💻Software as a Service (SaaS)

Software as a Service (SaaS) is a business model in which companies provide applications through the cloud via subscription. Instead of selling traditional licenses, the SaaS provider hosts the application on the internet, and the customer pays periodically (monthly or annually) for access. This model generates predictable recurring revenue and requires continuous investment in infrastructure, development, and support. For investors and analysts, SaaS is characterized by its own financial and operational metrics, as performance is measured based on subscription growth, customer retention, and long-term profitability.

Furthermore, the SaaS market is constantly evolving: demand grows alongside sectoral digitalization, technologies like Artificial Intelligence (AI) are being integrated into products, and new risks are emerging (e.g., over-reliance on AI-generated code).

1. Key Metrics and KPIs in SaaS 📈

In a SaaS company, business health is monitored using specific metrics. Below are the most important ones:

1.1 Recurring Revenue (ARR and MRR)

• ARR (Annual Recurring Revenue): The projection of annual revenue based on active subscriptions. It is calculated by multiplying the number of customers by the average annual revenue per customer. For example, 100 customers paying €1,000 per year generate €100,000 in ARR.

• MRR (Monthly Recurring Revenue): Measures monthly recurring revenue (calculated by dividing the ARR by 12).

These metrics help predict future income and evaluate the pace of growth. A steady increase in ARR/MRR indicates success in customer acquisition and expansion; a drop signals issues with sales or retention.

1.2 Churn Rate

Churn measures the percentage of customers or revenue lost over a specific period.

• Customer Churn: The percentage of users who cancel their subscription.

• Revenue Churn: The percentage of recurring revenue lost due to cancellations or plan downgrades.

For example, if you have 1,000 customers and 50 leave in one month, the customer churn is 5%. High churn indicates issues with satisfaction or perceived value and can derail growth. Reducing churn is essential: it means building customer loyalty (improving product, support, or pricing) and maintaining stable revenue.

1.3 Net Revenue Retention (NRR)

NRR evaluates how revenue from the existing customer base grows, accounting for upgrades, downgrades, and cancellations. It is calculated by comparing the recurring revenue of a group of customers at the end of a period versus the beginning.

For example, if customers generate €100,000 at the start of the quarter and—after renewals, upselling, or churn—they generate €120,000 at the end, the NRR would be 120%. An NRR > 100% indicates expansion (more revenue per customer) and low churn, which is ideal for scalability. A lower NRR (e.g., 80%) reveals a net loss of revenue, which alarms investors. NRR is an advanced metric that summarizes organic growth and customer satisfaction.

1.4 Customer Profitability

This is where you determine if the model is sustainable or if you are "burning" money inefficiently.

• CAC (Customer Acquisition Cost): How much it costs, in marketing and sales, to acquire a new customer.

• LTV (Lifetime Value): The total net profit you expect to earn from a customer throughout their relationship with the company.

• LTV/CAC Ratio: A "golden rule" is that the LTV should be at least 3 times the CAC for the model to be considered healthy.

1.5 CAC Payback Period

Measures how many months it takes for the company to recover the money invested in acquiring a customer (the CAC). If the period is under 12 months, it is considered excellent. If it takes longer than 24 months, the model may face cash flow issues.

1.6 Magic Number

Measures sales and marketing efficiency. It is calculated by comparing the growth in recurring revenue to what was spent on sales and marketing in the previous quarter. A number greater than 1 suggests that sales investment is highly efficient and the company should "step on the gas" regarding spending.

1.7 Remaining Performance Obligations (RPO)

RPO is an important accounting indicator in SaaS. It represents the value of signed contracts for which services have not yet been delivered or recognized as revenue. In other words, it reflects the backlog of contracted future revenue. It includes:

• Deferred Revenue: Payments received for future services.

• Unbilled Receivables: Contractual amounts pending fulfillment that haven't been invoiced yet.

For example, an annual subscription paid upfront can generate 11 months of deferred revenue at the start of the contract. A high RPO indicates a strong pipeline. It is usually divided into Current RPO (next 12 months) and Non-current RPO (beyond 12 months), which helps assess financial predictability.

1.8 The Rule of 40

For a mature SaaS company, the sum of the annual growth rate (%) and the profit margin (%) should be at least 40%. This balances growth and profitability: for example, growing at 30% with a 10% operating margin satisfies the rule. Exceeding 40% indicates a very healthy business; falling below it suggests the company should prioritize growth or optimize costs.

2. Stock-Based Compensation (SBC) 💸

Many SaaS companies, particularly in the tech sector, utilize Stock-Based Compensation to attract and retain talent. Instead of offering only cash salaries, they provide employees with stock options or Restricted Stock Units (RSUs). Conceptually, this turns employees into co-owners by granting them shares. From an accounting perspective, this benefit is recorded as a (non-cash) expense on the income statement.

How it works: A company allocates shares to employees under certain conditions (e.g., hitting performance milestones or remaining at the company for several years). At the time of the grant, the future value is estimated (using models like Black-Scholes) and recognized as an expense over the period the employee "earns" the shares (vesting). When the employee exercises an option (buys the share) or receives an RSU, new shares are issued (or purchased on the open market).

For shareholders and investors, this is doubly important:

While growth-stage companies often allow some level of dilution, mature companies are expected to control issuance or engage in share buybacks. Excessive new issuance can be viewed negatively, as it indicates the company is "overpaying" for its payroll with equity rather than generating sufficient cash value.

3. Vertical vs. Horizontal Software ⚙️

In the technology sector, software is classified by its market scope: horizontal or vertical.

3.1 Horizontal Software

This addresses needs common to multiple industries. These are generic solutions applicable to almost any business.

3.2 Vertical Software

This focuses on a specific industrial sector or niche, featuring highly specialized functions designed for the particular processes of that industry.

These differences matter for SaaS market strategy: horizontal products offer a higher potential volume of customers but face broader competition. Vertical products often have barriers to entry (niche expertise, certifications) and potentially higher margins, though their target audience is more limited.

4. Artificial Intelligence in SaaS 🤖: Opportunities and Risks

4.1 Opportunities

AI is transforming SaaS on multiple levels. On the positive side, SaaS companies integrate AI to add value: predictive data analysis (Big Data in the cloud), virtual assistants (customer support chatbots), automation of repetitive tasks, and personalization (product recommendations). This can improve user experience, increase operational efficiency, and open new niches, such as Conversational AI SaaS that processes text and voice.

Furthermore, AI accelerates the innovation cycle: using tools like AutoML or cloud AI platforms, SaaS companies can develop advanced features without starting from scratch.

4.2 Risks