SaaS, where companies license their software on an on demand basis may be the ideal way to generate revenue? This is because the model strikes a perfect equilibrium between the two main ways people have sold things in the past.
Let’s look at the two main models. The first selling model is an on demand model where people buy what they need when they need it. Let’s take an easy example, like Coca-Cola. When you want a Coke, you walk into a store and buy one. The Coke is inexpensive and easy to buy, and this is a reason why the model has worked. But there is a big issue. Every time a buyer walks in to buy a Coke, they have hundreds of other options to choose from (called consideration in marketing speak). Not just Pepsi, but Gatorade, water, iced tea, milk, etc. So to ensure that when a consumer is confronted with this choice, Coke spends a lot on advertising and marketing. So do all the others, and let has led to Coke and Pepsi becoming some of the largest advertisers. It’s expensive to have to re-sell your product over and over.
No let’s look at the other traditional way to sell something. This is the enterprise (I call it the buy it all now) method. Take Oracle as an example. If you would like to run Oracle Enterprise Software, you must buy an enterprise license, which can cost hundreds of thousands of dollars. Then you must buy a certain number of seats, the hardware and the skill to install it. It can cost millions. Say you are a small-to-midsize business that is growing. How many seats will you need? How many servers, etc? It’s a big bet and a big upfront investment. Because the potential purchasers are limited, Oracle only needs to market to raise awareness, but can use targeted sales tactics for consideration. They lose many customers who just don’t have the ability to reach the bar Oracle sets for entry.
Enter SaaS. SaaS removes the costs of both worlds. By signing users up for a subscription, buyers are not confronted with a consideration decision every time they use the software or add a user. SaaS vendors avoid the large marketing spend needed to maintain top-of-mind during the consideration process. Also, because SaaS usually has a low cost of entry, the model helps to capture those who can’t or are unwilling to afford the entry price of the buy it all now model.
SaaS vendors can charge a premium for this lower risk and convenience and this can lead to higher profit. But because SaaS usually incorporates the hosting and support as well, the total cost of ownership to a buyer is often lower than the enterprise model.
We should all be amazed that enterprise vendors have not shifted more quickly to the SaaS model, but my lack of amazement would be another discussion entirely.