SaaS (Software as a Service): Meaning and How It Works
SaaS (software as a service) is software that customers use over the internet, usually through a browser, and pay for with a recurring subscription instead of buying and installing it. The provider hosts, maintains and updates the software for everyone.
By Javier Alonso, Founder & CEO. Updated .
How SaaS works
The provider runs one version of the software on its own servers or cloud infrastructure. Customers sign in and use it, and every customer gets updates at the same time. Examples include email, project management, accounting and customer support tools.
This differs from traditional licensed software, where customers paid once and installed it themselves, and from infrastructure services, where customers rent computing resources to run their own software.
How SaaS companies make money
- Per seat: a price per user per month.
- Tiered: plans with increasing features or limits.
- Usage-based: pay for what you use, such as messages sent, credits consumed or data stored.
- Freemium: a free plan with paid upgrades.
- Hybrid: a base subscription plus usage charges.
Most SaaS companies offer monthly and annual billing, often with a discount for paying annually.
The metrics SaaS companies track
- MRR and ARR: recurring revenue.
- Churn: the share of customers or revenue lost each month.
- Net revenue retention: revenue from existing customers after upgrades, downgrades and churn.
- CAC and LTV: the economics of winning customers.
- Activation: the share of new sign-ups who reach the first meaningful outcome.
Why founders choose it, and the trade-offs
Advantages: predictable recurring revenue, high gross margins once built, and the ability to improve the product continuously for every customer.
Trade-offs: revenue builds slowly, one subscription at a time. Customers can cancel easily, so retention matters as much as acquisition. Hosting, security and support are ongoing costs.
A micro SaaS is a small SaaS business, often run by one or two people, that serves a narrow niche.
Example
A founder builds scheduling software for dance studios. Studios pay $49 a month for up to three instructors and $99 for unlimited instructors. With 200 studios, half on each plan, MRR is $14,800. The founder's focus is activation (studios importing their timetable in the first week) and churn, because a studio that stays three years is worth far more than one that leaves after three months.
For your role
- Builders
- Many solo builders start with a micro SaaS: one narrow problem, one customer type, a simple subscription.
- Investors
- For SaaS, net revenue retention and churn by cohort often tell you more than headline growth.
Primary sources
- What is SaaS? — Amazon Web Services
- SaaS Metrics 2.0 — David Skok, For Entrepreneurs
Common questions
- What does SaaS stand for?
- SaaS stands for software as a service: software accessed online and paid for with a subscription.
- What is an example of SaaS?
- Web-based email, project management, accounting and customer support tools are common examples. You sign in through a browser and pay monthly or annually.
- Is SaaS B2B or B2C?
- It can be either. Most SaaS revenue comes from businesses, but many consumer apps also use subscription software models.