Like with any business, the customer remains king in a SaaS business model. Ongoing customer relationship is of central importance when offering SaaS services and it directly affects the financial health of the business. With good customer relationship, SaaS businesses can lower their churn, generate significant recurring revenue, reduce costs and grow faster. Let’s look at how important customer relationship is in a SaaS business model.
As the traditional software business model stifles and more companies adopt the SaaS model, business owners transitioning from the perpetual software licensing business have to grapple with the reality that SaaS business is not dependent on the copies of software sold, but the number of customers the business has. The economics of licensed software do not apply in SaaS business model when evaluating capital, profitability and business value.
The traditional software vendor sells copies of his application to customers. Typically, the more copies he sells, the more revenue he generates. This is apart from other one-time sales that may occur for selling multi-user licenses, upgrades and other additions.
On the other hand, the SaaS business owner generates revenue by selling subscription to his customers. Every customer contributes to the overall revenue generated by the company. Revenues can be flexible if the business offers different pricing packages and enables upgrades and downgrades of service offerings.
The Fundamental Revenue Shift in SaaS Business Model
There is a shift in how revenue is generated by the traditional software vendor and the SaaS owner. For the former, revenue is recorded in the business when a user purchases a copy of the software. Traditional software features are fairly standard across all users and thus revenues from upgrades will not have a major impact on the overall revenue generated by initial sales. Thus, the vendor will have achieved his objectives after licensing the software the first time.
On the other hand, for the SaaS owner, revenue is recurring since it is generated through a subscription model. For continued revenue generation, the business has to maintain a good relationship with the customers. A strained relationship with customers can increase churn and in turn affect the financial health of the business.
Therefore, while a licensing software company’s costs are fixed in relation to the number of copies sold, the costs of a SaaS business are relative to the number of customers that the business supports. The costs go deeper from just the source code investment to the entire business infrastructure.
Why You Should Make SaaS Customers Happy
The SaaS business model is driven by happy customers. To get a higher ROI, founders have to minimize upfront fixed costs and maximize their margins by generating more revenues than variable costs. Thus, instead on focusing on the product ROI (where the traditional software vendor focuses on), they have to focus on the customer ROI.
The shift from product ROI to customer ROI emphasizes the need to keep your customers happy at all costs. This also explains the shift in SaaS revenue is from customer acquisition to customer retention and distribution.
SaaS businesses need to identify profitable distribution models that can scale without burning much capital. While a profitable distribution model is quite simple to conceptualize, achieving and maintaining it can prove a difficult task for any SaaS business that is at the expansion stage.
In the perpetual license model, high level metrics are used where a dollar in sales should produce 3 or 4 dollars in new customer. These amounts should also pay back the costs of sales and marketing in the first year. With SaaS business, the cost of customer acquisition does not necessarily have to be covered over the first year, but during the lifetime of the customer. Thus, a SaaS business can see increased costs during its expansion stage with barely enough money to run operations during the year. However, profitability may be seen in later years.
This being the case, SaaS businesses need to have a good relationship with their customers to ensure they use the services over the expected lifetime. Customers who fail to renew their subscription will lead the business to losses keeping in mind that the cost of acquiring them might have been higher than the revenues they would have generated during their subscription period.
The play in revenues is what sets perpetual licensing software companies and SaaS companies apart. The former may not have to think of customers after closing a deal since even revenue from renewals are typically lower than first customer revenues. On the other hand, SaaS companies have to keep customers close to them since profits can only be generated to the maximum if the customer stays subscribed to the service over the expected lifetime value.