What Is Your Revenue Model?
The who, what, when, where, why, and how of getting paid.
Startups are often asked “What is your business model?” Most of the time, the real question is “What is your revenue model?” Deciding how much to charge whom for what is a big and important issue for any company to resolve. Determining when to get paid and in what form can strongly impact your product growth and even why and how people adopt your product.
Since revenue is the fuel that keeps the business engine running, getting these decisions right can be the difference between life and death for startups.
The revenue model defines how a business captures value from its customers.
In order to capture value, the business must create value for customers, which is reflected in the value proposition, which we discussed last week. In reality, many businesses will create multiple forms of value for different types of customers.
For example, Google makes it easy for Internet users to find information and it helps advertisers reach potential customers. The diagram below shows a simplified version of the revenue model for Google.
Let me briefly walk through the pieces here.
Google’s value proposition to Internet Users is to make it easy for them to find information. Their brand strength and their success in delivering that value proposition are the primary means of acquiring and retaining these customers and the customers consume the value proposition through a variety of channels including Google’s website, mobile app, and voice assistant devices. Customers “pay” for the service by implicitly allowing Google to identify them and to build a profile around their identity. That value then contributes directly to the value proposition for advertisers.
Google’s value proposition to Advertisers is to connect them with potential customers. As above, their brand strength and success in delivering that value proposition are the primary means of acquiring and retaining customers. Google primarily delivers that value proposition through the Google Ads tools accessible through the Web and mobile apps and customer make cash payments to Google through automatic and manual electronic payments established online. That cash counts towards Google’s sales revenue and provides the bulk of the company’s cash flow.
I think this one example gives a sense for the components of a revenue model. It reflects the relationship between the value proposition and the customer, how that customer is acquired and retained, the nature of the payments made by the customer, and how much of that is actual cash contributing to the cash flow of the business.
That makes it sound simple, but there are so many different possible variants that business have a very complex set of decisions to make. For example, payments can be made in advance of, or after experiencing the value provided. Payments can be one time, on a regular (monthly or annual) subscription period, or based on actual usage. Payments can be direct or through a third party. And the real and perceived value delivered can take many different forms.
Here is a quick summary of some different forms of revenue models:
- Markup: A good is sold to a buyer at a sales price above the item’s cost in order to generate a profit.
- Commission: The value proposition is the mediation of a transaction between a buyer and a seller. The seller receives the purchase price but either the buyer or the seller pays the business a commission fee on the transaction.
- Advertising: The consumer of the primary product pays little or nothing, but agrees to receive targeted advertisements. The advertisers pay for access to the consumer.
- Loss Leader Product: The buyer purchases the primary product at an unprofitable price (sometimes free), but the business makes money on marked-up services or supplies necessary to continue using the product.
- Rental: The buyer pays to use a tangible product for a limited time but does not take ownership of the product.
- Subscription: The buyer pays to access an intangible (e.g. content or software) product or service for a specified time.
- Licensing: The buyer pays for the right to use an intangible product but does not technically own the product.
- Barter: The buyer and seller exchange non-cash products and services of value each to the other.
There are many other forms of revenue models, and each of these can take many different forms. But they all involve the same basic decisions to be made by the business in establishing how to offer the value proposition in a way that allows the business to capture the value and accomplish the business’ objectives.
In addition to understanding how the business brings in revenue, it’s essential to make sure that it can effectively create the value being offered. That will be our focus in tomorrow’s article.