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Revenue Models: The Advanced Guide To Revenue Modeling
Revenue modeling is a process of incorporating a sustainable financial model for revenue generation within a business modeldesign. Revenue modeling can help to understand what options make more sense in creating a digital business from scratch; alternatively, it can help in analyzing existing digital businesses and reverse engineer them.
A business model is a framework for finding a systematic way to unlock long-term value for an organization while delivering value to customers and capturing value through monetization strategies. A business model is a holistic framework to understand, design, and test your business assumptions in the marketplace.
A revenue stream is one of the foundational building blocks of a business model, and the economic value customers are willing to pay for the products and services offered. While a revenue stream is not a business model, it does influence how a business model works and delivers value.
For the sake of this guide, we’ll look at a key distinction: symmetrical vs. asymmetrical in several contexts. Remember that all classification methods have flaws and we can only take them into account as long as they help us better tune an existing business model.
I decided to use this classification, but any alternative classification works as long as we are able to grasp and understand the possibilities we have in terms of business model design.
Symmetrical vs. Asymmetrical business models
In an asymmetric business model, the organization doesn’t monetize the user directly, but it leverages the data users provide coupled with technology, thus have a key customer pay to sustain the core asset. For example, Google makes money by leveraging users’ data, combined with its algorithms sold to advertisers for visibility.
Business models can be of various types. For that matter, there might be as many business models as the companies we have in the marketplace. In this guide, we’ll use as reference symmetry vs. asymmetry to distinguish across two main business models categories.
In this particular case, we’ll look at revenue modeling by keeping a key distinction between symmetry and asymmetry from three different perspectives.
Users: who don’t pay for some or all the services offered by a platform (on the user-side), but they help the platform build it’s a core asset
Customers: who pay for the services offered (on the customer-side) to take advantage of the core asset of the platform
In such a business model, the platform assembles the anonymized data of its users who get a free service in exchange.
The assembled data gets processed (by the platform AI and algorithms) and it’s used to scale the platform, build a valuable core asset that can be financed by a set of customers willing to pay for it.
Asymmetrical: users ≠ customers
The asymmetry here stands in the fact that users and customers are two separate entities (asymmetrical cash model: users ≠ customers).
Think of how Google sells ads to companies, while its core products are all free to users.
Symmetrical: users = customers
Thus, in a cash symmetrical revenue model, users and customers are the same entity (symmetrical cash model: users = customers).
Think of how Netflix‘s users are also its customers.
Information: does the user know how the platform make money?
If there is information asymmetry it means there is one of the parties which knows more than the other side.
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. The company is profitable, yet it runs on negative cash flows due to upfront cash paid for content licensing and original content production.
In a symmetrical model, revenue generation is revealed, thus enabling the customers to know what they get for the service paid.
Scale: does the platform retain its margins as it scales?
Scale is the ability of a company to grow exponentially while keeping its margins grow with the platform’s revenues.
Symmetrical and Linear: margins tighten as the platform scales
In a linear symmetrical revenue model as the platform scales its margins tighten up, thus reducing the profitability of the platform.
Asymmetrical and Non-linear: margins keep growing as the platform scales
In a non-linear asymmetrical revenue model as the platform scales margins keep growing, thus keeping the platform highly profitable.
Spotify is a two-sided marketplace where artists and music fans encounter on a single platform. Founded in 2008 with the belief that music should be universally accessible with a seamless experience based on streaming audio and video. It generated over €4 billion in 2017, of which almost 90% based on premium memberships and 10% based on a free service that is ad-supported. The company recorded an operating loss of €378 million in 2017.
Freemium
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.Dropbox generated over 90% of its revenue via its self-serve channels to convert users in paying customers through in-product prompts and notifications, time-limited free trials of paid subscription plans, email campaigns, and lifecycle marketing. Dropbox generated over $1.1 billion revenue in 2017, with an average revenue per paying user of $111, $305 million in free cash flow and 11 million paying users
Subscription-based
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. The company is profitable, yet it runs on negative cash flows due to upfront cash paid for content licensing and original content production.
Consumption-based
Amazon AWS is a business unit of Amazon which sells cloud services, which are primarily consumption-based.
Commission-based
Airbnb is a platform business model making money by charging guests a service fee between 5% and 15% of the reservation, while the commission from hosts is generally 3%. The platform also charges hosts who offer experiences with a 20% service fee on the total paid amount.
Hidden revenue
In an hidden revenue generation the service provided is free, in so targeted or relevent that the average user doesn’t even realize how the platform makes money.
Razor and blade
In a regular razor and blade revenue model, the company sells the “razor” product at cost, while selling the “blade” at extremely high margins.
Direct
Tesla is vertically integrated. Therefore, the company runs and operates the Tesla’s plants where cars are manufactured and the Gigafactory which produces the battery packs and stationary storage systems for its electric vehicles, which are sold via direct channels like the Tesla online store and the Tesla physical stores.
Indirect
While Apple uses a hybrid distribution approach. A good portion of Apple’s products are sold via indirect distribution channels, like third-party cellular network carriers. This matter to understand, how, for years Apple has been able to sell expensive tech products at a wide audience, as it leveraged on indirect channels.
Hybrid revenue models
Amazon runs a platform business model as a core model with several business units within. Some units, like Prime and the Advertising business, are highly tied to the e-commerce platform. For instance, Prime helps Amazon reward repeat customers, thus enhancing its platform business. Other units, like AWS, helped improve Amazon’s tech infrastructure.
A good example of a business model that has different revenue models is Amazon. Based on each side of its business, Amazon has different revenue streams and models:
Within the Amazon core consumer e-commerce platform, there are two main types of revenue streams:
Amazon-branded products: on those products which are labeled and sourced by Amazon, the company sells them directly to consumers. Therefore, this is part of the revenue model, where Amazon has the highest margins and more control.
Amazon’s third-partiesproducts: those are products that Amazon hosts on its own e-commerce platform. Those products benefit from Amazon’s e-commerce visibility and sustained traffic. At the same time, Amazon will have the advantage of increasing the variety of products available in its stores, thus making them more appealing to consumers. However, compared to the branded product, Amazon will less control and reduced margins. Indeed, Amazon will split the revenues with third-party sellers.
To enable more capabilities to third party e-commerce stores, and at the same time, guarantee a better experience on its e-commerce (and we can argue also to have more control and margins) Amazon introduced over the years the third-party seller services:
Amazon third-party seller services: fulfilled by Amazon, perhaps enables sellers to host their inventories, and delivery with Amazon, thus collecting a royalty as a result of the sales made on the platform. Here, the revenue model is flipped. Indeed, Amazon will collect most of the revenues coming from the product sales (remember that Amazon also takes care of storing the inventory and fulfilling it to customers) and the seller will collect a royalty, thus a % of the sale.
Other revenue streams comprise:
Product advertising: Amazon is the most popular product search engine. Over the years it gave the options to e-commerce built on top of Amazon, to gain more visibility both on an impression or on a click-through rate basis. This means that Amazon sells advertising with a bidding model (similar to Google Ads).
Amazon Prime: born as an attempt by Amazon to increase the repeat business on the e-commerce platform, Prime turned into a real streaming entertaining business, competing with other companies, like Netflix. This revenue stream follows a subscription-based model.
Amazon AWS: Amazon AWS turned into a cloud infrastructure able to support many small, medium, and enterprise customers. The revenue model here runs primarily based on a consumption basis. Therefore, with a logic of pay-as-you-go.
Other Key Components of a Business Model
Your UVP is the exclusive feature or benefit you offer to your customers. It could be anything at all. If you offer a service, it could be “100% pay after satisfaction”. It could be a time factor offers. Say you provide a service that reviews CV. Your UVP could be “Get a revamped résumé in 24 hours”. This makes you stand out from every other person offering that service, as your unique offering is the ability to deliver in 24 hours. Your slogan could also be your UVP, as it automatically gives your audience what to expect from you.
The cost structure is one of the building blocks of a business model. It represents how companies spend most of their resources to keep generating demand for their products and services. The cost structure together with revenue streams, help assess the operational scalability of an organization.
In corporate finance, the financial structure is how corporations finance their assets (usually either through debt or equity). For the sake of reverse engineering businesses, we want to look at three critical elements to determine the model used to sustain its assets: cost structure, profitability, and cash flow generation.
Technological modeling is a discipline to provide the basis for companies to sustain innovation, thus developing incremental products. While also looking at breakthrough innovative products that can pave the way for long-term success. In a sort of Barbell Strategy, technological modeling suggests having a two-sided approach, on the one hand, to keep sustaining continuous innovation as a core part of the business model. On the other hand, it places bets on future developments that have the potential to break through and take a leap forward.
A distribution channel is the set of steps it takes for a product to get in the hands of the key customer or consumer. Distribution channels can be direct or indirect. Distribution can also be physical or digital, depending on the kind of business and industry.
A marketing channel represents the set of activities necessary to create a distribution for a product and make sure that the product is delivered in the hands of the right people and that the potential customer is satisfied with it. The marketing channel also needs to be aligned with the brand message of the company.
Other Revenue Model Case Studies
BuzzFeed is an American digital media company founded by Jonah Peretti, Kenneth Lerer, and John S. Johnson III in 2006. BuzzFeed had a focus on viral content. BuzzFeed’s website relies on advertising to make money. Advertising revenue streams comprise display ads, video advertising, native advertising, affiliate marketing, and subscriptions via the BuzzFeed News service.
Farfetch is an online luxury fashion retail platform founded by Portuguese entrepreneur José Neves, a stalwart of the fashion industry since the 1990s, with the vision of allowing anyone to purchase clothing from high-end brands from cities like Paris and Milan, from the comfort of their home. The company makes money through commissions, fulfillment services, and wholesale distributions.
Revolut an English fintech company offering banking and investment services to consumers. Founded in 2015 by Nikolay Storonsky and Vlad Yatsenko, the company initially produced a low-rate travel card. Storonsky in particular was an avid traveler who became tired of spending hundreds of pounds on currency exchange and foreign transaction fees. The Revolut app and core banking account are free to use. Instead, money is made through a combination of subscription fees, transaction fees, perks, and ancillary services.
eToro specializes in social trading, multi-asset brokerage, online investing, and Bitcoin exchange. EToro has a similarly diverse revenue generation model with a diverse product range through fees applied to CFD and non-CFD trades. Overnight and weekend interest fee. Withdrawal fees and conversion fees.
Oracle is a behemoth software company, founded in 1977 by Larry Ellison, Bob Miner, and Ed Oates. The company primarily followed the on-premise software model, but it mostly successfully transitioned to the cloud model. In fact, by 2020, cloud services represented most of its revenues. Indeed its lineup of software products comprises MySQL, Java, Middleware, Oracle Linux, and many others.
Zalando is a multi-national eCommerce company founded in 2008 by David Schneider and Robert Gentz, created under the name Ifansho, changed to Zalando as a reference to the Italian word zalare – or “making jokes”. Zalando generates revenues by purchasing stock and then selling it for a profit. Zalando also charges brands it partners with a commission for the privilege of selling on its platform. The commission Zalando collects on each sale is undisclosed. Zalando also collects advertising revenue from ads placed on its website and app.
E-Trade is a trading platform, allowing investors to trade common and preferred stocks, exchange-traded funds (ETFs), options, bonds, mutual funds, and futures contracts, acquired by Morgan Stanley in 2020 for $13 billion. E-Trade makes money through interest income, order flow, margin interests, options, future and bonds trading, and through other fees and service charges.
Tinder is among the most popular dating apps. Initially named MatchBox, it leveraged a “double opt-in” mechanism that helped remove the initial friction of having to meet strangers. Later on, the product was renamed Tinder. The company (now parts of the Match Group) makes money via its main subscription plans and premium features like boosts and super likes.
ClassPass is a North American fitness class provider using a flat-rate monthly subscription model. ClassPass primarily makes money via a subscription model leveraging five main plans, ranging from $15/month to $199/month. It also provides enterprise services to large companies like Under Armour, Morgan Stanley, and Google. Besides, ClassPass charges a cancellation fee of $15 if a cancellation is made within 12 hours of the class start time.
Reddit is a social news and discussion website that also rates web content. The platform was created in 2005 after founders Alexis Ohanian and Steve Huffman met venture capitalist Paul Graham and pitched the company as the “front page of the internet.” Reddit makes money primarily via advertising. It also offers premium membership plans.
Pricing Strategies
A pricing strategy or model helps companies find the pricing formula in fits with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricing strategy aligns the customer with the company’s long-term financial sustainability to build a solid business model.
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