The SaaS business model

SaaS stands for software as a service. Instead of installing a program from a disc and owning it forever, the customer logs in to software that runs on the company's servers and pays a monthly or yearly fee. Email, accounting tools, customer-support desks and design tools often work this way.

The customer rents access. If they stop paying, they lose access. For the company, this turns one-time sales into a stream of payments that repeats, and a business with repeat payments is easier to plan and to value.

The basic income is the subscription. Customers pay per user, per feature bundle, or by how much they use the product. Common ways to price it are listed below.

Most SaaS firms add extras on top: set-up or training fees, paid support, add-on modules and integrations. As customers grow, they move to bigger plans, and that extra revenue from existing customers is often the cheapest growth a SaaS firm gets.

• Per seat: a fixed fee for each user, for example per employee using the tool.
• Tiered plans: bundles such as Starter, Growth and Enterprise with more features at each step.
• Usage-based: the customer pays for what they use, such as messages sent or records stored.
• Freemium: a free plan to attract users, with paid upgrades. Our freemium guide covers it.

Three reasons. First, revenue repeats, so next year's income is partly known today. Second, the cost of serving one more customer is low, because the same software serves everyone. That gives high gross margins, the share of revenue left after direct costs. Third, a customer who stays for years can be worth many times what it cost to win them.

This is why SaaS companies are often valued as a multiple of their yearly recurring revenue. The multiple depends on growth, margins and churn, and it moves up and down with market mood. Read our revenue multiples guide for the details.

A handful of metrics tell you how healthy a SaaS company is. Learning them helps you read any funding story about one.

Annual recurring revenue (ARR) and monthly recurring revenue (MRR) measure the subscription income expected over a year or a month. Churn is the share of customers or revenue lost in a period. Net revenue retention shows whether existing customers pay more or less over time, after upgrades and cancellations. Customer acquisition cost (CAC) is what it costs to win a customer, and lifetime value (LTV) is what that customer pays over their stay. Investors often look at how many months of revenue it takes to repay the CAC.

• ARR and MRR: size of recurring revenue.
• Churn: customers or revenue lost.
• Net revenue retention: growth from the customers you already have.
• CAC and LTV: cost of winning a customer against what they are worth.
• Gross margin: revenue left after hosting and support costs.

A large share of Indian SaaS companies sell mainly to customers abroad, especially in the United States, using engineers based in India. Well-known examples include Zoho, which is privately held, and Freshworks, which listed on the Nasdaq in the United States in 2021. Selling in dollars while paying costs in rupees helps margins, and a strong engineering pool helps product quality.

Others sell to Indian businesses, such as small shops, schools or manufacturers. This market is large but price-sensitive, and customers often pay late or ask for discounts. Many founders start with the home market to learn, then go global, or the other way around. Both paths exist, and neither is clearly better.

Sales methods depend on price. Cheap tools sell by self-service: a user signs up on the website, tries it and pays by card. This is called product-led growth, and it needs little sales staff. Costly tools sell to big companies through a sales team that runs demos, negotiates contracts and handles security checks. Contracts there are larger and last longer, but each sale takes months.

Many companies run both: free sign-ups feed a sales team that chases the larger users. Marketing through content, search engines and partner directories supports either approach.

SaaS is not an easy business. Customers cancel when a cheaper tool appears or when their own business shrinks. Spending on sales can outrun income for years. Big companies can copy a feature and bundle it for free. And a product can be good but aimed at too small a market to support a large company.

Another risk is that growth is bought, not earned. If a company needs heavy discounts or large ad spending to keep adding customers, the numbers look good until the money runs out. Investors therefore check the quality of revenue, such as how many customers stay and how fast they pay, not only the size of it.

Indian SaaS firms that sell abroad generally treat exports of services as zero-rated for GST when conditions are met, and they must follow foreign exchange rules for receipts. Companies that hold customer personal data also face the Digital Personal Data Protection Act. Our guides on GST for startups and the DPDP Act cover those. Rules change, and this is general information, not tax or legal advice, so check with a professional.