What is SaaS?

Against a backdrop of light blue, three fluffy white clouds release a robust rain of blue pixels.

Software as a service (SaaS) refers to cloud-based software programs delivered to users over the internet. You probably use SaaS products even if you don’t realize it; in fact, much of our online lives are supported by SaaS. Google Workspace tools—including Gmail, Google Docs, and more—are SaaS products, as are Microsoft Outlook, Slack, Zoom, and thousands more.

Get to know and directly engage with senior McKinsey experts on SaaS

Anna Herlt is a senior partner in McKinsey’s Munich office, Ari Libarikian and Jeremy Schneider are senior partners in the New York office, and Chandra Gnanasambandam and Paul Roche are senior partners in the Bay Area office.

Salesforce, widely seen as the first SaaS company, was founded in 1999, but SaaS and cloud computing have only truly come into their own more recently. The COVID-19 pandemic rapidly accelerated organizations’ cloud migrations—the biotech company Moderna used cloud computing to deliver the first clinical batch of a COVID-19 vaccine candidate in just 42 days.

For more about the evolution of SaaS and what we can expect next for the industry, read on.

Learn more about McKinsey’s Technology, Media & Telecommunications Practice.

What’s the current state of the SaaS industry?

In 2022, the global SaaS market was worth about $3 trillion at the end of about a decade of rapid growth. Between 2011 and 2018, the global software industry’s market capitalization increased at double the rate of the overall market. At the time, we estimated that it could surge to up to $10 trillion by 2030. But the SaaS industry’s growth has slowed in recent years. Enterprises have decreased their IT spending as rising interest rates have led to cash flow issues.

As the industry transitions to a more balanced growth phase, boards and management teams should first seek to answer the question, “What is the best use of capital?” According to Aaron Levie, CEO of the SaaS company Box, figuring out “where you can drive profitability and operating margin and leverage without sacrificing at least healthy growth” is key to surviving past the scaling stage. Eventually, Box landed on a framework based on the “Rule of 40” (a popular metric that says a SaaS company’s growth rate, when added to its free cash flow rate, should equal 40 percent or higher).

SaaS transformed the global enterprise software market, but the recent unprecedented growth of gen AI has disrupted the software industry even faster and more thoroughly than SaaS. ChatGPT burst onto the scene at the end of November 2022; in 2023, large global enterprises spent around $15 billion on gen AI solutions, representing about 2 percent of the global enterprise software market. It took four years for enterprise spending on SaaS to reach that same market share milestone.

What impact will gen AI have on the software space and, by extension, the SaaS market? McKinsey research indicates that gen AI will trigger software customers to switch their vendors more frequently as they race to keep up with the latest innovations. SaaS organizations will do well to prepare for this shift by working to both keep up with software application development and protect existing client relationships.

What else can be sold as a service?

The XaaS—anything as a service—phenomenon is well underway. In the transport sector, trucking as a service is replacing the traditional truck ownership model as large-fleet customers pursue emissions reduction goals. Fintechs increasingly offer trading as a service to banks and other financial institutions that want to avoid building and maintaining their own trading capabilities.

Learn more about McKinsey’s Technology, Media & Telecommunications Practice.

How can software leaders stay ahead of the gen AI wave?

Gen AI has already transformed the software industry—and there’s no telling how deep the rabbit hole goes. To prepare for the gen AI future, software leaders can start by asking some fundamental questions, including:

Are we moving fast enough? First movers in the gen AI space appear to have had an advantage. Widely adopting and scaling the use of gen AI in software development could, therefore, be a no-regrets move.
Are we sufficiently reimagining our software category? Gen AI allows software leaders to reexamine and address customer needs in a totally new way, as well as to explore adjacencies they hadn’t thought of before.
Have we reallocated enough resources? If gen-AI-driven features and use cases seem on a path to contribute at least 10 to 20 percent of revenue within five years, an enterprise should think about devoting a similar share of R&D spending toward the technology.
Are we taking the proper steps forward? Ambitious enterprise leaders will want to consider how they price and package their products, as well as how they gather and use their proprietary data. Revamping product strategy and the road map for the gen AI era will also be essential.

Learn more about McKinsey’s Technology, Media & Telecommunications Practice.

Circular, white maze filled with white semicircles.

Looking for direct answers to other complex questions?

Explore the full McKinsey Explainers series

What is the product-led growth model?

In the product-led growth (PLG) model, organizations keep the product at the center of customer acquisition, retention, and expansion. This way, the theory goes, companies can scale their businesses with lower sales costs, greater product virality, and higher net retention. Pioneered by SaaS innovators Atlassian and Slack, the model is frequently seen as the best path to efficient growth and above-average returns.

But according to our research, PLG is rarely successful in isolation. Companies that successfully deploy elements of PLG often combine it with the more traditional enterprise model of sales-led growth (SLG), in which a salesperson sells the software to executives. This hybrid model is called product-led sales (PLS).

For traditionally sales-led enterprises, PLS offers two upsides. First, PLS can help sales-led enterprises expand their presence with small and medium-size enterprise customers because it helps minimize expensive human sales interactions. PLS also helps incumbent SaaS players respond to the evolving expectations of enterprise customers, including their need to experience a product’s value before committing to a large contract.

How can new SaaS business building help organizations drive growth?

Growth is a constant goal—and challenge—for most companies. We’ve found that many companies expect to get as much as 50 percent of their revenue from new businesses and products by 2026. SaaS can help by allowing companies access to all the software services they need without having to create the software themselves. But most organizations are not on a path that will get them there.

Building revenue with SaaS is about more than selling tech on a recurring revenue model and raking in profits. Particularly for nontech organizations, building a software business is hard work. Despite the broad push in recent years for companies of all kinds to start developing their own software, only six percent of global software revenues are earned by nontech companies.

Here are six key areas nontech incumbents can focus on when thinking about building a new SaaS business:

Innovate through rapid test-and-learn cycles. Incumbents frequently focus on “how to improve X” rather than “how to create Y.” Innovators are better able to creatively translate deep knowledge of the customer into minimal viable products that they can then iterate.
Capitalize on existing digital and data assets. Data is wealth for tech and nontech companies alike. Scrutinizing data can yield customer needs that are currently unmet by readily available products. For example, Anheuser-Busch InBev created a B2B SaaS e-commerce platform from data analysis that retailers can use to manage orders.
Plan for scale from day one. SaaS businesses can scale quickly, but only if two elements are in place: a detailed road map and flexible technology architecture.
Recruit talent from expanded talent pools. SaaS talent is hard to come by. Nontech incumbents could recruit from GitHub or open-source communities or arrange hackathons to attract a different kind of tech talent.
Tether pricing and selling to product usage. Organizations can gather data on which features customers value the most and adjust pricing accordingly.
Protect the funding. It can be hard to continue funding a new business that has yet to deliver results, but patience can pay off. Making decisions based on the number of interested partners or volume of interested leads can be a smarter strategy than typical metrics like margins and revenue.

Learn more about McKinsey’s Technology, Media & Telecommunications Practice, and check out job opportunities related to SaaS if you’re interested in working at McKinsey.