IEOR 190A Lecture 10: Innovation in Value Extraction

Today, our guest lecturer, Gigi Wang, talked about innovation in value extraction.

As Wang explains, business models describe not only how to make money, but how to run a profitable business. Some historical models include software licensing, renting property, or advertising. The digital world has enabled a whole new sector of business models, like storefronts, online booking, etc.

Upon the dawn of the internet, many were puzzled as to how to harness the power of the internet into a viable business model. This was changed in 1998 when Google came out with AdWords, which to this day generates most of Google’s profits. To develop a digital business model, it’s important to separate and determine the customer and the buyer, as the two may not always be the same entity. As a result, most services on the internet are not truly free; while you might be a consumer of a free service, someone else is paying for information that arises from your use of the service. Internet businesses have trended towards freemium models, offering services for free or low prices to lower the barriers towards adoption of their product as well as premium tiers for heavier users.

With this trend towards freemium models, businesses must make it easy for themselves to collect money. A good example is Solar City, who, rather than charging customers $50k upfront for solar panel installation, offers a $0 down leasing option that allows customers to generate income by selling electricity back to the grid. In fact, the freemium model applies to more than just e-services. In this digital era, recurring revenue has longer lifetime value everywhere; for example, 20 years ago, HP made heaps of money selling printers, which often costed more than $2000. Now, printers are significantly cheaper and accessible. Instead of earning revenue from hardware sales, HP makes money on the repeated sale of ink.

Let’s look at some common digital business models.

One common model is licensing technology or selling product licenses; rather than give away all of your intellectual property, licensing allows for the recurring revenue we talked about earlier, as customers must continually pay for a service.

Collaborative consumption is a new trend enabled by the internet. Dubbed part of the “sharing economy”, many applications like Uber, Lyft, and AirBNB allow individuals to make money by renting their property out to others. Here, companies make money by handling payment transactions and insurance elements.

Crowdsourcing is another popular model that takes advantage of the “many”, providing projects with the support of the crowd for content, brainpower, funding, and processes.

In the past few years, the model of monetizing data has become widely-adopted; many companies have sprung up to pioneer the field of Big Data. Data-monetization marks a shift away from the traditional referral fee/revenue share model of e-commerce and towards aggregating and selling consumer data.

One of the biggest problems in value extraction is finding the right balance for monetizing a service. Companies need to find a sweet spot between providing free, entry-level services and premium services to maximize revenue. For some companies, this means taking the customer/buyer divide beyond the freemium model and looking for alternative sources of revenue. For example, OpenTable, a company that allows users to make reservations for a number of restaurants, operates not by charging users fees but by charging the restaurants for finding them customers.

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