Ah, the digital age — computers, chrome and software all over the place. Indeed, software revolutionized the way we do business, but the SaaS revenue model revolutionized the software business. For customers, the benefits of the SaaS model were clear. It brought lower costs, lower commitment risk, and a try-before-you-buy model, which gave customers a remarkable opportunity to assess a product before making a purchase. Indeed, the benefit is so clear that a 2017 study conducted by BetterCloud found that 86% of organizations estimate that 80% of their business apps will be delivered through the SaaS model by 2022.
For software businesses, on the other hand, the SaaS model presented an entirely new way to build, distribute, market, sell, and support a software product. It literally affected every single part of a software operation. But the most significant change that the SaaS model brought — the one at the root of all the other changes — was the SaaS revenue model.
The Three Phases of the SaaS Revenue Model
Before SaaS (let’s call that time the Age of Sales), the software revenue model was transactional and all that mattered was the initial sale of the software product. Big, fancy salesmen sold long-term deals for one, two, even five million dollars a pop. Done. Hands dusted, gong rung, contract signed — all the revenue that was going to come from that deal had been generated.
Enter the SaaS revenue model. It swapped the single point of revenue with three essential phases (and it couldn’t have come at a better time):
Initial sale → Retention → Expansion
SaaS Revenue Model Phase 1: The Initial Sale
It still exists! And it’s still an essential part of the SaaS revenue model. “Closing” an initial sales includes everything from a simple self-serve upgrade to an annual contract shepherded by an inside salesperson.
If you play this phase well and show strong initial sales growth, you’ll get somewhere with your SaaS business. You’ll probably be able to raise some money, maybe even have a mini-brand — excellent! But wait — don’t ring the gong just yet. These days, an initial sale brings in far less revenue than in the traditional SaaS revenue model.
It’s still extremely important — you need a flow of new customers — but you also need to move on to…
SaaS Revenue Model Phase 2: Retention Revenue
“You mean we have to keep them happy?!? ! Forever??”– Early SaaS pioneer
Quite so, Mr. Early SaaS Pioneer. There’s a new (SaaS) revenue model in town.
Most early players, however, maintain the sales-first mentality even though they’re selling much smaller, month-to-month deals. They’re celebrating the initial sale disproportionately (and have been for years).
Not everyone, though. Some SaaS companies quickly realized the importance of retention. Indeed, they saw that an initial sale didn’t matter much if a new account canceled three, six — even 12 months later. They realized they couldn’t possibly sustain growth if they churned the customers they brought in. These people know how to play the game of SaaS.
Today’s SaaS pros realize that retention is the biggest revenue opportunity in SaaS. An initial sale might get you $500 in the bank when you convert that deal. But retention, retention will bring in that amount times the number of months the account stays active. And why? Here’s some fast math on that point:
- 1 month (initial sale): $500
- x 12 months = $6k
- x 24 months = $12k
- x 36 months = $24k
Indeed, the revenue opportunity from retention is exponentially larger than the initial sale. Execute well in this second phase, my friend, and you will build a solid, sustainable SaaS business. Excellent!
But wait (there’s more) — if you want to build a great SaaS business, crush the competition, and have a shot at an IPO, you’ll have to master the third phase of the SaaS revenue model: Expansion.
SaaS Revenue Model Phase 3: Expansion Revenue
Often overlooked, always important — this is where the true secret to SaaS growth lies. Savvy SaaS teams quickly realized that they could drive revenue growth by expanding existing accounts. Upsells, cross-sells, and any any other sells that could generate additional revenue from existing customers became SaaS staples. And it worked, mainly because the opportunity for second-order revenue was huge.
Just look at what happens when a SaaS company masters this phase:
And why? Expansion revenue is the root of the most magical of all SaaS metrics — Net Negative Churn.
What’s Net Negative Churn?
It’s simplicity itself! Here, take a look:
Churned Revenue – Expansion Revenue = Net Churn
Stay with us here. Churn is generally expressed as a positive number, so if expansion revenue exceeds it, then Net Churn is negative — that’s good. You don’t want churn, you want Net Negative Churn.
That way even if you never close another deal (who are we kidding, you’re a SaaS pro!), your business will continue to grow. Like magic.
Ready to master the three phases of SaaS Revenue? Get a demo of Sherlock.
Want SaaS Success? Make Organizational Shifts
You understand the realities of the three phases of SaaS revenue. Excellent! But that’s only half the battle. The other half is executing against it. You’ll need to shift the way you look at adoption, customer service, sales, and even marketing. Thanks to the SaaS model, the operations of software businesses are changing.
A Focus Shift for Your Sales Department
You’ve got a sales team. They might even be really good at what they do, but they’re going to require a makeover as SaaS companies tune-up their revenue model. In the old days, your sales team was singularly focused on identifying new prospects, pitching your solution to them, and closing the sale. While those goals still exist in a SaaS sales department, the department must shift its focus toward a more supportive role, especially in companies that offer a try-before-you-buy experience.
The Emergence of Customer Success
Once the early SaaS pioneers realized the importance of retention, they understood that the traditional post-sale approach wasn’t good enough. Building a strong retention revenue game is no longer about a reactive customer support approach, but more about building a proactive Customer Success operation.
A Customer Success operation that makes sure a SaaS product is properly adopted and integrated; one that drives education and oversees reactive support; A Customer Success operation to ultimately improve retention rates. Customer Success teams are no longer just passive caretakers of your client, but active drivers of revenue.
Enter the Chief Revenue Officer
Nowadays, SaaS pros (that’s you!) have come to understand the need for continuity across the three phases of the revenue model (that’s you, right?). If so, you need to replace the wall between your sales and customer success teams with a bridge. Siloing revenue responsibilities can lead to misaligned compensation systems, infighting, and an unhealthy revenue base.
What good is selling a new deal if you know it’s not a good long-term fit for the business? How do you coordinate your on-boarding efforts? How do you plan your expansion efforts?
These are the questions you need to ask if you want to win the game of SaaS. (You do, right?) Sophisticated SaaS leaders have realized this and are starting to organize Sales and CS under a single management point, a new role — the Chief Revenue Officer (CRO).
The CRO connects the full revenue lifecycle. She’s fully responsible for designing strategies and driving revenue growth across the three phases of SaaS revenue. Having one person responsible for that means no more throwing customers over the fence and forgetting about it, no more signing bad deals, no more churn (well, lower churn).
Product Engagement: The Key to Mastering the Three Phases of SaaS Revenue
The SaaS revenue model is absolutely dependent on product engagement. Product engagement tells us so much about our customers: who uses our solution? How do they use it? Where are they integrating? Where are they not integrating? You need to know the value you’re giving individual customers. You need to know how engaged they are — in every phase.
With this data on hand, SaaS companies can better prioritize where their marketing, sales and customer success teams spend their time and effort, maximizing their ability to create longstanding relationships with uniquely qualified customers and prospects.
Let’s examine the role product engagement plays in each revenue phase:
Product Engagement in the Initial Sales Phase
It’s a try-before-you-buy world. You offer a free-trial or a freemium option of your product, thinking it’ll give a customer the ability to use your product without ever talking to a salesperson. You’re right, but this also means that SaaS salespeople are almost always selling to accounts and users who have actually used the product.
Don’t waste that trial time by letting potential customers play around on their own. By measuring product engagement in this phase, tracking whether or not they are “activated”, and learning about which users on an account are getting the most value, you can ensure you’ll close the deal and go after the right leads.
For example, if you have 100 prospects in your system, a small sales team might be able to reliably focus on building relationships with 20 of them. Using engagement data to determine which of those 20 prospects that they should focus on not only helps to improve their success rates, but it sets the stage for improving retention and expansion revenue down the line.
Product engagement is an essential component in the initial sales phase. In fact, the Product Qualified Lead (PQL) has become a key part of the sales process for many SaaS businesses. Measuring and qualifying potential sales based on how they are engaging with the product during a trial is more effective than any other form of qualification and helps to drive more efficiency in a sales process.
Product Engagement in the Retention Phase
This is where product engagement shines naturally. Every SaaS business has a small percentage of accounts that continue to pay even though they aren’t using the product. Sounds great? Not so much. It’s impossible to build a strong SaaS business on these customers. If they’re not engaged, they’re going to churn.
As a future SaaS superstar, you need to keep a sharp eye on overall engagement levels for your paid accounts while your customer success team needs to know:
- The on-boarding progress of newly converted accounts;
- The engagement and adoption rates of all key accounts;
- Exactly which features are being adopted by each account and user;
- Which paid accounts are showing drops in engagement;
- Which users are showing drops in engagement
All of this data needs to be at the fingertips of your CS team if you are going to execute well during this retention phase. There can be no fishing, no guessing — no question.
Product Engagement in the Expansion Phase
This one’s elementary — unengaged accounts don’t expand. It doesn’t matter how many employees an account has, how many departments, how many different offices — if they aren’t using the product, then they aren’t going to expand.
Product engagement is a leading indicator of expansion revenue opportunities. Just as product engagement serves as an essential qualifier for new trial signups (i.e. PQLs), it also determines whether or not an account is prime for expansion.
Measuring product engagement levels of existing account users is a great way to identify expansion opportunities. User not using the product effectively? Don’t waste your time trying to convince them to expand. User loving your star feature? Give them a call and upsell.
In short, strong execution in the expansion phase is dependent on smart visibility to the engagement of your existing paid accounts.
Build a Winning SaaS Revenue Operation
In order to build a great SaaS revenue operation, there are three truths teams must accept:
- SaaS revenue goes well beyond an initial sale. There are three essential phases of revenue and a SaaS business must execute well in all three phases in order to become great;
- Building a management structure that provides continuity and strategic consistency across these three phases of revenue will ensure the best shot at success;
- Product engagement is the key to winning the game of SaaS. Great SaaS operations understand this and find a way to bring this data to their team in the most actionable way possible. Great SaaS revenue models seamlessly integrate product engagement insights into every part of their customer facing operations.
Do you want to build a winning SaaS revenue operation and become a great SaaS organization? Try Sherlock today.