When entrepreneurs use the term business model, they often mean “how the business earns money”. To understand the implications of this question deeper, however, it’s important to make the distinction between business model and revenue model:
- A revenue model is a narrow answer to that question. The revenue model is the combination of all your revenue streams. It’s concerned narrowly with the area of your business that involves clients transferring money to your organization.
- The business model is a more broad term. It involves the revenue model, but it’s also concerned with other aspects of the business like e.g. the cost structure. (This is well illustrated in the popular Business Model Canvas.) For example, while the revenue model of a traditional retailer is concerned only with customer transactions, the business model is concerned with suppliers, locations, marketing, employees, etc.
Because of this, simply choosing a business model for a startup is somewhat unrealistic. The innovative nature of the venture means that its exact business model would be a somewhat unique combination of different factors and involves multiple key choices related to the business.
Use A Blueprint
That said, you don’t have to reinvent the wheel.
Look at the established players in your industry. Imitate what they are doing and make iterations where needed based on the unique aspects of your business. For example, you might want to retain the same revenue model but offer distinct value propositions. It’s not a coincidence that almost all project management software solutions use a freemium subscription-based revenue model. What differentiates them is their exact solution, rather than the way they make money.
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The second option is to take a business model from another industry and to apply it to an industry where this model hasn’t been established yet. This is riskier, but being the first company to do it successfully has big benefits. For example, Booking.com did this by creating an online marketplace (similar to eBay) for the hospitality industry.
Use A Scalable Model
Scalability is a requirement rather than a choice for most startups. The extremely risky nature of the business implies that for the venture to be worthwhile, the potential needs to be big. Because of this, your business plan needs to be scalable.
A consultancy that charges by the hour is not particularly scalable, while a software solution with close to zero marginal costs (the cost of adding an additional customer) is extremely scalable. That’s why the vast majority of successful tech startups are in the digital world.
Understand Your Cost Structure, Pricing, And Marketing Channels
How much does it cost to develop the product or to run the service? How much does it cost to deliver it to your customers? How much are competitors charging customers for similar offerings?
Knowing the exact cost structure of your business would let you price your offering, which in turn would help you choose the correct marketing channels and revenue models.
Because of the low marginal costs of most software products “free” has become a popular pricing choice. That said, while giving away something for free is a great way to attract customers, it creates an obvious problem – how do you actually earn money?
Ads, affiliate offerings, and most importantly freemium offerings (i.e. part of your offering is free, another part is paid for) are the most common solutions to that problem, but they are not perfect.
Speaking in general, it’s safer to avoid “for free” business models in the very early stages of your startup. That way you can validate more easily if people truly want what you are making. You can always add free offerings when your startup project reaches the growth stage.
Understand Your Revenue Model
On the highest level, there are two types of revenue models – transactional and subscription models. The main difference is that in the first option you are selling ownership with one-time transactions, while in the second you are selling temporary access.
The subscription model makes a lot of sense in the scalable digital world because it provides predictable, recurring revenue to the company (and hopefully higher customer lifetime value) while at the same time requiring a smaller upfront investment by the customer.
Because of this, a lot of the older software giants (Microsoft, Adobe) are putting effort into migrating from a transactional to a subscription-based revenue model.
If you are building a scalable, digital startup, the subscription model should be the default choice in 2021.
- Use your competitors or tech startups in other industries as a blueprint.
- Make sure your business model can scale.
- Understand your cost structure as it will define your choice of marketing channels and pricing.
- Choose your revenue model.