Which Business Model Suits My Startup?
A business model can be defined as: ‘a plan for the successful operation of a business, identifying sources of revenue, the intended customer base, products, and details of financing’.
In order to execute upon a ground-breaking idea, founders must have a clear business model in mind with the following characteristics: profitable, feasible and suitable. In this article we will take a brief look at some of the most popular business models in the market, those who have executed them well and analyse some of their strongest and weakest aspects.
Ad-Based Revenue Model
Businesses adopting this model tend to provide a low-cost or free product or service, relying primarily on advertisement revenue paid for by brands looking to access the attention of their users. To make one’s platform commercial to brands, the platform should demonstrate the ability for the brands to convert the platform’s users. Brands would therefore appreciate working with platforms with high-traffic, focused and relevant user groups and the ability to demonstrate high click-through rates.
This specific revenue stream has been around far longer than the tech unicorns of today that have proliferated it so much. We have seen this from the emergence of traditional broadcast and print media — TV and radio shows, along with newspapers and magazines popularised this model during The Consumer Era (1940–1970s), as thriving consumer brands saw those outlets as great opportunities to reach their target customer.
The emergence of internet brought advertising to a new level — global reach, in an instant. Along with the wider reach, we also we saw a huge improvement in the efficiency of online advertisement, thanks to the new datasets available. Machine learning technologies are also now allowing our devices to detect, deduce and act upon consumer preferences in real-time.
Facebook is one of the most successful proponents of this particular revenue model — a staggering 98.66% or $31.9 billion of their total revenues in 2019 came from advertising services alone.
Subscription Revenue Model
Businesses using this model can enjoy recurring revenue in forms of monthly/yearly payments from their customers.
The key proponent of this model has the big advantage of facilitating customer retention and brand loyalty — a one-time sale of a product or service can become a recurring sale. Recurring income means more predictable revenue forecasting and often a more economically efficient use of customer acquisition budget. If you’re wondering whether this model might work for you, you must ensure that you are constantly delivering value to your consumers in order to avoid churn.
Traditionally this business model has always been popular with publishing houses of books, magazines and newspapers, since they could ensure a constant distribution of content to their loyal customers. More recently we have certainly seen the rise of the SaaS model, allowing the non-transferable and unlimited use of a centrally hosted software. We have also seen a pay-as-you-go subscription service where customer subscribe to repeat purchases of a product, businesses such as Dollar Shave Club and Birchbox have been successful with this strategy.
Overall there is certainly a trend in shifting away from capex to opex, as consumers do not demand ownership of products and enjoy building an on-going relationship with their suppliers.
Netflix is a subscription-based business model with three simple plans: basic, standard, and premium. They showcases their value through the entertainment experience they provide, and retains their customers by constantly updating its offerings and delivering fresh content.
The freemium model (the name comes from a combination of free and premium) is one in which a business offers their basic services for free, yet users must pay for additional premium features, extensions, functions or advantages. This business model allows customers a low barrier to enjoy a free version of their product, while making certain features exclusively available to premium users, for example ad free customer experience or additional features. This business model efficiently uses price discrimination, as the business is able to maximise profit by charging each customer the highest price that their user is willing to pay.
When adopting this type of business model, it is important to find the right balance between the free products offered and the marginal benefit that the paying consumer can gain. The main purpose of the company is to reduce customer acquisition cost (CAC) and gain usership, looking for their users to hit that ‘aha moment’ in order generate revenue inflow.
Dropbox offers 2GB of storage for free and charges a fee if users need more space. The company had a total revenue of $1.661 billion last year, an increase of 19% year-on-year with an average revenue of $123.07 per user, reflecting the potential profitability of this model.
Marketplaces aggregate different sellers into one platform who then compete with each other to provide the same or different product/service to buying users at competitive prices. A marketplace can be profitable as it will earn commission on every sale carried on its platform. It builds on the fact that it does not own any inventory and hence it does not incur in any inventory turnover risk. In addition to this, a marketplace can benefit from network effects and economy of scale, as scales drives its efficiencies.
A key obstacle that a start-up will encounter when building a marketplace is to attract both buyers and sellers to the platform, it is often said that growing a marketplace businesses can be as difficult as running two businesses at the same time. In order to successfully do so, it is important to win over the trust of your chosen ecosystem — when I say ecosystem, I mean every stakeholder that will come into contact with your brand, failure to do so will lead to leakage of users on both sides.
Booking Holdings Inc
Famous examples of successful marketplaces include Amazon and Booking.com. The online travel agency provides customers with a wide range of hotel choices on one website, making comparison and search much easier for the user. The company has contracts with hotels and take a commission on each booking of between 10%-30%, depending on the visibility the hotel requires. The high profitability of this business model is evident when noting the net profit margin of Booking Holdings Inc. in 2019 — that year they achieved a net profit margin 10 percentage points higher (32.29%) than that of other well-known players in the hospitality industry that adopt more traditional business models, such as Hilton Worldwide Holding.
The abovementioned business models are just a selected few among the large pool existent and they are not rigid structures a company must fit. For example, Spotify adopts a mixture of freemium, subscription and ad-based models.
If you’d like to explore which model might work for your business, feel free to book in a meeting with one of our team on us!