A glossary for Software Vendors - from SaaS to ARR
What is SaaS?
Software as a Services (SaaS) is a method to deploy and deliver your software. It is often combined with a subscription payment model. With SaaS, software vendors typically provide a complete product, run and managed by them, and charge a subcription fee to the customers to provide the software.With a SaaS offering, customers do not have to think about how the service is maintained or how the infrastructure is managed. SaaS with a subscription, can provide a low entry cost, flexible contract and fees combined with cloud driven product innovation and access from anywhere, making it an increasingly favourite way to purchase software solutions for many organizations.
What is a subscription?
A subscription, in the software context, is a way to pay for a product or service. Customers pay a fees on a regular basis (monthly, quarterly, annual and so on), to access a service. Whilst in the software world it is often combined with a SaaS delivery model, it can be associated also with on-premises or other software delivery models.
While a perpetual license, allows a customer to use a software indefinitely, with a subscription, they are entitled to use the software only during the subscription terms.
It is worth stressing how a SaaS model and a subscription model whilst often overlapping, can also be separate, the former focused on the technical aspect of delivering a software while the latter is more about a business model.
What is ARR? What about MRR?
ARR stands for Annual Recurring Revenue. This is an essential metric for a SaaS and subscription business. Subscriptions could have different terms and frequency. Some of your customers might have a 2 years subscription contract but billed monthly; others might be on a 1 year term and pay quarterly. ARR is a way to normalize and measure the health of a subscription business and 'normalize' how much revenue you can expect in the year from all your different customers.
It can help predict how much revenue you can expect in the upcoming year, it can be used to show the business progress, measure a company's growth
MRR is Monthly Recurring Revenue. It is very similar to ARR and the only difference is the period of time. ARR shows a longer term view, while MRR focuses on the short term.
What is LTV?
LTV, in the software context, refers to Lifetime Value (short for CLV or Customer Lifetime Value). LTV measure the profit your company makes from any given customer. It helps assesing the financial value of either an individual customer or it could be for the overall business.
It is often used in combination with the Customer Acquisition Cost (CAC). This compares the value of the customers with the cost of acquiring them. It helps making decisions about sales and marketing.
What is the churn rate?
Churn rate or attrition rate, is the measure of how many customers don't renew their subscription over a period of time. It is a term that can be used in many contexts, but it is a crucial indicator in a subscription business.
In the ideal world, none of your customers would leave your services and your churn rate would be a low as 0. In reality any SaaS subscription business will have a number of customers every year that will not renew the subscription and retain the services.
If the churn rate increases is a strong signal that the profitability of a software business might be at risk. It is vital to try and estimate the future chirn rate.
Most SaaS subscription business focus heavily on improving customer satisfaction to ensure their churn rate is a low as possible.
The churn rate might be voluntary or involuntary. In some cases the churn is completly out of the business' control (a customer closing down), whereas in other cases it could be a conscious decision to terminate the subscription to move to a different provider or not use the service at all. The latter, ie. voluntary churn, is the primary measure of churn for many companies as it is directly related to their business and can be more easily influenced.
What does deferred revenue mean?
This is a particularly important concept for SaaS Subscription companies. It changes the balance sheet and when transitioning from a perpetual license business has significant implications.
In the software space, deferred revenue refer to when a company receives payments for software services, that have not been delivered yet. If a customer pays for a 1 year subscription to a SaaS solution, they might pay the total subscription upfront. However the service is delivered over the course of the year. When the 1 year payment is received the company does not record the full revenue, but typically it will record the revenue on a monthly basis over the course of the 12 months.
Let's look at an example and compare it against a perpetual model.
Perpetual Model Subscription Model Payment $10,000 for a perpetual license $10,000 per year Revenue recognized in the month of sale $10,000 $10,000/12 = $833 Revenue recognized in the first 6 months $10,000 $833x6 = $5,000
As the financial year of a company passes, the impact is higher. If a company's financial year runs from January to December, if a software sales takes place for $10,000 in December, the business can count on the full $10,000 revenue. In a subscriptin business however, the company can only recognize as revenue only $10,000/12 = $833
The advantage of a subscription model, however is that, once the initial 2-3 years transition is passed, the company will have a more predictable revenue stream. As the business transforms from a perpetual license model to a subscription model, the focus on innovation, customer service and a better understanding of their client, typically allow companies to generate more value from their customers.
The initially lower investment, brings faster growth, by making it easier to reach new markets and expands in new areas.
What is the difference between IaaS, PaaS and SaaS?
Iaas means Infrastructure as a Service, PaaS is Platform as a Service and SaaS is Software as a Service.
They are all different models for cloud computing and they each represent different parts of the computing stack.
IaaS referes to the building blocks of Cloud IT and provides access to networking, computing and data storage. It is a flexible way to provide IT resources and it is similar to that which many IT departments are familiar with.
PaaS adds a level of service and management to the infrastructuire. It removes the need for organizations to manage the underlying hardware and operating systems. It allows a company to focus on the deployment and management of an application. This helps with being more efficient, as you would not need to worry about resources procurement, capacity planning, software maintenance, patching or any other tasks involved in running the application.
SaaS delivers a completed product that is run and managed by the service provider. SaaS normally refers to an end-user application. With SaaS, there is no need to think about how the service is maintained, how the underlying infrastructure is managed. A buyer of SaaS only needs to worry about how to use the particular piece of software.
What is an availability zone?
AWS Cloud computing resources are housed in highly available data center facilities. To provide additional scalability and reliability, these data center facilities are located in different physical locations. These locations are categorized by regions and Availability Zones (AZs).
AWS Regions are large and widely dispersed into separate geographic locations. Availability Zones are distinct locations within an AWS Region that are engineered to be isolated from failures in other Availability Zones. They provide inexpensive, low-latency network connectivity to other Availability Zones in the same AWS Region.
AZs give customers the ability to operate production applications and databases that are more highly available, fault tolerant, and scalable than would be possible from a single data center. All AZs in an AWS Region are interconnected with high-bandwidth, low-latency networking, over fully redundant, dedicated metro fiber providing high-throughput, low-latency networking between AZs. All traffic between AZs is encrypted. The network performance is sufficient to accomplish synchronous replication between AZs. AZs make partitioning applications for high availability easy. If an application is partitioned across AZs, companies are better isolated and protected from issues such as power outages, lightning strikes, tornadoes, earthquakes, and more. AZs are physically separated by a meaningful distance, many kilometers, from any other AZ, although all are within 100 km (60 miles) of each other.
Are Cloud and SaaS the same thing?
Cloud and SaaS tend to go hand in hand in the software world. Normally for a software vendor to deliver their solution as a service, they would typically need to rely on the cloud to deliver their solutionl.
Cloud computing referes to the on-demand availability of computer resources like servers, processing power, storage and databases, which are located remotely and can be accessed through a network connection.
SaaS is a software deliver model which relies on cloud computing to provide access and deliver software capablities to a licenses customer. The application is accessed via the Internet and the user does not need to install and maintain the sofware locally.
So cloud and SaaS are closely related, but they are somewhat different concepts.
What is an ISV?
ISV stands for Independent Software Vendor. ISVs are also known as a software publishers or software businesse. They are organizations specializing in making and selling software, as opposed to computer hardware, designed for mass or niche markets. This is in contrast to in-house software, which is developed by the organization that will use it, or custom software, which is designed or adapted for a single, specific third party. Software vendors can provide their solutions in different ways. It can be sold as SaaS on a subscription or as a perpetual license, or it can be deployed on-premise, in a data center or in the cloud.