For years, subscription software as a service (SaaS) has been the fastest growing business model for technology entrepreneurs and investors. SaaS Capital Index It peaked in 2021, fell months later, and at the end of 2022 venture capital firms raised the lowest amount in a decade. However, the reasons for this rise and fall have not been adequately analyzed, and the implications are lessons for other companies whose enrollment model is a key part of their growth plans.
The subscription business grew more than 300% between 2012 and 2018, five times faster than revenue for S&P 500 companies. In the wake of the Covid-19 pandemic, SaaS offerings are coming to market as companies encourage companies to add subscriptions to their core product lines. This article explains why the model emerged, why it failed in the technology sector, and what lessons have been learned from this approach.
History of SaaS
SaaS has grown due to both supply and demand factors. Because cloud technology allows companies to offer low-cost software subscriptions, often with a "freemium" pricing model, these companies need a low-cost customer acquisition model. The SaaS model with new and less experienced vendors has reduced rental and compensation costs compared to the traditional enterprise software model. With an in-house sales team making outbound calls but not physically on site, the model also reduces travel, hospitality and administration costs. Businesses can do this because digital marketing has been a low-cost lead generation method for years, and its core value is that it makes life easier for first-time marketers: "Now they pay $1-2 million for technology solutions: For someone, do the same thing but with $1 - How about a demo for a product that costs $2,000?
On the demand side, customers felt more comfortable with remote interactions with sellers, while pre-sale research and online demos facilitated this buying method. At a time of low interest rates and ample investor capital, the economies of scale and geography of this approach have enabled many SAA companies to grow without worrying about short-term profitability. The pandemic requires more online interaction and has temporarily halted the growth of many subscription businesses.
A famous example is Peloton. In 2020, the pandemic will lead to massive growth in subscription-based fitness services (and a $50 billion valuation), founder and then-CEO John Foley said. to "strengthen the balance sheet" in 2022. But Peloton wasn't the only one: Similar declines, layoffs and revised growth forecasts at Shopify, DocuSign, Salesforce and others attest to the subscription model during the pandemic.
One result was the "SaaS Crash" of 2022. Another outcome, accelerated by rising interest rates and higher capital spending, is a shift in investor sentiment from "consolidated growth" to "sustainable" incremental profitability, with subscriptions based on more sustainable growth drivers . Model.
Principles of Sustainable Development
Recurring income from subscription services is not dead. With an understanding of the fundamental dynamics of the model and lessons learned from SaaS outages, the best days are yet to come. Start by following these principles:
It's a tie, not a tie.
Traditional sales models focus on customer acquisition and "funnel" or "pipeline". But this approach fails when used in the recurring revenue business, where the customer lifecycle is more like a loop than a funnel.
With a subscription model, most of the revenue is generated outside of the marketing channel. Historically, many B2B markets have relied on a business development culture focused on high-cost products and big-budget buyers. It is no coincidence that the acronym BANT (Budget, Authority, Demand, Time) began with a "B", a core sales methodology created by IBM in the 1960s. However, most SaaS services are tailored to buyers' operating budgets and are purchased based on the impact of the service. The biggest cost to customers is the cost of the time people spend using the service, which is often greater than the purchase price. A lifecycle framework is not "closed" but "closed/available".
Conversely, affective communication has implications for seller pricing as it means that price matches relevant customer value. HubSpot initially charged a flat monthly subscription fee, but later linked pricing to the number of contacts in the customer's database. As the customer base grows, so does the value of the service and the opportunity to share that success with impactful pricing. The ratio varies for other subscription companies. Fintech companies typically charge a fee per transaction: usage is more seasonal than part of a client's marketing or proof of sale, like HubSpot. The prices of other subscription companies are often based on features combined with additional services. In each case, the affected price unit affects how you sell and to whom you sell.
quality not quantity
Most sales leaders ask what it will take to double their sales, and they often say, "I need twice as many leads and twice as many people to call those leads." This shows a direct relationship between drivers and income. But SaaS works like a connected system: lead generation and qualification affect conversion rate and retention in complex ways throughout the process. A small difference in either direction means a big difference in annual recurring revenue (ARR). One of the lessons learned from the SaaS debacle is that this snowball effect applies to subscription models as they scale up and down. It is such a character in Hemingway's novel that when asked how he became bankrupt, he replies, "Well, little by little, then all at once."
Change the way you think about lead generation with opt-ins to focus on quality over quantity. One of the reasons is that the traditional main sources in this business model - paid search and other online marketing tools - are becoming increasingly crowded, expensive and an example of declining responses. The average cost of Google Ads increased by approximately 20% in 2021 and another 19% in 2022, and the average cost in industries such as entertainment, travel and home furnishings. Meanwhile, conversion rates fell to around 14 percent in 2022, marking a multi-year decline as the medium fills up. So the current joke among CMOs is, "Where's the best place to bury a man?" Search engine page two because nobody goes there!
A more fundamental reason to focus on lead quality is that switching from an owner-based model to a subscription model shifts risk from buyer to seller. When buying prepaid, the buyer bears most of the risk of installation, integration and leverage. With a subscription, the vendor builds the infrastructure, develops the software and manages the service. And because revenue is generated monthly or quarterly, many subscription businesses take months to recoup customer acquisition costs and require annual renewals to maintain a profitable business. In this context, identify the right customers at an early stage, because the cost of false positives is high.
Automated tools allow companies to send thousands of email templates: "Hello <First Name>, You may be faced with <Problem_Statement> as <Job_Title> at <Company Name>. This not only leads to many false positives, but the customer's problem and solution are not dynamic. For example, during the pandemic, pharmaceutical companies bought online dating software to help their salespeople connect with healthcare professionals. Now these salespeople can safely visit hospitals and doctors' offices, and the relevant influence has shifted from remote action to immediate action: "I have a matter to discuss." : Can you name your specialist in this field?
Not just service, but customer success.
With subscription models, recurring revenue is the result of recurring influences, and service is important throughout the customer lifecycle. In response to a content marketing article, a prospect may visit your website and click through for more information. If the product is sold through trials, the service provided during that time is critical. Most subscription offers measure their impact by relative usage, and that usage is in turn driven by the onboarding process rather than an ad or hypothetical ROI at the customer's point of purchase.
This differs from the service order fulfillment and problem solving role in traditional sales models. Some SaaS companies aptly call their service teams Customer Success (CS) teams, as these steps are critical to closing sales, onboarding customers, conducting business reviews to monitor the ongoing impact of products, and extending of the customer life cycle. CS provides monthly reports for apps like Slack, detailing the number of one-on-one and group calls, volume, type of content shared, and more. This rich and often dispersed user community makes value visible to customers, which in turn provides CS usage data that supports impact and recurring revenue.
In contrast, the misunderstanding of CS in this model is a contributing factor to the failure of SaaS. When demand drops and costs need to be cut, terminating a CS representative often seems like an "easy" decision for many managers, "after all, we've already won the customer". However, CS affects revenue in at least two ways, which together typically outweigh the savings from reducing CS:
- Reduce confusion in a business model that links customer lifetime value (LTV) to subscription length. Increasing customer retention by a month or two often has a disproportionate impact on LTV in a subscription model; And
- Increase usage and expansion by renewing, selling and cross-selling to others in that business or family, and at a lower cost than acquiring new customers.
This affects sales metrics and management. For the subscription model, net revenue retention (NRR: initial revenue + revenue expansion - revenue reduction / initial revenue) is a better measure of new customer growth, as the NRR reflects relevant economics, including upgrades, additional services and user additions. Decline, fewer users and/or customer turnover. Likewise, it's common for sales managers to refer to their reps as "hunters" (good at finding new customers) or "farmers" (key account managers). But these roles are highly redundant in a subscription model and require cross-functional engagement with non-business teams, and business leaders need to rethink their hiring criteria and KPIs to deal with this reality.
Technology and the Internet of Things make subscription services a huge opportunity for companies in industries beyond software. Despite the term "projected profit", no business model is self-managed. Learn from pioneers in this field, both from their ideas and from their mistakes.
