4 Types of Revenue Models Every Entrepreneur Should Know About
Whenever I hear someone tell me things like, “I want to create an app to help people find the cheapest price for a product!” or “My startup idea is going change the world!”, I ask them, “What is your revenue model? How do you make money?”
After a long silence, they will usually reply, “Oh, I haven’t figured that out yet. Maybe advertising?”
Whenever people tell me that I know they haven’t figured out a sustainable revenue model for their idea. My question then becomes this: how are you going to survive if you don’t generate money?
This isn’t what most people want to hear but it is a valid concern. Startups have a 90% failure rate in the first year and most of the time it is attributed to not making enough money or not making money at all.
This happened to me too when I started my first business in 1997 and again and again over the next seven years of my entrepreneurial journey. Eventhough I was a persistent entrepreneur, I couldn’t make money from my businesses and that led to their folding.
If I could have done it all over again, I would have studied the revenue model first. This way, at least, I had a better chance of succeeding. So, as an incubator manager, I am putting what I learned from my failures to help new entrepreneurs to look at areas which I consider the “blind spots” of entrepreneurship – areas in which enthusiastic founders happily neglect when they become narrowly focused on how cool their ideas are and how their ideas are going to change the world.
That is why today I want you to take a deeper look at revenue models.
What is a revenue model?
A revenue model lays out the process by which your business makes money. In a revenue model you specify how you are going to charge for the products or services that you provide. It is a system design in which a business makes money from the solutions, products and services that it provides – all of which provides value to your customers.
The outcome of creating value for your customers is a revenue stream that you can rely on to keep your business going. Your revenue stream is the bloodline of your business and can mean going past your first year or having to call it quits.
There are many different types of revenue models. Every company creates its own unique revenue model. Businesses with existing revenue models can even reinvent their revenue models to capture new segments of the market or to adjust to a new generation of customers and competitors.
For early stage startups especially, a strong and innovative revenue model is important as investors want to see how your startup will allow them to make a return on their investment.
In this article, I will show you four types of revenue streams and what you can expect from using them in your own business.
1. Recurring Revenue Model
The recurring revenue model is an entrepreneur’s dream. It creates a continuous, recurring revenue based on a one-time deliverable. Although companies require more time and capital to implement recurring revenue schemes, the long term returns are ultimately worth the investment.
IBM is an excellent example of a company founded on the recurring revenue model. IBM performs a one-time installation and implementation of their clients’ computing hardware. Doing this binds them to long-term service contracts that include relatively non-labour-intensive software updates, system maintenance and support.
2. Transactional Revenue Model
Transactional revenue models are based on selling goods. Transactional revenue models are less attractive than recurring revenue because the company has to “do” something new for every sale. If they are selling a physical product they will have to built and the ship the product every single time to make money.
Toothpaste and printer toner provide good examples of transactional-revenue products. E-commerce companies are also mostly on the transactional revenue model.
3. Project Revenue Model
In a project revenue model revenue is generated based on successive, one-time projects. Companies reliant on project revenue have limited opportunity to build scale economies, face sporadic income and must expend resources to maintain relationships.
They also need to continuously prove themselves to clients and prepare bids for subsequent projects. With a project-based revenue model, companies may have repeating customers, but they have no real means of knowing when the next sale might occur.
4. Service Revenue Model
The least attractive revenue model is the service revenue model. While the previous three revenue models sell goods, possibly in combination with service, the service revenue model essentially sells time.
Time is easy to compete on, easy to negotiate down and cannot be leveraged. By implementing a services-based revenue model, a company’s income stream will tend to be highly uneven, and may also remain low compared to other models.
Free Is Not a Revenue Model
Many entrepreneurs do not put in a lot of thought when designing their revenue model. Some will say “give it free, lock in the customer and then sell advertisements!”. This is simpler said than done! To be attractive for advertisers to advertise, you must have at least 100 million users on your platform.
Can you do that in Malaysia? What would it take and how long would it take for you to reach 100 million users? Free is not a revenue model. There must be a monetization strategy to a freemium model. Take for example, Google. Google offers its search engine for free but its user base is so huge that it offers Google Adsense and Adwords as its monetization model. So, nothing is for free.
The next time you start thinking about revenue models, starting thinking with two criteria in mind – scalability and recurring. Scalability means that you could find customers paying for the same thing in the much larger markets and recurring is to have them transacting with you, every minutes, every hour, every day, every week, every month and every year. Start thinking about this: what kind of business will keep generating income for you even when you sleep?