What are the SaaS Revenue Model Phases?

If you are building a SaaS business, then you need an excellent understanding of the SaaS revenue model phases. We at DevTeam.Space can guide you, thanks to our software development experience.

After setting the context, we talk about the SaaS revenue model phases. We discuss how SaaS businesses can manage these phases. Finally, we talk about aspects like business models, pricing models, pricing strategies, and product management KPIs.

Setting the context: SaaS business models, pricing models, and pricing strategies differ from traditional licensed software

The SaaS delivery model attained significant popularity due to the value it offers to customers. The global SaaS market is witnessing significant growth.

A Cision PR Newswire report projects this market to grow from $158.2 billion in 2020 to $307.3 billion by 2026. The report estimates a CAGR of 11.7% during the 2020-2026 period.

SaaS businesses differ noticeably from traditional license-based software, e.g.:

• The revenue model phases are different.
• SaaS products reduce upfront investments for customers.   
• SaaS businesses offer various innovative pricing models. An example is the “pay as you go” (PAYG) model, which reduces the costs to customers.
• Clients don’t need to install SaaS products.
• The price for SaaS products includes upgrades.

The 3 phases of the SaaS revenue model

Software companies offering SaaS products need to manage SaaS revenue models differently from traditional licensed software product companies. The 3 SaaS revenue model phases are as follows:

SaaS revenue model phase 1: The initial sale

The initial sales exist in the SaaS model as it exists in the traditional saas revenue model. However, the importance of this phase varies.

The initial sale is very important in the traditional software model. Successful SaaS companies accord high importance to the other phases too, and we talk about that shortly. 

The sales team of your SaaS company needs to close the initial sales. You get a flow of new customers. You make some money by closing these transactions, and your brand gets prominence.  

SaaS revenue model phase 2: Retention revenue

Unlike the world of traditional licensed software products, your SaaS business can’t depend primarily on the initial sale. You need to focus on retaining existing customers.

The initial sale wouldn’t help you much if customers cancel the subscription. You need predictable revenue streams. You need to retain the paying customers, which will generate revenue continuously.

You get more revenue by retaining customers than from the initial sale. That’s another advantage in addition to a predictable revenue stream. 

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SaaS revenue model phase 3: Expansion revenue

Expansion revenue, i.e., the 3^rd SaaS revenue model phase can deliver considerable growth to SaaS businesses. SaaS companies can drive revenue growth by expanding business with existing customers. They achieve this with the help of upsells and cross-sells.

SaaS companies need to execute this phase smartly. That helps them to achieve a “Net Negative Churn”.

A note about “Net Negative Churn”

What is “Net Negative Churn”? It’s one of the important SaaS metrics. The formula for this is as follows:

Churned Revenue – Expansion Revenue = Net Churn.

You don’t want positive revenue churn in your SaaS business since it means diminishing revenue. If expansion revenue is greater than churned revenue, then you get a net negative churn. You want that. It means that your business is growing.

The importance of SaaS product engagement for managing the 3 phases of the SaaS revenue Model

We now talk about how you can manage the SaaS revenue model phases effectively. You first need to focus on product engagement. Do the following:

1. Manage product engagement in the initial sales phase

Measure whether your potential customers and new users get value from your product. Let’s take an example. You might have offered a free trial as a part of the sales process.

Find out whether the trial users find your product valuable. Avoid a “hands-off” approach at this stage. Instead of that, monitor product engagement. Check whether the trial users are utilizing your product. Help them to gain value from your product. 

Review the product engagement data. Find out where you will most likely succeed in closing the initial sale. Focus on these end-users and build an initial customer base. This helps you to focus on revenue retention and expansion later.

2. Manage product engagement in the retention phase

Manage product engagement so that you don’t face customer churn. This helps you to get a predictable revenue stream.

Consider the example of customers that don’t use your product regularly. They might continue to pay the monthly subscription fees, however, they aren’t engaged. You face the risk of customer churn.

Monitor the following key metrics to manage product engagement in the retention phase:

• The progress of onboarding of new customers;
• Engagement rates for all customers;
• Adoption rates for all customers;
• Metrics showing the engagement and adoption of each feature;
• Metrics that show which existing customers have a drop in engagement.

3. Manage product engagement in the expansion phase

Can upsell and cross-sells work with an existing customer that doesn’t engage with your SaaS product? They can’t. You need to manage product engagement carefully during the revenue expansion phase.

Find out which end-users aren’t using your SaaS product. Upsells and cross-sells won’t work with them. You first need to prevent customer churn, therefore, focus on customer retention measures.

For revenue expansion, focus on customers that engage with your product. Talk to them. Explain what more you can offer. 

Cultural and organizational shifts needed in SaaS businesses to manage the SaaS revenue model phases

You need to make multiple cultural and organizational shifts to manage the SaaS revenue model phases. These are as follows:

• Sales teams need to support new customers: In traditional software product companies, sales teams focus on identifying opportunities and closing deals. They do that in SaaS companies too. Furthermore, they need to support new customers. E.g., they need to understand and resolve challenges faced by end-users that avail of a trial.
• A focus on the success of customers: You need to build a customer success team. It needs to ensure that the new and existing customers adopt your product. This team will resolve challenges and help in retaining customers.
• Your organization needs an integrated strategy to manage all the revenue model phases: A senior leader in your organization should oversee all the revenue model phases. This involves strategizing and driving revenue growth across the 3 phases.

A quick overview of prominent SaaS business models

Before you can manage the SaaS revenue model phases, you need to choose a suitable SaaS business model. The two key SaaS business models are as follows:

1. Low-touch SaaS

This model caters to SaaS businesses that typically focus on individual end-users. They make easy-to-use products. End-users can learn them intuitively, alternatively, they can use an automated onboarding process.

End-users generally pay for these products from their own pockets. These SaaS products cost relatively less. SaaS businesses need to acquire many customers, and they often provide a free trial.

Do you have a low-touch SaaS product? You want customers to visit your website. Furthermore, you want them to sign up for the free trial.

You might have a subscription revenue stream model. Satisfied end-users will sign-up for a paid product after the trial. You focus more on marketing than direct sales.  

2. High-touch SaaS

The high-touch SaaS model caters to enterprises and large organizations. You should use this model if you have an enterprise-grade software product involving complexities. Such SaaS products typically carry a higher price tag.

Your potential customers might have customized requirements. You need to support them. Therefore, you need a hands-on direct sales team.

You also need a proactive approach to handling your customer service operations. Your team must manage customers proactively instead of just resolving support tickets.

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Popular pricing models for SaaS businesses

To manage SaaS revenue model phases, you should choose the right SaaS pricing model. The popular pricing models for SaaS businesses are as follows:

1. Freemium model

You provide a free version of your product with certain limitations. Furthermore, you provide a paid version. Hootsuite, a software to manage social media activities uses the freemium model. LinkedIn uses it too.

The free version might have limited features or capacity. It might have usage-based limitations, e.g., the free version supports internal use only.

The freemium model can boost the initial adoption of a SaaS product. It can make a product popular very quickly.

However, you face the challenge of generating revenues quickly to support the free users. You might face a higher customer churn since customers have no risk.

2. Flat-rate pricing

The flat-rate pricing model involves just one flat rate for your SaaS product. Basecamp, a popular project management SaaS product uses this model.

Your sales team will find it easy to communicate. Customers understand this simple model well. However, this model doesn’t allow it to cater to various market segments. You might find this model rigid.

3. PAYG (pay-as-you-go) or usage-based pricing model

The pay-as-you-go (PAYG) pricing model is also known as the usage-based pricing model. Your customers pay more if they use your SaaS product more. They pay less when the usage is less.

Cloud computing majors like Amazon Web Services (AWS) use this model. SaaS companies use it too, e.g., Chargify, a recurring billing platform.

This model has several advantages. Customers get transparency about pricing, and they have a lower entry barrier. They also get a scalable pricing model. You get compensated for “heavy users”.

However, you find it hard to align pricing to value. You can’t estimate your revenue stream clearly. Customers find it hard to estimate their costs too.

4. Tiered pricing model

You can use the tiered pricing model to offer different bundles of features for different prices. HubSpot, the SaaS content marketing company uses this model. Salesforce Cloud CRM (Customer Relationship Management) uses this model too.

You get better flexibility since you can cater to different market segments. You can acquire more customers, and you can execute more upsells. However, your customers might find your pricing model complex.

5. Per-user pricing model

The per-user pricing model ties the price of your SaaS product to the number of users. You offer a per-user price. Microsoft uses this model for its Microsoft 365 Business plans.

This is a simple pricing model, and it offers incentives to innovate. You can predict your revenue stream.

However, companies with questionable practices might ask team members to share user IDs. You also find it hard to align price to value.

6. Per-active user pricing model

This model is a variation of the per-user pricing model. You charge only for active users. Slack uses this pricing model well.

Your customers find this model useful since they pay for active users only. This prompts them to increase adoption, which is an advantage for you. This pricing model doesn’t deliver any notable advantages for SMBs (small and medium businesses) since they have smaller teams.

7. Per-feature pricing model

You can use the per-feature pricing model for your SaaS product. You offer different pricing tiers according to the functionality offered. Every upgrade unlocks new features for end-users. Evernote uses this model.

Your customers get clarity over costs and benefits. They can see what they will get if they pay more, which makes upsells easier. However, this pricing model is hard to implement.

The established pricing strategies that SaaS companies can use

You should choose the right pricing strategy to manage the revenue model. Choose one from the following options:

1. Cost-plus pricing

You calculate your costs and then add a profit margin. Include all relevant costs. This model ensures that you get a profit, which is an advantage. You can’t tie the value of your SaaS product to its price, which is a limitation.   

2. Competitor-based pricing

This pricing strategy involves studying the pricing plans of your competitors. You model your pricing plans based on what competitors have done.

SaaS start-ups often use this strategy. They don’t have past data for sales, and this strategy gives them a benchmark. You still don’t tie your price to value, which is a disadvantage.

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3. Value-based pricing

You conduct comprehensive market analysis and hear from your customers. Customers can tell you what they might pay for the value they get.

This pricing strategy allows you to tie price to value, which is a big advantage. You will find this strategy hard to implement though. It takes plenty of analysis and deep conversations with clients.

Which product management KPIs and metrics should SaaS start-ups measure?

Measure the important product management KPIs to manage your SaaS revenue model phases. The following KPIs/metrics are a few examples:

1. Customer satisfaction (CSAT)

You can use CSAT scores to find out whether your customers are happy. You can use a CSAT survey tool for this. Create a questionnaire covering all relevant aspects of your SaaS business.

Use the following formula:

CSAT = (the number of positive responses x 100)/the total number of responses.

2. Customer retention rate

You use this KPI to find out how well you retain your customers. Use the following formula:

Customer retention rate = {(the number of customers at the end of a specific period of time – the number of new customers onboarded during that period) x 100}/ the number of customers at the beginning of that period.

3. Churn rate

This KPI is the opposite of the retention rate. Measure the rate of customer churn by using the following formula:

Customer churn rate = customers lost / total customers.

4. Customer lifetime value (LTV)

By calculating the customer lifetime value, you get to know how much long-term revenue you can expect from customers. Calculate it using the following formula:

Customer Lifetime Value = average revenue per user x average customer lifetime.

5. Customer acquisition cost (CAC)

You use CAC to measure the costs to secure new customers. Include all relevant costs in your calculations. These could include infrastructure costs, compensations, marketing expenses, sales-related expenses, etc.

Calculate CAC as follows:

CAC = operational costs, sales expenses, and marketing expenses for a period of time / the number of new customers acquired during that period.

6. Monthly recurring revenue (MRR)

You can use MRR to monitor profitability and predictable revenue. Use the following formula:

MRR = average revenue per user on a monthly basis x the total number of users in a month.

7. Annual recurring revenue (ARR)

If you use a subscription business model, then you will find ARR a useful KPI. ARR shows the money you get annually for the life of a subscription. Calculate it by dividing the total contract value by the number of relative years.

Final thoughts

The software revenue model has financial and strategic implications for startups and small businesses. We talked about the different SaaS revenue model phases. We reviewed the key considerations for SaaS businesses to manage these phases. Contact DevTeam.Space if you need assistance with SaaS development.

FAQs on Software as a Service Revenue Model