The following is a contribution from Rod Solar, Founder & Fractional CMO of LiveseySolar
If you’ve run an agency, you’ll know you’re trading time for money. ⏳⇣💲⇣
Even if you are charging $200/hour, you stop making money when you or your team stops working. Your earnings are limited to the finite amount of time that you have. That’s the first problem with the agency model. The business owns you because you essentially act like an employee, not the other way around.
The SaaS model lets your customers pay for products untethered to your time. Your revenue ceiling is irrespective of the time you spend working. ⏳⇡💲⇡
Winning new business in an agency model is hard because you need to sell at a higher price point, and you probably need to be a better salesperson. I don’t know you at all, and maybe you’re amazing, but in all likelihood, you aren’t.
With a SaaS model, you’re selling a system that ranges between $300 to 1000/month, which is considerably easier to sell than agency services which (should) cost a LOT more than that. That means Customer Acquisition Cost for a SaaS is usually lower than for an agency.
Client Retention Cost
Fulfilling work for agency customers is a one-off, which will always cost you more to produce than SaaS. You will likely still need to onboard and support your SaaS customers, but that is much less time intensive than creating new deliverables from scratch for every agency client.
With SaaS, you build it once and sell it again and again. Your labor applies one-to-many instead of one-to-one. Customer Retention Cost is lower in a SaaS than in an agency model.
Scaling Your Agency
To expand an agency, you’ll need to hire people. Recruitment and hiring are major challenges. Then you’ll need to deal with all the work that arises from trying to retain staff (and it’s backbreaking work keeping creative people happy and engaged). When they leave (and they will), you’ll have to teach new hires everything repeatedly. If a key person leaves your agency – you’re in deep trouble as you now need to spend time replacing and training them up to the same production standard.
In SaaS, you can run a business that turns over $1MM in recurring revenue with a way smaller labor-to-sales ratio.
Your agency’s gross profit will be around 45% after you deduct your recharged costs, chargeable wages, freelancer costs, and your market rate. A SaaS company’s gross profit rates tend to be considerably higher (i.e. 65% to 75% is normal).
Your agency’s customer churn rate is super high. That’s the number of customers that leave compared to the customers you bring on. You might always bring on new customers, but if you’re losing them just as fast, you are spinning your wheels. It’s especially damaging when you lose big customers that might account for 10-20% of your revenue.
A SaaS company’s churn rate (3-5%) is much lower than an agency’s typical churn rate (upwards of 50%). And when you lose a SaaS customer, they’ll only account for a small fraction of your recurring revenue, so it’ll be much easier to absorb and recover the loss.
Lifetime Client Value
The Lifetime Customer Value of agency clients is low. Let’s say you sell a customer a $5000 website. Maybe you can get SEO and paid traffic for a couple thousand a month, but maybe not. When the customer leaves you (and they will), they take all that revenue with them and give it to another agency (including all the third-party software tools you advised them to buy).
With a SaaS model, you can sell them a product for $300 to $ 1000 a month, and they might remain customers for years. You can even rebill usage fees like calls and SMS and keep the whole markup. If you want, you can still upsell agency services to those customers. When they stop needing your agency services, they’ll likely still keep their SaaS.
Selling Your Agency
Finally, if you ever want to sell your business, selling an agency is very difficult because most talent and relationships belong to you. The more valuable you are to the business, the less valuable the business is. That’s why multiples for agencies tend to be 1-3X of EBITDA (Earnings Before Interest Tax and Depreciation) at best.
On the other hand, a professionally managed SaaS with healthy recurring revenue from many more customers in a large and growing total addressable market might be worth as high as 10-15X of EBITDA.
Which model is best for you? That is your decision, but hopefully, this post gave you the insight you needed heading into 2023!
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