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January 1, 2021

If you’re like most people, you probably use some form of cloud-based software every day. Whether it’s for work or personal use, chances are good that you’re relying on at least one SaaS (Software as a Service) application. In this blog post, we will discuss SaaS economics and explain how SaaS differs from other cloud services.

The SaaS Economics: Everything You Need To Know

Software as a service (SaaS) delivers software over the internet in a pay-as-you-go model. This approach allows businesses to avoid the high upfront costs of traditional software licenses and instead pay a monthly subscription fee.

As a result, businesses can free up cash flow and better match their spending to their actual usage.

How a single new sales rep’s revenue builds over time, with no ramp-up period

Subscriptions are beneficial to businesses because they provide a steady revenue stream. For instance, if you sold a monthly subscription in January, that client will continue to pay you each month.

The chart shows the effect on revenue of not losing any clients, while the graph shows the effect if 2.5% of your clients were to unsubscribe each month.

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Churn, bookings, and MRR for a new sales hire

The above chart assumes that no ramp up time is needed for the new reps. Let’s look at how bookings, churn, and MRRs will change when new sales reps are brought on:

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The chart above shows the growth curve of new customer accounts, which slowly increases as time goes by, while the graph below depicts how revenue steadily rises, but is then negated by account cancellations.

For new entrepreneurs, this monthly recurring revenue (MRR) chart probably seems straightforward, but for seasoned business owners, it’s worth going over the three parts that make up your total revenue.

SaaS Cash Flow Trough

Now let’s examine how timing affects a new sales rep. Sales reps have costs that show up immediately, but revenues don’t start coming in until later.

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In the image below, we can see how ARR (monthly recurring revenue) increases steadily over time, while MRR (Monthly Recurring Revenue) remains flat. This, in turn, creates a cashflow problem that many companies face.

In the righthand chart, we can see that a new employee takes 11 months to breakeven and start contributing to profits.

The length of time a new salesperson takes to start contributing to a software company’s bottom line will vary widely from company to company, depending on many different factors. This time period is later than the one shown on the left-hand chart, which assumes a 80% gross profit margin.

Now let’s examine how these expenses, and the resulting profits, look on a combined, or aggregate, level.

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The above chart clearly shows that the cash flow trough for startups is $110,000, and that it will take 23 months before the investment is recovered.

These losses of capital can be very upsetting to inexperienced traders.

What the chart above shows is that once a software as a service (SaaS) company goes through its initial investment phase, the profit potential from new customer acquisitions increases dramatically. This is because of the fact that a software company’s margins are very high and that customers can be scaled very quickly, meaning each additional client has a disproportionate effect on profits.

This chart is the secret to understanding a software as a service (SaaS) company’s finances.

In my next blog, I will explore how ramping up a sales team where you hire many salespeople at once affects the Trough of Sorrow. I will also be looking at how accepting payments a year ahead of time can impact your cash flows.

How the Inputs to the Model Work

The starting points:

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This calculator takes a number of variable factors into account when generating its output. By changing the values in the highlighted yellow boxes, you can see what effect they have on the outcome.

Note that 15% of booked revenue is discounted to account for unsuccessful new hires and salespeople who leave the company. It’s common to hear that 30% of sales are lost due to turnover.

Even though some sales people will fail, they will still be contributing to some amount of revenue. Therefore, I have estimated that 15% of sales reps will quit.

Marketing Funnel Economics – How Do Marketing Costs Increase As We Add Sales People?

Now, let’s examine how adding salespeople affects your marketing expenses.

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The lefthand image illustrates the flow of the sales funnel, while the righthand image shows the breakdown of the process.

Paid leads are generated through advertising, while organic (or unpaid) lead generation is achieved through SEO, social media, and other inbound marketing strategies.

The model is assuming that 50% of visitors will be coming from organic search, which will increase at a similar rate as PPC.

The monthly cost of hiring new salespeople is $8,698. This amount is often not considered when calculating the cost of acquiring new customers.

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The Model Also Computes CAC and LTV (Life Time Value of a Customer)

This model only provides a rough estimate of CAC (cost of acquiring a customer). It also doesn’t account for other costs such as for sales and marketing teams.

(It’s not too hard to figure out how much you’re spending to acquire a new customer: just add up all of your monthly expenses, then divide that by how many customers you acquired in that month.)

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SaaS Trends for 2022

Although the coronavirus outbreak caused the global economy to contract, cloud computing continued to grow.

Organizations are continuing to move towards digital business initiatives and cloud-based models in order to modernize their environments, improve system reliability, support hybrid work models, and address other new realities compelled by the pandemic. Brandon Medford, senior principal analyst at Gartner, believes that this trend will continue into 2022 and beyond.

According to research from analyst firm, Gartner, by 2021, businesses will spend $396 billion dollars on public cloud services and by 2022, that number will jump to $482.

The coronavirus outbreak has accelerated the adoption of cloud technologies, according to research firm Gartner.

“This is especially the case for scenarios such as working remotely, collaborating with others, and using new services to support your hybrid team.”.

Software as a Service (SaaS) solutions are one of the fastest growing segments of the IT market.

SaaS models are becoming increasingly popular among organizations for a variety of reasons, including flexibility and affordability. Subscription-based and centrally located on remote cloud networks, SaaS solutions offer a number of advantages over traditional software models. With the pandemic necessitating more remote work than ever, the need for SaaS will only continue to grow.

The pandemic has forced more people to work remotely than ever before, and this trend is only expected to continue. As a result, the demand for SaaS solutions will likely increase as well.

In today’s article, we’ll take a look at some of the trends in the Software as a Service (SaaS) industry for 2022.

Cloud growth: SaaS vs other cloud services

The market for cloud-based software is certainly promising.

SaaS growth will continue to outpace that of other cloud services in the coming years as more and more companies adopt SaaS solutions for a variety of business functions. While SaaS initially gained traction in core engineering and sales applications, its reach has now extended far beyond those initial territories. This continued growth can be attributed to the many benefits that SaaS offers, including increased flexibility, scalability, and cost-effectiveness.

SaaS has been the first cloud service to take off and maintain significant dominance in the market. Gartner estimates that this trend will continue well into 2022, making SaaS a key player in the cloud services industry.

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SaaS growth is beginning to slow, especially when compared to other cloud services. Platform as a service (PaaS) and infrastructure as a service (IaaS) are projected to double from 2020 levels. This continued growth in other cloud services may eventually erode SaaS’s current market dominance.

(Learn more about the differences between Software as a Service, Platform as a Service, and Infrastructure as a Service.).

Conclusion

The bottom line is that SaaS provides a number of advantages for both users and businesses, especially when it comes to economic growth. For businesses, SaaS can help reduce upfront costs, increase efficiency, and scale more easily. And for users, SaaS applications are typically more affordable and easier to use than their traditional counterparts. So if you’re looking to get the most bang for your buck – economically speaking – then SaaS is definitely worth considering.

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