The SaaS world is going through a period of evolution. The days of focusing exclusively on growth appear to be drawing to a close. Growing in popularity is solid business fundamentals and a focus on profitability. Let’s talk about what this means for the economics of SaaS and the leaders of those businesses.
Background
Historically, SaaS businesses have followed typically one of two paths:
- Growth at all costs (Ponzi)
- Return on investment (ROI)
Now while I’ve spent time studying the first, I’ve never really understood or believed in that approach. This version (Ponzi) is the one that is rapidly falling out of favor in the SaaS community. This economic model doesn’t seem to make any sense for SaaS companies (or really any companies). To me this approach has always felt like a ponzi scheme.
Examples of companies that have followed this economic model would be the likes of Uber or Twitter. What’s never been clear to me for these companies is – what is the end game? At what point do these SaaS companies reach economies of scale that actually put them in the black?
Well it appears I wasn’t the only one with these concerns and in fact, back when Uber held their IPO they reported that they ‘may never be profitable’. If I were one of their investors I would be more nervous than excited.
The story over at Twitter is even worse. A sale of the company to Elon Musk eventually went through in 2022 and it’s pretty much been all bad news from there including mass layoffs and embarrassing feature rollouts. In fact, Musk even acknowledged that he definitely overpaid for Twitter.
At the beginning of 2023 we find ourselves staring down the barrel of another economic recession. This has renewed scrutiny over this flawed economic model for SaaS companies. During these times, SaaS companies with flawed economic models oftentimes struggle to perform or even stay alive. There’s a huge graveyard with all of the proof you’ll ever need to know that this economic model is beyond risky.
So what are you to do instead? Let’s talk about that next.
When Does a SaaS Company Become Profitable?
The short answer is ASAP. Portability is a foundational element of a healthy business. This has largely never changed, but if someone makes a bunch of money with a lottery ticket that’s when bad ideas spread like wildfire.
Your SaaS company needs a path to profitability very early in its history. Without it, you won’t have a business or even a charity. I would argue companies like Uber and Twitter are more of a hobby. If they don’t become profitable, they will ultimately die. It’s only a matter of time until the piggy bank runs out.
Gone are the days of reinvesting everything into growth. Companies like Uber and Twitter are constantly taking losses that somehow lead to growth? Growth of what? Certainly not profitability.
The way to protect your SaaS business is to establish it as a profitable business as soon as possible. If you have a sound economic model for your SaaS business then you will build resiliency that these companies have never had. You will be able to manage your own growth and continuously provide the world with value through your product.
There are lots of examples of companies that have followed this sound economic model with great success, such as Zoom. Some have even never taken outside capital to grow, such as Mailchimp. Let’s talk about what we can learn from the success of their approach to building a sound economic model for a SaaS company.
Solve a Painful Problem
Don’t build a solution to a problem that doesn’t exist. If you do, even a ton of money raised won’t make you successful. There are many examples of these failures.
This may seem obvious, but you’d be surprised at how many SaaS products don’t solve real problems. Let’s talk about what I mean by a real painful problem.
Pain comes from your customer not being able to make the progress they need. This can come in the form of high costs or lost time. Your product needs to get them unstuck and enable them to achieve their goals. If it does, you will have sufficiently cured this pain for them.
Expensive problems (lost time, money, etc.) are painful problems and you need to laser focus on the biggest one for your customer. This is the beginning of building a healthy economic model for your SaaS.
Generate a Strong ROI
Without a return on investment, your customers will eventually churn – it’s only a matter of time. It doesn’t matter how flashy your product is – marketing doesn’t solve your customer’s problem. That’s what draws them in, but your product needs to perform to keep them.
Performing looks like providing them with a strong return on their investment. The value your product provides needs to lead to dollars and cents for your customer. The area your product can pull this from to give it back to your customer is typically in time or cost savings. Whatever it is, you need to calculate it and ensure it is providing them with a strong return.
You may be wondering how strong this return needs to be. Well, the stronger the return the stickier and more valuable the product. As a general rule, I’d recommend your product generate at least a 200% return on investment for your customer. This means if you’re charging $100 a month that you should be providing $200 in savings.
Prove the Model Before You Scale
Scaling is expensive. You need to reinforce your product with critical features and hosting that supports performance at much greater volume. Plus you need to hire to manage that growth well. These are all expensive propositions. Premature scaling kills a ton of SaaS businesses and wrecks your economic model.
You need to pay close attention to the experience of your customers with your product. You’re looking for irrefutable social proof that your value proposition is effective. We know what you can measure, but what does your customer report? Do they agree or do they have different numbers than you do? Either way, their word is what really matters.
Social proof can only come from your customer. They need to provide you with solid proof that it is working for them and providing them with a strong return. Once you collect enough of this data, you’ll know you have what you need to succeed at scale.
Summary
Use this guidance to tear apart your SaaS economic model. How does it stack up? Do you fall more into the ponzi category or the ROI category? If you’re pushing for the former, you need to switch to the latter.
Stop taking the lead from companies like Uber and Twitter. Start following along the likes of Zoom and MailChimp. You’ll be glad that you did.
I love to geek out about the economics of SaaS. If you’re doing it right, it should be highly profitable. If you have concerns or would like an independent evaluation, book a free product strategy call with me to find out.
