What is a Revenue Model?
Modern-day start-ups can be of many different types. They can be differentiated on the basis of several parameters. One of the parameters which are used for such differentiation is called the revenue model. Many people confuse the term revenue model with the more commonly used business model. In this article, we will have a closer look at what a revenue model is and how it is different from a business model.
What is a Revenue Model?
Let’s begin by understanding the difference between the terms business model and revenue model. It is important to understand that a revenue model is the subset of a business model. The business model details the entire process which will be used to generate value for the customer. On the other hand, the revenue model only provides details about the process which will be used to generate the revenues of the company. The two terms are quite interconnected and one can influence the other.
A revenue model is very important since it impacts the pricing strategy, marketing strategy as well as profitability of the business. The revenue model of the company determines how much free cash flow will be generated at various stages of the business. The entrepreneur can then decide how to utilize this free cash flow in order to maximize their gain.
A thorough understanding of the revenue model is vital for start-ups since it helps them structure their expenses in such a way that they do not overburden the business.
Commonly Used Types of Revenue Models
There are several different types of revenue models that are commonly used by start-ups. Entrepreneurs need to understand the pros and cons of each model before they decide on which one is best for their company.
- Production Model: A production-based revenue model is used by companies engaged in more traditional businesses. As a part of this model, the company produces the goods which it sells to the customers. As a result, costs are incurred at various stages of the process of the production process. On the other hand, revenues are generated when the actual sale is made to the customer.
The problem with this revenue model is that it tends to be very asset-intensive. Hence, companies that use this revenue model have to take on large obligations for the procurement and maintenance of equipment.
- Markup Model: A markup model is followed by most retailers across the globe. Here, the company does not engage in manufacturing the product itself. Instead, the company generally outsources the manufacturing process. The company buys the manufactured products for a certain amount, adds their own markup, and then sells it at a higher cost.
Companies that follow the markup model tend to concentrate more on branding and creating an intangible brand image. This image allows them to sell products at a higher markup and hence generate even higher profits.
- Licensing Model: The licensing model is another form of revenue model which is commonly used by start-ups. Under this model, the company generates revenue by providing a time-bound license to another company to use its products or services. Software companies commonly use the licensing model. These companies create software products and authorize users to use these products by selling licenses. These licenses are time-bound and need to be renewed periodically. This helps generate a recurring revenue stream for the company.
- Subscription Model: The subscription model is a fairly recent invention. A subscription model is based on the existence of a library of goods or services. Instead of selling single units of the product to the user, the company sells access to the entire library.
Many modern businesses such as Netflix and Spotify are based around a subscription-based business model. Earlier the music industry used to sell single copies of music albums. However, over time the revenue model has evolved. Nowadays, companies sell a subscription to an entire library. The benefit of a subscription-based model is that the recurring revenues tend to be quite stable allowing the company to plan its marketing activities with less uncertainty.
- Ad Based Model: Ad-based business models are when the company does not generate revenue from individual users. Instead, it collects data or other such valuable information from the users and then provides this information to advertisers.
Advertisers are willing to pay a good price if the information helps them increase their sales by targeting the correct users. Companies like Facebook are examples of ad-based business models.
Companies with this revenue model should try to create a great user experience since this will allow them to generate more data in a targeted manner which can then be sold to the advertisers.
- Freemium Model: The problem with a subscription-based and an ad-based revenue model is that they don’t give the user a choice. Hence, a new form of hybrid model called the freemium model has come into existence.
In this model, users are given a choice as to whether they want to pay a subscription fee and avoid the advertisements or whether they want to continue listening to advertisements and sharing their personal information to avoid paying a fee.
A revenue model should be carefully chosen after taking into account the customer segment which is being targeted as well as the competition. The revenue model can have a huge impact on the future growth potential of a business.
Many industries have been transformed by simply changing the revenue model. For instance, the music industry has gone from a sales-based model to a subscription-based freemium model. Companies like Spotify have been able to generate billions of dollars in revenue by simply changing the revenue model of their company.
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