Ensuring that your software product meets market needs is only one of the components of success. A no less important factor is how you as a business are going to get profit from your product. And this is where software business models come into play. They define the way and conditions according to which you’ll deliver products or services to clients and help you forecast how much money you’ll be able to make.
This article explains the most popular business models for a software development company, with their advantages and disadvantages. Read on to learn how they work and deliver value to customers, and through which business model your company can receive more income.
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A business model is the conceptual basis of any business. What is the definition of a business model? The term itself implies the description of business activities related to selling goods or providing services, and the forecast (model creation) of future profit.
In simple words, we can say that a business model describes the mechanism of how a company makes money via selling its software products. It explains what costs and expenses you have, how much money you can charge for a product or service, and how you can deliver value to clients at the right price.
Business model characteristics include:
- Everything it takes to create a product: design, resources, production, labor, etc.
- Everything you need to sell a product: marketing, service delivery, promotion, sales.
- How customers pay: pricing strategy, payment methods, payment terms, etc.
Various business models can improve any of these three components. You may be able to minimize costs at the design and production stage. Or you have resources for more effective marketing and sales methods. Or maybe you are ready to offer an innovative payment method for customers.
There is also a concept of business model archetypes derived from Carl Jung’s theory of personality types and distinguishing seven archetypes: product, service, trade, brokerage, subscription, marketplace, ecosystem. Their deep understanding helps companies build sustainable and viable business models.
The essence of an efficient business model is to get more money from customers than is required to develop a product.
Types of Software Business Models
Types of software development business models depend on what audience the product is intended for, how the company distributes and licenses it, and what sources of income it uses. For each model, you need to develop your own marketing strategy and adjust the work of all company departments.
The table below depicts the basic types of software business models divided by categories.
|Types of software business models
|How you deliver your products or services to customers
|On what conditions users can access the source code
|How you create your revenue streams
|Who your clients are
Now, let’s discuss each category in detail, beginning with distribution strategies.
On-Premises Software Business Model
The on-premises software distribution business model assumes that software is installed on customer hardware. This means you buy some software product and get a distribution kit to install it on your proprietary server, where all the data will be stored.
With this model, suppliers are not responsible for data security, except for cases when there are security breaches in their software. They provide support services only on-demand, and warn that resolving some issues may be problematic since specialists can’t directly access installed software.
- The highest level of corporate data security.
- The autonomy of such a solution, especially when it comes to deployment in your own data center.
- Access to the databases can be obtained at any time of the day, even if for some reason it is not possible to use the internet connection.
The main shortcoming of this model is the need to maintain the physical infrastructure on your own. Users need to deal with installation, integration, updates and overall maintenance, which requires a staff of qualified employees and significantly increases expenses.
Who Should Use the On-Premises Business Model?
- Companies that require the continuous and reliable performance of software apps, for example those working with heavy graphics.
- Companies handling sensitive data, for example those in the healthcare industry.
- Businesses that should operate in conditions of unstable network connection, for example oil and gas exploration companies working in remote areas with poor coverage.
- Businesses that have powerful proprietary hardware infrastructure.
Cloud-Based Software Business Models
Cloud-based programs are already deployed on a remote server. After the purchase, clients receive not a distribution kit, but access to an already installed solution, and have only to configure it according to their individual needs.
Cloud software has become a real breakthrough for both users and developers. The former don’t have to bother about installation — everything happens in the browser. For the latter, cloud-based software distribution models have dramatically improved the collection of payments, since clients use various types of subscriptions.
In the case of cloud technologies, the service provider takes responsibility for all infrastructure tasks. You don’t have to think about what kind of hardware programs should run on — they just work, and you use them. Backups, updates, infrastructure expansion — everything happens without your participation, which is very comfortable.
Another significant feature of cloud software is flexibility. If needed, the customer can quickly increase the hardware capacity by paying for additional services. No additional manipulations with hardware are required.
But new challenges also came with the cloud business model. Among them are data leakage issues and dependence on an internet connection. Indeed, without the internet, no cloud service is available. The transmission of sensitive data over public communication channels may lead to their interception. And, storing information on third-party servers with multiple backups does not allow you to keep track of these copies.
However, you can minimize risks by selecting one of the four cloud deployment models, which better suites your business:
- Public cloud — is open to the public, offers shared storage and the lowest level of security.
- Private cloud — is open to only one organization, offers the highest level of security.
- Community cloud — is open to several organizations with similar backgrounds.
- Hybrid cloud — combines various types of clouds.
Now, let’s look at the three types of cloud-based software business models: SaaS (Software as a Service), PaaS (Platform as a Service), IaaS (Infrastructure as a Service).
Software as a Service (SaaS) Business Model
SaaS (Software as a Service) is a business model in which a software product is provided as a web service on a subscription basis. Customers get the opportunity to immediately use the product without wasting time on software installation. Programs are already configured for various business tasks. CRM, ERP, ITSM systems, task trackers and other software can be provided as SaaS solutions. Today, this is one of the most popular business models: online services are in demand by both large and small businesses.
Popular SaaS services include Gmail, Dropbox, Figma, Slack, SAP Concur, etc.
- Remote configuration and maintenance. SaaS solutions are centrally managed and hosted on a remote server. The supplier is responsible for setting up the required hardware and software.
- Remote use. Online services can be used remotely, without being tied to a specific workplace or platform. Access to services is possible from any location and using various devices (PC, tablets, smartphones).
- Recurrent payments. Clients use the software product on the basis of a regular fee (monthly, semi-annual or annual). This allows the owner of the online service to receive a stable income from users loyal to the product.
- Reasonable price. Customers pay only for using the service. They do not need to spend money on building and supporting proprietary infrastructure, and maintaining software.
- Connectivity. Constant internet connection is a must, otherwise SaaS solutions won’t work. This is a disadvantage for some categories of users who reside or work in areas with poor network coverage.
- No control. Users of SaaS solutions have no control over them and totally depend on providers in terms of management and fixing issues.
What Buyers Need to Know
If you want to buy a SaaS business, you should first estimate the feasibility of such a purchase. Analyze the following key indicators:
- The number of paying customers
- Churn rate
- Customer acquisition cost (CAC)
- Lifetime value (LTV), or the total profit from one client for the entire time of working with them.
- Churn rate
- Returning users
These indicators help you understand whether the business can potentially be profitable. It is important to control the churn rate of users and ensure that LTV exceeds the customer acquisition cost. An LTV equal to three or more CAC is considered a good indicator.
If you purchase an established company with permanent employees, find out if they are ready to continue working with the new owner. Also ensure that the seller hands over source code documentation, all necessary instructions and regulations.
What Sellers Need to Know
- When preparing to sell your SaaS business, try to reduce the churn rate. A low number of customer unsubscribes indicates the quality of the online service.
- Try to increase LTV: the online service income is formed on the basis of regular payments, so the higher the amount of profit that an individual client brings, the more expensive the business will cost.
- Optimize customer acquisition cost. The low cost of a lead will be an advantage when selling a business.
- A big advantage will be a team of professionals who will be able to continue working with the new owner.
- SaaS is a complex product, so get ready to provide the buyer with detailed documentation as well as training and support over some time.
- Do not try to hide the weaknesses of your business. It is better to discuss them with the buyer and suggest possible solutions. This way you’ll increase the mutual trust with the investor and will help them draw up a business plan for further development.
Who Best Fits a SaaS Business Model?
SaaS services are beneficial for companies that do not have the opportunity to buy on-premises solutions. Large companies can use this model for short-term projects that require quick, simple, and affordable solutions.
This model is also interesting to customers who need an application available via mobile devices.
Online services will be of interest to investors who want to implement developments in their own project. For example, owners of fitness rooms can buy a SaaS widget for making client appointments and implement it into their work.
Platform as a Service (PaaS) Business Model
Platform as a Service (PaaS) is a model for providing cloud services, in which the customer receives a ready-made custom software environment that includes development tools, a runtime environment, administration and management tools, and services. With PaaS services, developers can create everything from simple mobile apps to complex business software.
The PaaS business model is mostly demanded among software developers. With its help, they can quickly deploy the required software environment needed to create and test a product. Customers get the opportunity to focus on developing their own solutions, rather than spend time deploying, configuring and maintaining servers, installing operating systems and other software.
Infrastructure as a Service (IaaS) Business Model
Infrastructure as a Service (IaaS) is the delivery of computing resources through the cloud. As a ready-made solution, the client can choose data storage, virtual server, operating system and the amount of resources.
IaaS users independently manage applications, operating systems and specialized software, and the provider maintains the operation of servers, storage systems and other physical equipment.
IaaS services can be relevant for startups, small and large businesses. Cloud services are an alternative to buying hardware and creating local infrastructure. As business needs grow, companies have to introduce new services and applications, and this is where the flexibility of IaaS services comes in handy.
Among the well-known IaaS examples are Amazon Web Services (AWS) and Microsoft Azure.
Hybrid Software Business Model
This business model is based on the integrated approach, allowing customers to combine on-premises and cloud services within one business. For example, a company may choose to store sensitive data on a local server, but use a cloud software solution for managing tasks. When selecting this model, customers should find the balance in terms of data security, tech support and overall costs.
Open Source Software Business Models
No one has any doubts about the high efficiency of an open source development model. However, the monetization of open source software is still questionable.
Particularly, the issue is essential for developers, since every good idea requires specific financial funds for implementation. And the imperfection of the open source system leaves many questions on how to earn money.
In addition, companies using open source software must clearly understand how the solution provider receives money. Otherwise, they will have reasonable concerns about the possibility of long-term support for the tools they need.
There are three main commercial open source business models.
Support and services
Under this model, the product itself remains free, while money is earned through technical support, training, and customization. As a rule, software providers openly publish the source code and distribute solutions in binary files.
This model implies that the developer can release the solution under several licenses. For example, a software program may be available under a free General Public License (GPL) and a separate proprietary license. In this case, the second version should have some functional differences that take into account the interests of commercial customers.
Thus, the free option is used to involve the community in the development, to familiarize potential users with the product capabilities and get feedback. While the advanced release is supplied for money and offers additional functions, service support, and other improvements.
This model offers users a free software product, the functionality of which is extended by adding commercial proprietary plug-ins. In other words, there is a free core with limited features and a range of proprietary software products based on this core.
Fee-Base or Software Licensing Business Models
These models determine the paid terms under which you may use software. The following are types of licenses most widely used in the market.
- Perpetual license — the customer pays for a product version once and uses it with no limits. However, updated versions should be purchased separately.
- Subscription license — the customer pays for a limited time period, during which they will be able to access the software. It is based on recurrent payments.
- Feature license — different customers can buy the same software at different prices depending on the set of features they need to access.
- User-based license — software is purchased for a particular user who can access it from all devices by providing personal credentials.
There are many more options such as trial, concurrent, floating, metered licensing, etc.
Every company may have zero to numerous sources of revenue called revenue streams. A revenue model is the strategy of creating and managing such streams. There can be a bundle of revenue models.
- Ad-based model — advertising business is a powerful tool for attracting clients and increasing your income. It implies the creation of ads for your software products or services and placing them on channels with high user traffic.
- Sales — performed by using various methods and tool, including websites, direct negotiations, resellers, etc.
- Affiliate revenue model — implies the promotion of relevant products and getting commission for successful deals.
- Freemium model — when basic features of a software product are offered for free, and a premium is charged for advanced functionality that users will probably need.
Target audience models
And finally, you can’t build your software development business model without keeping in mind your target audience. Overall, there are two large target audience models: Business-to-Business (B2B) and Business-to-Consumer (B2C).
- B2B supposes cooperation between business entities and requires a team of specialists that can conduct negotiations.
- B2C supposes cooperation with a diverse audience of individual users. For this purpose, you need specialists that can gather and analyze large amounts of customer data.
We’ve discussed the basic business models used by software development companies. But the list is infinite and there can be other options. The right business model interaction within a company is the guarantee that your product or service will be recognized by customers and will bring you desired profit.