer who most benefits and pays for your offering. A common hurdle to reach growth stage for a SaaS business is clarity of the customer segmentation. For businesses that have slowing growth, or are startups, this is a vital area for attention. In my own practice building SaaS companies, the number one issue is ill-defined customer segmentation. Often entrepreneurial CEOs feel compelled to target a billion-plus dollar Total Addressable Market (TAM) with the logic that owning a small part of something big means they could grow very large. However this deprives sales, marketing and product teams the focus necessary to penetrate the customer segment quickly. The result is burning through budget and calendar with inconsistent sales and low revenue growth.
There are many ways to segment a market to find your ideal customers. Some common ways to slice up a market includes combinations of these:
Number of employees
A product or technology they rely on
The process or techniques they use
The markets they target for their own sales
The job title or role
The behavior they exhibit
3. Revenue Streams
Depending on the product or service you sell, you need to have a clear understanding of the ways you’re going to make money from each Customer Segment. This is your revenue model. The revenue model is a ripe area for innovation in the SaaS Business Model. One of the key advantages of the SaaS Business Model is the recurring revenue subscription. This subscription model pays dividends for months and years.
Your Revenue Streams should be defined in several factors that can be strategic to your business. For example, can you accept credit cards, or do you require a Purchase Order and contracts negotiations? Are you paid annually in advance, or month-to-month? Is there an upsell path to higher price tiers? Is it based on metered use, seats, value or another underlying unit of measure?
In the acquisition price of a SaaS company, the rate of revenue growth in the subscription business is a key factor for the valuation. This does not include revenue obtained from non-recurring engineering or professional services. Revenue from these latter streams is valued at a much smaller multiple.
Below are several common means that SaaS businesses generate revenue:
Advertising. While it's relatively easy to plug in an advertising system to generate some revenue, this model requires that ads displayed from your products convert well for the advertiser, and that you can serve a lot of ads to a lot of users. Platforms as YouTube, Twitter, Google, and Facebook, along with many other free-to-download apps and services have grown mostly by advertising. You need a large user base with significant time engagement on your offering to generate significant revenue.
Subscriptions. This model would be the best match for your SaaS, PaaS, or IaaS business. It also applies to on-demand streaming services, such as Netflix, Spotify, or any online publishers, such as the Wall Street Journal. The monthly cost, when it's paid, and the length of the contract can vary substantially among businesses and deserves continuous testing.
Sponsorship. If you’re a small team of developers providing a useful, engaging, and preferably unique service, donations may be a way to go. A PayPal donate button can help pay the bills.
Freemium. It’s a no-brainer why this model is so extensively used by a number of web services. By attracting an audience to the basic set of features, you provide the paying customers (another Customer Segment) premium features. Freemium is great for getting customers to try your product and decide if they like it. You must have a solid strategy and testing to discover how to convert these users to paying customers. Because of the free entry price, this revenue model can result in a lot of churn from non-ideal customers.
Fee-based. This model requires a large pool of users who find the service valuable enough to pay a small fee. These fees can be either percent-based or flat and allow for easy income calculation. Venmo, Lyft, Stripe, and online marketplaces use this model.
4. Customer Relationships
Customer Relationships define how you work with customers to deliver the customer experience they require to be happy. A contrasting two ends of the spectrum are low-touch, self-serve approach on one end to a high touch, concierge experience on the other.
It's important to put your customer at the forefront of this decision. What experience do they expect from a solution such as yours? Customers of inexpensive products with low contractual commitment and fast time-to-value might be fine with a no-touch model.
Customers for more expensive enterprise solution that integrate with existing systems, are mission critical, and have longer time to value are going to more likely require a high touch model.
Here are five cases of Customer Relationships:
Personal assistance. This category includes face-to-face contact, live support and concierge onboarding. Make sure your customers can contact you at any time prior to or after the purchase, and make sure the contact channels are appropriate to the customer segment.
Self-service. This type of relationship is often used for B2C models and has also been leveraged in B2B successfully by companies like Slack and Atlassian. Except for automated updates and onboarding guidance, you don’t usually communicate with your users in this case.
Automated service. This is how Netflix and Spotify maintain relationships with their customers. By providing AI-powered recommendations of movies and playlists, the services imitate human interaction and keep customers engaged.
Communities. When customers leverage information from other customers then your model may be community. LinkedIn and Twitch.tv are examples.
Co-creation. User-generated content is big factor in the growth of the Internet. Anyone who’s uploaded a video to YouTube or a story on Medium has contributed a service. The role of the company, in this case, is to precisely match content creators and content consumers.
The Channels element captures how a company aims to deliver the Value Proposition to its Customer Segments. Channels can also create brand awareness and provide post-purchase customer support.
There are many options for distribution of SaaS products, each with different returns on your investment and management challenges. It's important that the chosen channel aligns with the Customer Relationship - high touch relationships need channels that deliver high touch experiences. Some of the more common methods of distribution for the SaaS Business Model:
App Store / Marketplace. The advantage to this channel is that you are riding on the marketing investments of another company. The Apple App Store or SalesForce AppExchange are leading examples. These stores give you visibility without a lot of work, but they can also be difficult to stand out and can take a significant percentage of your sales. Posting in a marketplace is just the beginning, be prepared to invest in it to stand out and make it successful.
Direct Sales. Having your own sales team to call on customers face-to-face will have a high CAC, but is powerful. You control exactly what is happening, retain 100% of your revenue, and build deep relationships with the customer. In B2B SaaS Business Models, this is often used. In Enterprise SaaS it's very common because the customer expectations for custom integrations, data sharing and support require close relationships and trust. If you have a high Life Time Value (LTV) and low churn, then this model may be appropriate.
Indirect Sales. When you don't require face to face relationships to close deals and deliver customer satisfaction, an inside sales team can be your answer. Indirect teams pursue inbound leads and outreach through email, voice and other means. An indirect sales team can be the right solution with a lower CAC for customers with lower LTV than Direct Sales. There is a growing set of acronyms being used to describe these teams including Sales Development Representatives (SDR), Business Development Representatives (BDR) and Inside sales.
Product-led Growth. This technique requires close coordination with your products and engineering teams. PLG means making your product sell itself. Building in upgrade paths or features that virally spread of the use of the product is the sales function. Products like Atlassian, Slack and other collaborative systems are natural examples. Inviting people to join a conversation is the virality that exposes more people to Slack. Every Zoom customer introduces Zoom to everyone they bring into a conference call. Designing virality into your product can be very effective for a low CAC expansion.
Resellers. There are many organization that will resell your product using their own sales teams. They may ask anywhere from 30% to 60% of your revenue for deals they sell. In some cases, this can be a strong channel. It works best when the reseller is wrapping professional service around your product installation, or is a specialist in a market where you have little access. As your primary channel, Resellers require a great deal of care and feeding. It's notoriously hard to motivate someone else's sales team to sell your products especially if they have their own products to sell. It's also a challenge to forecast sales because a reseller will often resist committing to your sales goal.
6. Key Partnerships
This building block defines your network of partners and suppliers that make your business model successful. Think of these as strategic partnerships with other companies that you rely on to either deliver or sell your products. Not all your partners are your Key Partners. If they are strategic then you want to allocate time and money into advancing the partnership.
Here's a test to decide if they are strategic: If they stopped being a partner today, what impact would it have on your ability to generate sales? Would you be unable to deliver your value proposition? Would you suddenly be scrambling urgently to find an alternative? Would you need to re-forecast your sales number for the next few quarters?
Partners fall into several buckets, some of the common types for the SaaS Business Model are below.
Supplier: A 3rd party that you rely on for an API, component, or technology to deliver and support your own product. Especially if the 3rd party has a unique offering or you have integrated with it in ways that are expensive to change.
Resellers and distributors: A 3rd party that is a core part of your sales engine and takes a commission on the sale. Sometimes they may offer additional products, professional services and tier 1 support.
Strategic Partners: Often your customers expect an entire experience to solve their problems and you only deliver one part. For enterprise SaaS, the integration and support teams to hold the customers hands and deliver a customized production solution are part of the customer experience needed to close a sale. Without other components, your product may not deliver the complete solution your target market expects.
7. Cost Structure
Delivering your offering incurs costs. The Cost Structure is the core make up and drivers of your costs. This is one of the most advantages areas for the SaaS Business Model compared to most other models.
The beauty of the SaaS Business Model lies in its scalability and very low capital costs. The key element of SaaS is that you can add customers geometrically but your costs to service the customers scales linearly, or less. The reason is the fundamental economics of delivering your value proposition via the cloud. Adding 100 new customers likely does not increase your cloud costs beyond a small blip. Once the engineering, software, storage, and communications reach scale, the rate of growth for cost of goods delivered becomes very low.
Since the technical delivery costs flatten, the top increasing cost in the SaaS Business Model are driven by your go-to-market tactics. Accelerating your company means pouring money into new customer acquisition. For example, if you can invest $1 of cash into CAC to capture $1 Annual Recurring Revenue, you are building a healthy company. Now the investment in CAC becomes a key variable to grow.
The SaaS Business Model is valued for being extremely capital efficient and maintaining a predictable CAC versus LTV.
8. Key Activities
Key Activities are critical areas the business spends time to make its model work. While every company spends time on legal, HR, and finance tasks, they are likely not key activities unless they are part of your Value Proposition. For the SaaS Business Model, you probably depend on great engineering and sales but please dig deeper to reveal the Key Activities. Bill.com, for example, made low Cost of Acquisition (CAC) a strategic advantage. They have invested heavily on the Key Activity of test and optimization to create low-touch conversions to sales.
In the SaaS Business Model, Product Led Growth is a strategy for growing customers and market size at low CAC. If this is part of your plan, then dedicating energy and money improving its results is a Key Activity.
Your Key Activity may be using supervised machine learning to reduce your manual effort and scale your company cost effectively. Investments such as these are strategic imperatives rather than 90 day projects. These Key Activities give you a unique advantages you can measure - improved scaling, faster deployment time, lower cost / higher quality sales leads, improved accuracy and precision, larger partnership networks, cost effective and repeatable geographic expansion playbooks.
9. Key Resources
Key resources are the critical things you rely on to deliver your Value Proposition to your Customer Segments and supporting Customer Relationships. You want to protect your key resources, eliminate critical dependencies on them and optimize their use.
In the SaaS Business Model, a cloud-based software product is delivered often as a subscription. The obvious resources involved are software engineers, your cloud infrastructure, sales and marketing. But look a little deeper to uncover your true Key Resources. Consider, for example, what secret sauce and IP you bring to the table to make your product unique, or to deliver it with a low cost of acquisition. It does not have to be technical. Possibly Key Resources are your customer base or your contractual arrangements.
One Key Resource I see SaaS companies often fail to recognize is their data. SaaS business models often produce copious amounts of valuable data about your users, the users behaviors and more.
Key Resources vary among companies based on the details of their SaaS business model. The most important ones support your unique ability to deliver your value proposition to your customers.
The SaaS Business Model is a beautiful thing. Capital efficient, agile, and highly scalable. That doesn't mean it is easy and the choices you make in your Business Model can mean the difference between explosive scale, tepid growth and failure. Each piece of the canvas should be tested and tuned constantly over time to find your growth and align your teams. As Alex Osterwalder, creator of the Business Model Canvas, said:
“The same products, services or technologies can fail or succeed depending on the business model you choose. Exploring the possibilities is critical to finding a successful business model. Settling on first ideas risks the possibility of missing potential that can only be discovered by prototyping and testing different alternatives.”
If you are struggling to scale your revenue and need help crafting your SaaS Business Model, contact me at Jeff@thecuriepoint.com to schedule a free session to discuss it.