Revenue Management for the SaaS Industry
If you’re reading this off a computer screen, chances are you rely on some version of the Microsoft Office suite during work to produce reports (Microsoft Word), presentations (Microsoft Powerpoint), and spreadsheets (Microsoft Excel). We buy this software package for a one-time fee, install it to our computer, and it’s ours to keep. However, in 2013 Microsoft came up with a new offering: Office 365. Instead of the one-time fee, users now have to pay a monthly/yearly subscription, essentially renting the software. Sounds crazy to pay monthly fees for something you could own by buying a CD, right? As an individual, the notion of “renting software” might be rather foreign. The pricing for Office 365 might be off-putting, as one would rather pay a single flat fee now, than receive credit card bills monthly into the indefinite future. On the other hand, Office 365 is likely to see more frequent releases of new features and updates compared to the traditional Office Suite. An Introduction to the SaaS Industry Whatever your views are towards its application to consumer software, the business model of “renting software” has already been proven in the enterprise software industry. The name for this business model is Software as a Service, or SaaS for short. The Wikipedia page for SaaS gives us the following definition: “Software as a Service (SaaS) is a software licensing and delivery model in which software is licensed on a subscription basis and is centrally hosted.” Confused? Here is a brief explanation of how it typically works:
*Table adapted from “A Little Less About Pricing. A Little More About Deal Size. Please.” by Jason Lemkin
Having discussed how revenues are earned and maximized in the SaaS industry, what do you think about the characteristics of this field and these tactics that are used to achieve revenue growth? Please feel free to leave your questions and/or comments on this article.
- The software developed by the SaaS company is installed on a central platform, like how Office 2016 is installed on your computer. (This platform could be a group of servers physically located in the SaaS company or server capacity rented from a cloud computing vendor.)
- The user gets the right to use the software by paying software licensing fees to the SaaS company. Using the Internet, the user accesses the software which is hosted on the central platform. This licensing agreement works like your phone bill, in that you pay a monthly fee to access the telephone network.
- Relatively fixed capacity
- Perishable inventory
- High fixed costs, low variable costs
- Inventoried demand
- Time-variable demand
- Varying customer price sensitivity
- A Variable Component: This is usually based on the number of users, volume of usage (transactions, messages, storage), number of servers, or number of accesses to a network. With this fence, enterprises with large number of users (their employees) usually have no choice but to pay a higher subscription rate. Example: Salesforce Performance Edition at USD$300/user/month
- Bundling of Modules: Business software typically comes in modules that offer different functions or address different needs, even if these modules all operate on the same platform. Enterprise customers require different “bundles” for their companies’ specific needs, allowing the SaaS vendor to price differently for the sum of these parts. Example: Zoho’s variety of mobile apps
- Bundling of Services: Customers may be allowed to select the level of service and support received. The SaaS vendor can provide different levels of service and support separately from the right to use the software, with large enterprises typically preferring high levels of service and support due to the change management involved in adopting new software. Example: Netsuite’s services
- Customization: Enterprise customers may require customization of the software package. While this is not ideal in SaaS, as any changes made on the central platform will affect the software used by all other customers, the SaaS company may choose to work these customizations into their development schedule as new features, or set up a separate instance for customers with specific needs, or other technical workarounds. Of course, customers that require customization would see accordingly larger contracts. Example: Zendesk’s Professional plan offering “custom private apps”
- Controlled Availability: This is the availability of certain discounted rates to particular market segments. Example: Nonprofits receive free access to LinkedIn Talent Finder plan
- Customer Characteristics (Special Price Tiers): Special price tiers arise due to unique circumstances not listed in the physical fences above, such as the need to acquire a strategically important customer, or unique characteristics of a sector that the customer operates in. Some may appear in the form of unlimited licenses, or revenue-sharing agreements. No examples here, as information for these types of deals would not be made public, but these are likely to involve either large deal sizes or strategic discounts.
- Transaction Characteristics: This involves charging different prices based on the structure/process of the transaction itself, such as customers being able to buy subscriptions at lower rates from channel partners who in turn generate lots of revenue for the SaaS company. Price could also differ based on the frequency of the payment stream Example: Gametize’s monthly rate is USD $100 while the annual rate is USD $1000
- Product Line: SaaS companies differentiate their services by listing different subscription packages on their website to appeal to different market segments (often the lower price tiers). This is similar to the fences of module bundles and service bundles; however, the product line is displayed publicly whereas the bundling is negotiated privately. Example: Basecamp’s 3 simple packages
Average Annual Contract Value (USD)
|Supportable Sales & Marketing Activities|
$60 – $1,000
|Limited to Freemium/Viral marketing models. Unable to support 1-on-1 marketing or full-time sales rep.|
$1,000 – $5,000
Previous tier + Inside Sales team, limited 1-on-1 marketing. Limited to low marketing costs per lead.
|$5,000 – $20,000||
Previous tiers + Field sales, increased cost-per-lead, prospecting and outbound sales
Previous tiers + Ability to spend four-figure amounts to acquire customers, frequent overseas sales meetings