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Why SaaS? The Pros and Cons of Starting a Software Subscription Business

by Vitaliy Podoba
Vitaliy Podoba avatar
Why SaaS? The Pros and Cons of Starting a Software Subscription Business

With this article, we’re launching “SaaS MBA” series. Lessons will cover all the aspects of building SaaS business from idea validation to growth.

The first section of our SaaS MBA articles is “Getting Started”. And in the weeks to come we’ll be covering 6 key lessons:

  • Why SaaS? The pros & cons of a subscription model for software companies
  • SaaS goals: How to make sure your SaaS idea aligns with your goals
  • How to generate, brainstorm and pick your SaaS idea
  • Validating your SaaS idea
  • SaaS business plan preparation
  • Creating your SaaS business name

Today in our first lesson we’ll talk about the pros and cons of the SaaS business model.

You can expect most lessons in our series to be short and tightly focused on one key thing—they’re also highly practical.

But today’s topic is pretty subjective. The best thing I can do for you is to provide you with all the information you need to evaluate the pros and cons of a SaaS business model compared to possible alternatives.

So make yourself a good cup of tea and get ready to dig into this high-level long read.

In this lesson we:

  1. Review what a SaaS business is really all about
  2. Cover a few good examples of existing SaaS businesses in different categories
  3. Compare SaaS to other types of businesses and business models
  4. Extract a key takeaway from this comparison
  5. Set you up with homework to help you find the right fit for your business

So let’s get started!

What is SaaS?

These days there is no strict line that tells you whether a specific website, web service or web application is SaaS (which stands for Software as a Service) or not.

If you can use a specific functionality online and it’s done by a software component, then technically we can call it a SaaS application.

Today, we can identify 3 core pillars that define every SaaS product and differentiate it from other types of software products:

  1. A SaaS software product is hosted in the cloud.
  2. It can be accessed via a browser over an internet connection.
  3. A SaaS product is licensed on a subscription basis—usually monthly or annually.

Keep in mind that SaaS is an online service where the core value is provided by the software component.

How SaaS differs from other types of online tech startups

Since 2011 our agency has developed more than 80 custom software projects. Most of them fall into one of the following 3 business models:

  1. Marketplace: where 2 parties are connected to sell, rent, provide services and exchange ideas.
    Core Value: Connecting consumers with sellers.
    E.g. Amazon, Uber, Etsy, Airbnb.
  2. Social Network: where groups of people connect to pursue their own personal or business goals.
    Core Value: Staying in touch with your network of contacts.
    E.g. Facebook, Twitter, Instagram, Reddit, closed paid groups.
  3. SaaS: provides value to its customers without necessarily connecting the customer to the other party.
    Core Value: Putting access to and control of service in the hands of customers to get faster results more cheaply and efficiently.
    E.g. MailChimp, Gmail, Dropbox, FreshBooks.

While there are a lot more business models in the tech startup world, if you analyze them you’ll see that they’re often a mix of these three models.

For example, Facebook, with its huge infrastructure, is primarily a Social Network. But it’s also a Marketing Automation SaaS allowing you to grow your business with its Ads Manager. Plus, it is a Marketplace for Facebook Apps (Games, Productivity Apps, etc…).

Mobile games usually follow a SaaS business model with an on-premise installed software product and server-side residing on the cloud. But these days any game app is also a Social Network where you compete with people from the network, socialize and share your successes.

Despite the mix of these models, each is completely different in terms of how you’d approach building and growing it.

Based on our agency experience I’d highly suggest you consider SaaS over Marketplace or Social Network models.

Marketplace and Social Network startups are harder to start: you’re usually faced with a chicken-egg problem. You cannot provide core value to your first user before other users join in.

With SaaS, it’s much easier to provide core value at the very beginning, as soon as you have your first user.

We built a few marketplaces for our clients, and in most cases, it was a failure at the end from a business perspective. SaaS startups have a much higher success rate in SoftFormance history.

Is a SaaS Business Easier to Start?

While SaaS is much easier to start than a Marketplace or Social Network tech startup, any SaaS is still a regular business with all its consequences.

10-15 years ago, when SaaS was still a new term, a lot of programmers and technical geeks were trying to conquer this new business model.

At that time it looked like a dream business: you developed a piece of software on your own, put it out there on the internet, collected money and never talked to your customer. Kind of a no-selling, no-marketing, no-support type of business—just building your product and enjoying the process.

While that was partially true 10-15 years ago for small SaaS-es serving the B2C (Business to Customer) sector with low pricing tiers, those days are definitely gone.

Today, even in the B2C sector, support is very important.

Now we have too many software products around us doing a lot of different things. Competition is higher than ever and you need to compete on all fronts at the highest possible level. Marketing, support, and, of course, technology.

With a monthly subscription business model, customers are constantly looking for a better and cheaper solution to their needs. Changing a software provider is super easy.

We’ll talk more about customer retention in the Product Strategy part of our SaaS MBA series.

For now, I can tell you that while SaaS is definitely easier to start than a lot of other types of businesses, it has its own pros and cons.

Good SaaS Examples

We’ve prepared a list of the most popular SaaS categories on the market along with existing SaaS leaders as examples.

Check it out to review your current SaaS idea or come up with something new.

And now that we’ve agreed on what a SaaS business model actually means and checked in on existing SaaS examples, let’s move on to the nitty-gritty of comparing SaaS with competing models.

All SaaS Competitors

If you google “SaaS pros and cons” you’ll see that 95% of articles focus on comparing SaaS to on-premise installed software products. And most of these articles are also focused on pros & cons for SaaS users, not for SaaS founders.

So I want to compare the SaaS business model with literally all the other possible types of businesses, both online & offline businesses and technology and non-technological startups. And also to some other sub-types of SaaS.

We’ll go over the following models one by one:

  • Regular offline business
  • Online business, non-technological (E-commerce, Education, etc.)
  • Tech Startup (Marketplace, Social Network, etc.)
  • IASS, PASS and other kinds of subscription-based technology business models
  • Software Products licensed and installed on-premise

Let’s start from simple offline businesses.

SaaS vs Offline Businesses

This one is pretty simple and obvious.

Like any other software product, SaaS would win over an Offline Business model because:

  • You don’t need to deal with offline assets and invest in physical things (business location, raw products, tools, etc.). As a founder and CEO of SaaS business, you can do 99% of your daily tasks with a PC and the Internet.
  • All your employees can also be remote and not require in-person communication. The employees of Basecamp LLC (a 20-year-old SaaS company) are all remote.
  • SaaS is easier to scale and go worldwide. You can serve clients worldwide using the same cloud instance, internet, and web browser.

An Offline Business model beats SaaS (like any other tech startup) in these areas:

  • Every SaaS is unique and usually competes worldwide. There is no such thing as a SaaS franchise to re-use and improve your odds of success dramatically.
  • An offline business like a hotel or restaurant is also easier to plan and launch within budget and on deadline.
    With a tech startup, you could end up with a 3-times higher budget if you don’t hire a proper development agency and don’t do a proper planning workshop.
  • With SaaS, you can only serve people with good internet access and only PC/mobile users. Make sure you pick the right SaaS niche and idea (we’ll discuss this later in our SaaS MBA series).

I think you’re reading this article right now because you’re more into technology, online startups and maybe would like to be free of geolocation while running your business.

But I still wanted to go as wide as possible for comparison. So let’s move on to the online side now.

SaaS vs Other Online Businesses

There are 2 other viable online business models that aren’t really technology-focused but can be delivered over the internet and without any offline assets:

  • E-commerce
  • Educational (aka info-) busines

Whether you pick E-commerce (online retail), Educational courses (online school) or SaaS is completely up to you.

And while these 2 business types have some obvious advantages over SaaS (or any other kind of tech startup), the main criteria here should be your personal preferences.

Are you more into technology or more into sales or more into teaching others?

Don’t get me wrong. Each of these business types would require skills in all three areas. But each of them would require core expertise where you’d spend most of your time:

  • SaaS (or any other tech startup).
    Core Activity: Building a technological product and cooperating with the development team.
    You will still need to market and sell it like in any other type of business. You don’t need to be a programmer to start and successfully run SaaS. But you’ll need to understand the high-level view of programming in order to make decisions and guide your team.

  • Education.
    Core Activity: Producing educational materials and teaching others.
    Examples include an online school, online courses, a portal with video lessons (e.g. Udemy, Coursera), a closed paid educational group, online masterclasses, etc.

  • E-commerce.
    Core Activity: Find cheap vendors/products and sell them at a higher price.
    You’ll also manage your online store, inventory and might even need to organize the physical warehouse and do a lot of offline logistics.

With most tech startup ideas (including SaaS) you can avoid any offline logistics (warehouses, manufacturing, etc.). An office and human resouces would be the only offline assets you need to invest in. But even Basecamp, a multi-million company, hires employees remotely.

Educational and E-commerce directions might require some offline logistics. So take this into consideration as well.

So, consider: what kind of activities do you like the most? Selling products online, working with your team on a technology product or teaching others?

Meanwhile, let’s move on to the next section.

SaaS vs Other Tech Startups

We’ve already discussed the three main types of tech startup business models: Marketplace, Social Network and SaaS.

You already know that tech startups are usually a mix of 2-3 of these models, and you know that social networks and marketplaces are harder to start.

But there is one huge advantage to Marketplace and Social Network business models: if you get into a particular sector on the ground floor, it’ll be harder for your competitors to beat you. With SaaS, it’s a bit easier for competitors to replicate your service and software product.

Despite this, I recommend that you choose the most practical route and pick the model that’s the easiest to launch.

You’ll have a lot of opportunities to innovate and implement unique differentiators that make your business stand out from competitors as you grow—something we’ll talk more about in one of our upcoming SaaS MBA lessons.

SaaS vs IaaS & PaaS

IaaS (Infrastructure as a Service) and PaaS (Platform as a Service) also fall into the tech startups category. But they deserve separate attention because they are a bit similar to SaaS in terms of business model.

IaaS is a service that allows you to host your application. In the most simplistic form, IaaS services are hosting providers that charge monthly. Usually, you are provided with a virtual server with full access to the operational system. You (or your development partner) would install your app there and completely manage it, maintaining all the infrastructure, including OS upgrades.

Good IaaS examples include companies like AWS EC2, Rackspace, Google Compute Engine (GCE) and Digital Ocean Droplets.

PaaS on the other hand provides a higher level of abstraction where you deploy your app code and data, and everything else (including on-demand scaling) is done by a service provider. Usually, such services are focused on specific programming languages and technology stack. Usually, they’re more expensive.

Good PaaS examples include platforms like AWS Elastic Beanstalk, Heroku and Windows Azure.

Put simply, IaaS and PaaS are services that you use to host your SaaS application.

I don’t recommend either of these business models. They are more complex in technology infrastructure and are more about administration activities and customer support than about providing a specific software product.

But I wanted to cover them in this lesson so that you can become more familiar with the tech startup landscape.

SaaS vs On-Premise Software Products

Of course, I can’t finish our SaaS comparison without covering licensed software products and products installed on-premise.

So, let’s start with the advantages of SaaS over on-premise software:

  • SaaS is usually easier, faster and more cost-effective to develop, maintain, support and scale than on-premise installed software (be it mobile or desktop app).
    You don’t need to support multiple OS-es and devices. You only need to support multiple web browsers, which is way easier.
    You don’t need to help your customers with local device issues. You just update your code on one production server and let it work for every user.
    And it’s much easier to spot and replicate front-end related bugs with tools like Sentry and online support chats.

  • SaaS is easier to sell and market.
    You don’t need Sales Reps if you sell a monthly subscription, especially if your SaaS pricing tiers are at the low end.

  • These days it’s much easier to find a good development partner for a web application than a desktop application.
    The same goes for mobile app developers. Mobile app technologies are pretty restricted.
    With a web application, you’re free to pick from a wide technology stack.

  • You can predict your monthly and annual revenue based on your existing users, marketing plan and churn rate.
    A subscription-based model gives you a good base during tough times when you can’t predict new customers sales.

  • And there are many more advantages that naturally flow from the above points…

These strengths, however, can turn into weak points when compared to one-time sold products:

  • Usually, SaaS can’t achieve large upfront sales for re-investment and to help you grow faster.
    With SaaS, you charge monthly. At most, you can try selling an annual plan.
    Some SaaS-es try selling 2-3-5 years plan. But it’ll work for you only if you’re a well-established business with happy customers that have been with you for months and years.

  • SaaS is easier to start but also easier to lose.
    Competition is high and you need to keep your customers happy from month to month. You can be out of the game pretty fast in the SaaS world.
    SaaS users are constantly on the lookout for better, cheaper service. It’s easier than ever to switch software products, especially monthly subscription-based products.

  • In rare cases, your startup idea cannot be built and served via a web browser due to technology restrictions.
    In that case, you might need to build it as a native desktop/mobile app.
    But that would be a really rare situation. If Photoshop went online and is now sold on a monthly subscription, then your SaaS idea can work too.

  • You can’t serve a client with a poor internet connection.
    So make sure you’re targeting the proper customer segment that knows how to use the tools. We’ll talk about this a bit further in our SaaS MBA series.

  • It’s harder to scale support for an on-premise installed product.
    On the other side, if your on-premises installed product does not require a shared server and it is a standalone desktop/mobile app, you’ll never experience scaling issues as each new customer uses its own installation.
    With a cloud-based SaaS app, your server load will grow with every new online user.

  • Finally, if your SaaS idea aims at big enterprises, you might need to adapt your SaaS product so that your big customers can install it on-premise on their own servers.
    There are good examples of SaaS business that provides high-end pricing tiers for on-premise installation. For example, this ERP system provides on-premise (self-hosted) and cloud-based pricing tiers at the same time.

Consider Your Client Base

The final piece to weigh when choosing a business model is who you will serve: big enterprises or small businesses? Consumers or the business sector?

For new businesses, in particular, it’s almost a no-brainer to quickly deploy a collection of SaaS business apps and pay for them with a monthly subscription, rather than invest heavily in on-premises IT infrastructure and in-house technical support.

Perhaps the biggest problem facing small businesses is the enormous amount of choice that’s already available in the SaaS market—particularly if they’re unwilling or unable to sign up with a cloud services broker.

Larger businesses have a different set of problems to contend with when it comes to SaaS adoption, mostly centering around integration with existing on-premise enterprise applications (into which many may well be locked with costly contracts).

Still, enterprises looking to expand into new regions, or adopt new “social” business processes, may well find that SaaS is the most cost-effective way to go.

My bet would be to go 100% with SaaS and to avoid on-premise installations at any price.

Key Takeaway

So what should you take as the key point from this lesson?

Go for the SaaS business model in all cases with any business idea?

No!

I’d definitely suggest you start with the market.

Go to the market, find a pain, then come up with a viable solution.

Be it SaaS, or another kind of tech startup, or software installed on-premise, or offline business or service based business, or a mix of all of them…. The model doesn’t matter as much as the problem you’re trying to solve for your clients.

In order to be successful, you need to satisfy a market need. So don’t stick to a specific business model or type of business.

So, I’m basically suggesting that you not go with SaaS in this first lesson of our SaaS MBA. Sounds weird, right?

During one of our SaaS Startup Planning Workshops, we had a situation where we suggested our client not proceed with his idea in a SaaS format. In that particular case, we suggested he start with a done-for-you services model and only then think about some automation with a software component.

In other words, we actually turned down a new deal on custom software development for us.

You can also check out my short post here on how professional service providers can start by selling an educational course, and only then jump to a SaaS model.

My point here is that at SoftFormance, we won’t start a custom software development project if we don’t believe the idea can be turned into a viable business.

The tech startup world is challenging and only a fraction of startups turn into profitable businesses. So we try our best to contribute to those SaaS ideas that have the highest potential to make money for our clients.

Make sense?

Your Homework

Now it’s time to take some next steps to get you on the right track to choosing the best business model for your needs.

1. Do Your Research

If you don’t know much about other tech startup business models yet, Google is your friend. Get to know a bit more about Online Marketplaces, Social Networks and other types of online businesses.

2. Start Asking Questions

Return to your SaaS idea and think it over carefully. Can you implement it in any other business format that would make it faster and easier to start serving your customers? Can your idea be delivered via some preliminary stage before converting it into a software product?

How you can start selling it faster? How you can come up with an MVP version faster and ideally with as little programming as possible at first?

And for those of you who have landed on SaaS as the business model you want to pursue, follow up on the rest of the articles in this series.

Share your findings and questions in the commentsI’ll do my best to reply to each one.