Why Your SaaS Business Model Is Flawed

If you are reading this article, then there is a high chance that

  1. You are a startup business owner
  2. You have a SaaS product
  3. Your SaaS product is not making money

And the reason I am writing this article is because this is not a very niche problem. There are thousands of SaaS products out there and more often than not, these startups are not making money. At least not enough to keep investors happy.

A big reason for this boils down to the business model. It is flawed.

This is not unique to SaaS businesses. According to one study, nearly 42% of startups fail because they offer a product or service that the market doesn’t need.

With SaaS products, the problem of flawed business model is compounded because so many of the startups in this space you see today follow a similar pattern of monetization.

  1. They have a freemium version and expect to convert a fraction of these users into paid customers
  2. They have a subscription model that costs a flat fee based on the features that the customer needs
  3. They have a per-user pricing that is based on the number of people in the customer end who will use the product
  4. SaaS products all have a tiered pricing model with premium features for the higher priced versions
  5. A lot of SaaS businesses invest more in marketing and less on sales. Marketing is seen as a scalable and sustainable strategy over sales

To be honest, this model worked fine for a lot of early-entrants in the SaaS space. Freemium (or free trial for that matter) encourages more users to sign up and once they get used to the product, you push them towards becoming paid customers. Subscription pricing is also good for customers since it is more predictable from a budgeting perspective.

Finally, investing in marketing (inbound marketing to be more specific) helped SaaS startups reach a global scale without the need to have a sales force that is distributed across each of their markets.

So what went wrong with SaaS businesses?

Nothing, in fact. All those points that helped SaaS startups scale up fast a decade back are still valid. Large players like Hubspot are still killing it with these techniques.

What has changed however is the sheer number of SaaS players. Pick any industry – find a niche and dig deeper into a micro-niche and you will find a SaaS business operating in this space. The mere presence of thousands of SaaS businesses has meant that the dynamics in the ecosystem has changed.

Let’s think about this from a customer’s perspective – there are tons of options to choose from for any product that they want. What this has meant is that a feature you wish to charge for is already provided for free by a competitor.

This has sort of created a race to the bottom and a craving for more free stuff among customers. In other words, the motivation to pay for commodity products is lower today than what existed a decade back.

That doesn’t mean that premium customers who pay for quality do not exist anymore. They very much do. But there is a greater defragmentation of offerings that could bring down their motivation to pay.

Think about this – a business of any size needs to pay for a domain name, hosting space, email marketing platform, an email gateway to begin with. In addition to this, they pay for analytics, help desk, CRM, ERP, VoIP and a host of other services. Add a few dozen dollars for each of these services (“per user” charges wherever applicable) and you will find that the costs shoot up pretty fast.

The result is two-fold – customers pay for the heavily necessary tools like CRM, ERP, email marketing and hosting. More often than not, they go with the large players since they get multiple products and services in one suite.

Not surprisingly then, if you are a bootstrapped startup working on a niche offering, your product is the one that a customer will sign out from anytime they face budget cuts.

How do you fix the SaaS business model?

A big reason why a lot of these challenges exist is because of the flawed pricing model. The subscription model works alright if your product is just one of a handful of tools that the customer needs. But when a customer is paying for dozens of apps, this pricing model gets very expensive.

In some ways, the flawed pricing model itself exists because of a flawed business funding model. A number of failed SaaS businesses are VC-funded startups – these are businesses that put valuation ahead of profitability.

This works when you are a Hubspot or Salesforce. But when you are targeting a very small niche, there is not enough dough in the market to keep growing.

Bootstrapped businesses are more focused on profitability and are likely to make good decisions of pricing.

One quick way to resolve this is to replace a subscription based pricing model with lifetime credits. This way, your customer only spends money for what they use. This pricing model has been popular among PaaS providers like AWS where users only spend money for what they use.

This pricing model is straight-forward for tools where your costs are directly proportional to consumption (like in the case of hosting). Email marketing services, SMS tools can all be offered using this pricing model.

This way, customers also get access to all your premium features without having to shell out a fortune each month (regardless of whether they use these features or not). It is a fair way to price your products and consumers are less likely to feel cheated since the money they pay is only expended based on your consumption.

The next step is to switch your focus from marketing to sales. Yes, sales is less scalable globally compared to marketing. But if you are in an industry with dozens of competitors, focusing on a global audience does not make sense.

Instead, invest in a sales team that will target customers from within an industry or a small geography. A big advantage with this strategy is that you can shape your product based on what a small niche of customers want.

In the early stages of your product, you could target a broader industry and shape your product over time based on what profile of customers convert to the latter stages of your sales pipeline. This automatically sets you apart from competitors in your industry.

Most importantly, sales is heavily result-oriented and a major chunk of salespeople salary are through commissions.That is, you only spend money for acquired revenues. In contrast, marketing requires capital investment that can take time to fructify (or not deliver results at all).

This does not mean that you should ditch your marketing strategy. Not at all. Marketing helps you scale up in ways that sales can never help. I am a marketer after all. But by being completely reliant on marketing, you are deferring your profitability and are thus going to be depending completely on your investors to survive.

Not surprising then that when you look into it, businesses that have been successfully self-funded all have strong sales teams while VC-funded startups often tend to invest heavily in marketing.The former is desperate for profitability to stay alive while investors need the latter to grow exponentially.

Do you have a SaaS businesses that failed or is not making money? I am interested to talk to you. Drop in an email or comment and let us discuss ways to fix your business.