This question came to me on a popular Q&A site. I thought it may also be helpful to many of you questioning how you may generate a profit from your product or service, so I am resharing it here with some additional content.
First off, let’s define what a SaaS is before we start talking about how they make money.
What is a SaaS?
“SaaS” (pronounced “Sass”) stands for “Software As A Service”. It is a software licensing and delivery model in which software is made available to the user on a subscription basis and is centrally hosted.
What does that all mean? It means that rather than having to install or download a copy of an application, users can access the product from a web or mobile browser. The product’s provider then manages and updates the software based on user needs.
Remember the Microsoft Office CDs we used to all use to install their software? And now we all just access our Word and Excel files through their website or app? This is an example of how SaaS has changed how we access and use software.
Due to technological advances – and the fact that it generates huge profits – the SaaS model has recently exploded in popularity and has been incorporated into the strategy of nearly all leading enterprise software companies.
Some well-known companies and products using the SaaS model include:
Unlike traditional software, which is often sold with an upfront cost per license, SaaS providers generally price access to their product using a subscription fee – most commonly a monthly or annual fee. A benefit to the user is the initial setup cost for SaaS is typically lower than the equivalent software because the provider can leverage (or scale) access to a “single source” of their product across a lot of users.
SaaS vendors typically price their applications based on some parameters, such as the number of users, the amount of storage, number of end clients, or number of connections. However, because in a SaaS environment customers’ data reside with the SaaS vendor, opportunities exist to charge per transaction, event, or other units of value.
A few popular SaaS revenue models:
An extremely popular model right now is a recurring billing model or subscription. Think of Dollar Shave Club for non-SaaS companies. Subscriptions can be paid on a regular basis, weekly, monthly or as a subscription that requires a minimum amount every month. Subscription models may also be bundled with other products or services to create pricing variations.
SaaS companies may also lean towards injecting advertising into their product or platform to generate revenue or offset expenses. Many social networks (it could be argued whether or not they are SaaS companies) have taken this route to generate revenues.
Freemium (Free + Premium)
The Freemium model works by combining a free version of the product or service (with basic features turned on) with upgradable features available for a fee (generally a subscription). The popular image editing app, Over, does a great job within the freemium realm of combining a ton of free features with a catalog of “Pro” elements. You can either buy these elements individually for a one-off fee or upgrade to their monthly/annual membership to unlock all of the Pro features for one price…. albeit recurring.
Finally, it is important to recognize that no product is “free”. Someone is paying for the business to remain afloat. Getting back to popular social media networks, if you are not paying for the service, you are the service. Advertisers will pay big dollars for access to you and your data. This is perhaps the most expensive option for users. Once your data is “sold” there is no regaining it.
The key to determining how SaaS companies make money is to understand what kind of relationships they have with their customers, investors, and stakeholders.