The Benefits of Software as a Service

February 6, 2018 by Coleman McCormick

We’re out at the SaaStr Annual again this year, a yearly gathering of companies all focused on the same challenges of how to build and grow SaaS businesses.

SaaS really came into its own as a style of software in the early to mid 2000s with the rise and expansion of the internet as a new vector for delivering software to users. Salesforce was probably the earliest and best-known example of a new model of hosting software on behalf of customers (now known as “the cloud”, then it was an “ASP”). While it’s no longer considered new to deliver software as a hosted service, it’s still surprisingly poorly understood in terms of the advantages it affords buyers of software.

SaaS business

My favorite thing about the subscription structure is how well it aligns incentives for both buyers and sellers. While this alignment applies to app developers and buyers in consumer software, the incentives are even more substantial with business applications, and more important to the long-term relationship between product creators and buyers.

The issue of ongoing support and maintenance with a high-investment business application is more pronounced: If Salesforce is down, my sales team’s time is wasted and I’m losing money. The incurred cost is real, significant, and computable. Whereas if I can’t get support for my personal text editor application that’s $5/mo, that same level of criticality isn’t there. Support and updates are just a small (and obvious) reason why the ongoing subscription model is better for product makers, and in turn, buyers.

But let’s dig in some more. Why is the SaaS model better than the way we used to buy software (in a box, with new versions and upgrades coming once a year)?

Lowering Barriers to Entry

First: subscription pricing significantly reduces the “getting started” barrier for buyers and sellers. If I go from charging you $1,000 up front for a powerful CAD application to a monthly subscription model for $79/mo, you and I both win. You like it because you’re comfortable paying that first $79 with no touch to get started, just subscribing online; no friction there. I like it because I don’t have to front-load investment into convincing you of the value. This potentially expands my customer count and gets past the initial transaction quickly. That lower barrier to entry makes the buying process so much less stressful. Now if the purchase doesn’t work out after a couple of months of usage, you’re only out a couple hundred bucks instead of the total $1000.

Predictability

Second: there’s predictability on the spending and earning side. As a buyer of fixed-cost products, you have to predict ahead of time what next year’s cost might be for the 2019 version, decide whether or not you need to include it in your budget, and have to forecast possible expansion use far in advance. With SaaS you can limit all three of those problems1. As the seller, I get to enjoy the magic of recurring revenue (or in the lingo, MRR – monthly recurring revenue).

Fair Pricing to Value

Third: pricing is easier2. In an older “box software” model, I would have to figure out the appropriate “lifetime value” my product has on the day I sell it, and balance this with what price the market will bear. Once it’s sold, there’s no space for experimentation to map price to value – the deal’s done.

SaaS can be fluid here, giving me space to fit the ongoing delivery of value to the price. Of course I don’t want to be changing pricing every month, but it’s within my control to keep the pricing at an effective and sustainable level. When setting pricing, I can break it down to a smaller unit of time, as in “what value does this have to my customer over a month or quarter?”, without trying to predict how long they’ll be my customer. That’s called CLTV (customer lifetime value) and it’s a key metric to track after signing on customers. After a year or so, I have CLTV data I can use to inform pricing. Managing CLTV versus CAC (customer acquisition cost) relationship is part of the SaaS pathfinding to a repeatable business3.

What are the Drawbacks?

So what are the downsides? I don’t think there are any absolute negatives for anyone. For the seller, the major downside is that you have to keep earning the money for your product month over month, year over year. And I’d say buyers would actually call that a major upside! There’s no opportunity to sell a lemon to a customer and take home the reward — if your product doesn’t live up to the promise, you might only collect 1/12th of what you spent to get the customer in the first place.

In SaaS you have to keep delivering and growing value if you want to keep that middle R in “MRR” alive. I call this a “downside” for sellers insofar as it creates a new business challenge to overcome. Selling your product this way actually has huge long-term benefits to your product and company health. It prevents you from taking shortcuts for easy money.

This is the greatest thing about the SaaS model: keeping everyone honest. It allows the best products to float to the top of the market. To compete and grow as a SaaS product, you have to keep up with the competition, track ever-growing customer expectations, release new capabilities, maintain stability, and continually harden security. Buyers are kept honest by their spend; they have to keep buying if they want the backup of ongoing support, updates, new features, solid security, and more.

These two posts from Ben Thompson give a great rundown of companies switching to SaaS, and why subscription business models are better for incentives.

  1. There’ll always be exceptions here, even in SaaS. But you can at least put most of your customers in a consistent bucket. 

  2. Of course a SaaS product could change their pricing along the way, too. But at least the individual purchasing events are more predictable, on average. And not to imply that pricing is ever objectively easy

  3. SaaStr is the best resource for all things unit economics and metrics. A gold mine of prior art for anyone in the SaaS market. 

Coleman

About the author

Coleman is VP of Product at Spatial Networks, working every day with our customers and our design team to bring better data management capabilities to users.

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