A digital business model might be defined as a model that leverages digital technologies to improve several aspects of an organization. From how the company acquires customers, to what product/service it provides. A digital business model is such when digital technology helps enhance its value proposition.
A few myths about digital business models
We all like to think of digital business models as innovative for their own sake.
However, in many cases innovation happens by combining aspects of existing business models to create a unique formula.
Not a single formula, but rather a recipe with ingredients to be tested
Almost like taking the existing ingredients, and remixing them by using different quantities and cooking time, an “innovative” business model is often the result of those recombinations.
And it requires a lot of tweaking.
Digital is not just about the product/service
You create an ebook, sell it on the web and you call your business a digital business.
Sure, that is a digital product but the fact that your product is delivered digitally doesn’t make it a digital business.
There are a few other things to take into account.
Digital is not just about distribution
You build a website, call it a platform, and you have a digital business.
However, a website is just like a physical window shop, in order for you to create a sustainable flow of customers/partners/users you need to make it scalable.
That requires understanding what models fit best the potential customers/users identified.
However, it took years before Google would develop all the building blocks (former Google AdWords, and Adsense) to make it extremely scalable.
Initially, Google was just closing advertising deals on its search pages leveraging on salespeople, just like a traditional organization.
When Google finally built its two primary ad platforms (AdWords, now Google Ads and AdSense) its business growth picked up together with its traffic growth.
Before Netflix would become a viable streaming platform it took decades. And before that, it was primarily a DVD-rental company.
DVD-rental, in 2019, made up less than two percent of the overall Netflix revenues (interesting enough the company still reported over two million DVD members as of 2019).
Yet, when video streaming became technically viable, Netflix’s business model also evolved, thus making the company surf a different market (video streaming) rather than DVD rental.
A simple business model that delivers enough value to potential customers will get you through the first growth stages.
A model for each stage
Amazon wanted to develop a way for third-party sellers to build their e-commerce on top of Amazon’s infrastructure (at the time that was called Merchant.com) to push on its mission to provide a wide variety of products.
Yet Merchant.com was a “jumbled mess,” and the company over the years developed what would become Amazon AWS, now one of the most successful business units, within Amazon.
While Amazon AWS is now a company within a company.
That infrastructure helped Amazon build a more scalable business model and push to a different stage of growth, probably not possible without the contribution of AWS.
Yet, what would later become AWS only started to be developed in 2000 (Amazon started in 1994).
And only after a few stages of hypergrowth do the company goes through.
A new way of doing business
Therefore, building a digital business requires mastering new ways of looking at your business.
They primarily move around a key pillar (your customers/users or those for which your service/product provides a clear advantage) and a few elements:
Product/Service
Building a digital product/service requires a mindset that goes from something scarce to something potentially unlimited.
Digital products/services can also be quite expensive.
Think of how platforms like Google have to spend billions to keep operating their digital assets by also investing in massive physical infrastructures (data centers).
A platform business model generates value by enabling interactions between people, groups, and users by leveraging network effects. Platform business models usually comprise two sides: supply and demand. Kicking off the interactions between those two sides is one of the crucial elements for a platform business model’s success.
Distribution
Building a digital distribution means understanding the various channels existing on the web.
New channels come every few years.
But some of the channels you might want to take into account to enhance your digital business are:
A digital business model value proposition can often be delivered by providing the upside without the downside.
Think of how Google makes you search for anything without requiring you to bring an encyclopedia in your pocket.
Leveraging on consolidated models
As the story goes McDonald’s started to use a franchising model to grow its restaurant business, and it became over the 1960s a giant in the restaurant business (or real estate depending on the perspective).
McDonald’s leveraged the existing “Speedy Service System” developed by the McDonald’s brothers (what we would later call “fast food”) which was an incredible process development able to provide an improved product at a faster pace.
The speedy system itself represented the application of the manufacturing process to the restaurant business.
Later another important building block was added.
The franchising model really became widely applied during the 1920s and 1930s in the restaurant business.
As new physical communication networks (in the US the Interstate Highway System) enabled people to move long distances with their cars.
Later on, Ray Kroc would apply in its most aggressive form the franchising model (different formats already existed centuries before) to McDonald’s existing operation to create one of the most scalable restaurant businesses in the world.
But is franchising a business model, a revenue model, or a growth (expansion) strategy?
McDonald’s is a heavy-franchised business model. In 2021, over 56% of the total revenues came from franchised restaurants. The long-term goal of the company is to transition toward 95% of franchised restaurants (in 2020 franchised restaurants were 93% of the total). The company generated over $23 billion in revenues in 2021, of which $9.78 billion from owned restaurants and $13 billion from franchised restaurants.
Amazon’s flywheel? Part product, part distribution
Amazon was among those players on the web who developed a successful affiliate program, which would work as an incredible growth strategy for the company.
In 1996, Amazon associates could place banner or text links that were directed to Amazon to get a commission on the sale.
Not so different from the franchising model in the physical world, the affiliate model would enable a digital property to leverage Amazon’s brand and sell its products and get a commission in exchange.
The affiliate model wasn’t new, as it was already launched starting in 1994, yet Amazon tweaked it and made it widely successful.
Not surprised, then, if you associate affiliate marketing with Amazon.
Affiliate marketing today sounds as old as the web (indeed it is), yet back in the late 1990s that was one of those innovations (which idea was old yet applied to the web) that helped build some of the tech giants we know today.
Yet affiliate marketing alone doesn’t make a business model.
Amazon has a diversified business model. In 2021 Amazon posted over $469 billion in revenues and over $33 billion in net profits. Online stores contributed to over 47% of Amazon revenues, Third-party Seller Services, Amazon AWS, Subscription Services, Advertising revenues, and Physical Stores.
Are digital businesses fragile?
Many of the new digital business models try to apply old or new philosophies to the web.
For such reason, they might work in the short-medium term (5-10 years), but prove extremely fragile in the long run (20-50 years).
Thus, it’s important when building a digital business to know its advantages but also its drawbacks.
And a way to prevent a digital business to fail is to have a buffer (that is also why tech giants sit on large piles of cash as a buffer).
Open source is licensed and usually developed and maintained by a community of independent developers. While the freemium is developed in-house. Thus the freemium gives the company that developed it, full control over its distribution. In an open-source model, the for-profit company has to distribute its premium version per its open-source licensing model.
An open-source model makes software free to access, and it generally gives the ability to a community of programmers to contribute to it.
Those two ingredients are essential.
Free makes it spread very quickly. And the community side of it is what eventually determines its success.
An open source isn’t a model which companies can leverage to build a sustainable business model.
Companies like Red Hat, for instance, make money by charging premium subscriptions and for training and services associated with its open-source software.
Indeed, in 2018, Red Hat generated over $2.9 billion in revenues, of which, $2.57 was from subscriptions and $346 million from training and services.
Red Hat isn’t the only possible way to monetize open-source software.
For instance, we covered already the Mozilla Business Model and how its for-profit side makes money through partnerships and distribution agreements with search engines.
Most of Mozilla Corporation’s revenues come from royalties earned through Firefox web browser search partnerships and distribution deals. Back in 2008 Mozilla Firefox controlled over 26% of the browser market. Today, due to the market dominance of Google Chrome and Safari, Mozilla has less than 5% in market share. In 2021, Mozilla Corporation generated $441 million in royalties, which represented almost 89% of its income.
Going back to the Red Hat case study by looking at its annual report Red Hat explains its business model as follows:
Development. We employ an open source development model. The open source development model allows us to use the collective input, resources and knowledge of a global community of contributors who can collaborate to develop, maintain and enhance software because the human-readable source code for that software is publicly available and licenses permit modification.
Licensing. We typically distribute our software offerings under open source licenses that permit access to the software’s human-readable source code.
Subscriptions. We provide our software offerings primarily under annual or multi-year subscriptions as well as ondemand through our certified cloud and service providers (“CCSPs”).
Therefore, as highlighted in its annual report, thanks to the open-source business model, Red Hat has three key advantages:
Quick and effective development via a global community of qualified contributors who are not on the company’s balance sheet.
Great distribution via free licensing of its software.
Paid subscriptions for premium and enterprise customers.
Building up an open source-based business model isn’t simple and its success highly depends on the ability of the project to engage the community of developers and contributors in working on the source code to improve it and make it very valuable.
Also, such a model where a free service does allow strong marketing for the product.
But it doesn’t necessarily translate into revenues for the company.
For instance, Red Hut 2018 employed $1.2 billion in sales and marketing expenses to distribute its paying subscriptions.
That represented 41% of its total revenues which comprised “primarily of salaries and other related costs for sales and marketing personnel, sales commissions, travel, public relations and marketing materials and trade shows.“
Free model
The free model has become quite pervasive on the web.
Starting from Netscape going on, companies have built great products and released them for free with the hope that once enough people would get used to them, monetization would not be an issue.
While this model worked pretty well for products that scaled up quickly, amassed investments to sustain their infrastructure in the short term, and then found a monetization strategy.
Companies like Google and Facebook have started in this way.
They released a free service to a larger and larger user base.
Attracted the first angel investors, then venture capitalists they had to then quickly turn to the advertising model to monetize their users, to avoid being left without cash and investors.
Google is a platform, and a tech media company running an attention-based business model. As of 2021, Alphabet’s Google generated over $257 billion in revenue. Over $209 billion (over 81% of the total revenues) came from Google Advertising products (Google Search, YouTube Ads, and Network Members sites). They were followed by over $28 billion in other revenues (comprising Google Play, Pixel phones, and YouTube Premium), and by Google Cloud, which generated over $19 billion in 2021.
Thus, while a free service allows to scale up at a marketing level, the company will still have to figure out how to monetize the service provided.
There are usually a few routes:
A basic version of the product, and a more advanced paid version (freemium model).
One side gets the service for free, and the other side finances it (asymmetric model).
Training materials or info products adjacent to the core topic of the product (educational model).
A free basic service, and a more advanced paid service (usage model).
A job board that connects talented people with employees (job board model).
Those are just some examples of how an open-source model can be monetized.
Freemium model
The freemium is usually a growth and branding strategy rather than a business model. A free service is provided to a majority of users, while a small percentage of those users convert into paying customers through either marketing or sales funnel. The free users not converting in customers help spread the brand.
The freemium model has gained popularity in the last decade. The reason is simple; this model allows a high virality growth.
Cases like Dropbox, MailChimp, Spotify, and many others have created viral growth thanks to these models.
At its core, a freemium model has a free version available to anyone, with no friction.
Prompts within those free services to switch to paid subscriptions to get more volume, no advertising, or more data.
Spotify is a two-sided marketplace where artists and music fans engage. Spotify has a free ad-supported service and a paid membership. Founded in 2008 with the belief that music should be universally accessible, it generated €9.66 billion in 2021. Of these revenues, 87.5% or €8.46 billion came from premium memberships, while over 12.5% or €1.2 billion came from ad-supported members.
For instance, Spotify offers a free limited service, advertising-supported.
But if users decide to get the premium service, they can listen to music without interruption from advertising and also download music to listen to offline.
Dropbox instead, makes you use more space with a premium service.
And MailChimp gives you advanced features and the ability to handle more subscribers in your email list.
If you opt for this model, you need to make sure you have the following:
A strong enterprise customer base.
An optimized conversion funnel to switch free users to paid ones.
A robust technological infrastructure that can handle a broad base of free users.
Subscription-based model
We’re living in a subscription economy.
The most entertaining and customer-centered services we know today, from Netflix to Spotify and Amazon Prime follow a subscription model.
This model can be very powerful as it carries a few built-in advantages:
A loyal user base.
A continuous stream of predictable revenues.
A more predictable sales pipeline.
In short, many companies are “subscribing” to this model as it allows them to build a sustainable revenue stream over time.
However, it is essential to remark that creating this kind of model isn’t a simple task.
Indeed, companies like Netflix and Spotify spend billions of dollars in producing original content that can make those subscribers want to renew their plans.
Netflix is a subscription-based business model making money with three simple plans: basic, standard, and premium, giving access to stream series, movies, and shows. Leveraging on a streaming platform, Netflix generated over $29.6 billion in 2021, with an operating income of over $6 billion and a net income of over $5 billion.
Usually, a model that relies on a subscription also requires essential investments in infrastructures, as what makes the services offered through this model is the ability of those platforms to know precisely what to watch or listen to next.
Also, you’ll need to build a process skewed toward a great customer experience to minimize churn rates and improve lifetime customer value.
When your CAC or customer acquisition cost is higher than the lifetime value of your customers, your business will soon be bankrupt.
On-demand model
The Web finally allowed people to consume content at their own pace and schedule.
What mass media, like TV and Radio, didn’t accomplish, the Web did.
An on-demand consumption allows people to have access to the content at different time intervals.
Also, it doesn’t make sense any longer to have a single product or service offering for anyone at scale.
Thanks to the on-demand model
This is true for content but also for any other kind of service. Netflix had popularized this model when it made it available at any time its shows through the platform.
Yet other services, like Uber, and Lyft also built their success by leveraging the on-demand model.
As technological platforms allow people to interact instantaneously, it makes possible those kinds of services.
Uber follows a business model become popular in the era of technological innovation. This is called two-sided marketplace, and it has a simple premise. You create a platform with great user experience, some elements of gamification, make it easy for two sides of a transaction to connect. This happens especially in industries where those two sides were prevented from transacting as the industry was dominated by a third party, which extracted most of the profits for that industry. When that third party is removed via the two-sided marketplace, the owner of the platform collects a fee from both sides of the transaction.
The on-demand model can be monetized in several ways. From subscriptions to fees for each transaction on a platform.
The critical ingredient is to create a smooth user experience, in which you barely realize there is someone in the backend manufacturing that experience.
Peer-to-peer, two-sided marketplace
A peer-to-peer marketplace is a platform where usually two sides are participating in a transaction, which can be about products (Etsy) or services (Uber, Airbnb, LinkedIn).
A peer-to-peer, or two-sided marketplace often falls into the chicken or the egg dilemma, where the marketplace to work needs both sides to interact.
Yet the paradox is that to have demand on the platform you need a continuously generated supply.
At the same time to have the supply you need to create demand.
Imagine the Uber case; the platform works as soon as there are enough drivers on the road to offer an on-demand and convenient service when riders need it.
However, drivers want to drive at their convenience and when the fees are high enough to justify their effort.
Therefore, the peer-to-peer marketplace usually faces several challenges in making sure the supply side is served adequately to justify the demand.
Uber, Airbnb, and Etsy all face this issue. For instance, Uber uses several strategies to enhance the supply of drivers on its platform by using dynamic pricing strategies, like surge pricing.
Dynamic pricing is the practice of having multiple price points based on several factors, such as customer segments, peak times of service, and time-based consumption that allow the company is applying dynamic pricing to expand its revenue generation.
You can appreciate the importance of drivers’ supply for Uber by the fact that companies like HyreCar have built their whole value proposition based on the supply scarcity on Uber.
HyreCar is a peer-to-peer marketplace where owners of cars can rent their idle vehicles to drivers that want to make an additional income via ride-sharing services like Uber, and Lyft. As a two-sided marketplace, HyreCar makes money by charging drivers for direct insurance and a 10% fee on the weekly rental expense. And by taking a 15% fee from owners’ weekly rental income.
E-commerce model
One of the first companies that proved the web wasn’t made just of connected computers but of people ready to purchase physical stuff on it was Amazon.
Started as a book store the company soon branched out to sell music and related products.
Until it became the everything store!
Amazon has a business model with many moving parts. With the e-commerce platform which generated over $222 billion in 2021, followed by third-party stores services which generated over $103 billion, Amazon AWS, which generated over $62 billion, Amazon advertising which generated over $31 billion and Amazon Prime which also generated over $31 billion, and physical stores which generated over $17 billion.
Today an e-commerce business model is taken for granted and is among the most used digital business models.
Ad-supported model
If Amazon had proved that the web could become an everything store, a company that changed the way media could be consumed was Google.
Rather than just having to type a website address in a browser, people could search for anything they wanted.
Google made all its services, and apps completely free.
While on the other side it monetized the data captured via its search engine pages with an advertising network called AdWords (now Google Ads).
When Google IPOed back in 2004, it showed the business world how powerful its digital advertising business was.
Indeed, in a matter of a few years, Google passed the billion dollars mark. In 2017 its advertising business passed the hundred and ten billion dollar mark!
To make sure, while a digital advertising business might be easy to set up, it’s not an easy one to run and make profitable.
Unless you’re Google or Facebook with their dominant advertising marketplaces, you won’t be probably able to make money via advertising alone unless you have a very large user base.
Google (now Alphabet) primarily makes money through advertising. The Google search engine, while free, is monetized with paid advertising. In 2021 Google’s advertising generated over $209 billion (beyond Google Search, this comprises YouTube Ads and the Network Members Sites) compared to $257 billion in net sales. Advertising represented over 81% of net sales, followed by Google Cloud ($19 billion) and Google’s other revenue streams (Google Play, Pixel phones, and YouTube Premium).
Hidden revenue generation model
Hidden revenue generation is about making money while the people that most use your service barely realize that.
A great example is Facebook (and Google).
If you ask an average Facebook or Google user, she won’t know how the company monetizes.
That’s because those companies have invested massive resources in creating this kind of experience.
Facebook, the main product of Meta is an attention merchant. As such, its algorithms condense the attention of over 2.91 billion monthly active users as of June 2021. Meta generated $117.9 billion in revenues, in 2021, of which $114.9 billion was from advertising (97.4% of the total revenues) and over $2.2 billion from Reality Labs (the augmented and virtual reality products arm).
It’s all about mixing things up to find your own recipe
Each model we saw above isn’t a complete business model that can be applied entirely to a company.
Often business models are the fruit of the combination of several parts. For instance, Airbnb and Uber are on-demand, peer-to-peer marketplaces.
Amazon is an e-commerce platform, which leveraged over the years on affiliates to spin its flywheel.
Many businesses we analyzed throughout the research use several models to build a successful business model.
For instance, Google leverages an open-source model for some of its products, while it monetizes its core product (the search engine) with a hidden revenue model and it also leverages on making its products free to large masses to gain traction quickly and make of its products a standard!
Thus, finding your digital business model will require time, customer feedback, vision, understanding of the existing market, and potentially opening new markets.
Level of digitalization of a business model
Digital and tech business models can be classified according to four levels of transformation into digitally-enabled, digitally-enhanced, tech or platform business models, and business platforms/ecosystems.
When looking at a digital business model, there might be several layers of digitalization of a company.
You start from a level where digital channels are primarily leveraged to amplify the reach of the product and service. Thus, there is no change in real terms of the product or service, but only in terms of perceived value.
A second step, if when the wall between product and marketing/distribution is wrecked off, there you start getting a digital business, in a sense, as finally, the digital part becomes a key component of the product’s value proposition.
And from there you can move to tech business models or platforms, where the technology becomes the key enhancer of the value proposition.
A tech business model is made of four main components: value model (value propositions, mission, vision), technological model (R&D management), distribution model (sales and marketing organizational structure), and financial model (revenue modeling, cost structure, profitability and cash generation/management). Those elements coming together can serve as the basis to build a solid tech business model.
Blockchain-based business models and the Web 3.0
As we move toward Web 3.0, it’s important to understand how Blockchain Business Models work, and below is a FourWeekMBA framework to analyze them:
A Blockchain Business Model according to the FourWeekMBA framework is made of four main components: Value Model (Core Philosophy, Core Values and Value Propositions for the key stakeholders), Blockchain Model (Protocol Rules, Network Shape and Applications Layer/Ecosystem), Distribution Model (the key channels amplifying the protocol and its communities), and the Economic Model (the dynamics/incentives through which protocol players make money). Those elements coming together can serve as the basis to build and analyze a solid Blockchain Business Model.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
