Revenue Models: The Business of Driving the Bottom Line
Posted November 17, 2016 by
To ensure the economic viability of a company, a business needs to create a revenue model suited for its specific industry. This model must produce income that leads to profitability. The purpose of a revenue model is to project cash flow, forecast revenue estimates and communicate the company’s value proposition. This process is ongoing and should align with a company’s strategic plan. This article will describe a few of the most common revenue models applied in business practices.
Revenue Models vs. Business Models
It is important to note the difference between the terms “revenue model” and “business model,” as they are often used interchangeably. A revenue model outlines precisely how a business acquires income, how it sets prices, how it positions itself in the marketplace and how these elements relate to the overall strategy of the company. A business model is more comprehensive. Although opinions differ on its exact definition, a business model often includes one or more of the following elements: overall business strategy design, products, services, customer interaction policies, organizational strategies, value propositions and business logic, according to “Defining the Business Model in the New World of Digital Business” by Al-Debei et al. Clarification on these terms is key to understanding any individual revenue model’s place within a company.
Types of Revenue Models
Below are a few of the most common revenue model types.
Advertising is a very traditional form of revenue. In this model, income is earned by selling physical or virtual space to other businesses or individuals in order for them to promote their own products or services. Advertising can be found in an extensive variety of media outlets, such as billboards, TV, radio, newspapers and magazines. The model also includes promoted internet content and sponsorships. The internet in particular has its own unique subset of advertising revenue models. In the cost-per-thousand (CPM) model, for example, a company generates revenue by setting prices based on how many impressions per thousand an ad receives. Another internet revenue model, cost per click (CPC), charges advertisers based on how many times their ads are clicked by users.
While advertising has the ability to reach large audiences, it requires those audiences to be likely to engage with the company in order to be a revenue model worthy of a business’ consideration, explains BMN! Advertising also has the potential to diminish overall user experience, particularly on websites, which can prove detrimental for business outcomes. Examples of companies that commonly use advertising as a revenue model include Facebook and Pinterest.
Also known as Software as a Service, or SaaS, this revenue model consists of “software that is rented rather than purchased,” PC Magazine says. It is a subscription-based model in which a business allows others to use its software or services. Customers then have access to the software and its latest updates until their subscription ends. It is generally a revenue model designed for business usage rather than the general public.
The licensing model can be useful for managing the risks of software acquisition, which can be costly in terms of time, staff and budget requirements, explains Microsoft. However, SaaS can also prove problematic. The price may not be worth it based on a company’s budget, or a company may be hesitant to move its IT functions to an exterior source. Salesforce is a particularly well-known example of this model.
Manufacturing is the process of changing raw materials, substances or components into new or finished products. Revenue is earned when these products are sold. The process of manufacturingcan include any form or process of shaping, joining or finishing materials, explains the National Programme on Technology Enhanced Learning (NPTEL). Some subsets of these processes include welding, casting, printing, riveting, electro forming and forging. Businesses that use manufacturing as a revenue model may either manufacture their own materials or contract the work out to other factories, businesses and plants.
While manufacturing can be useful in that it allows businesses to control the quality and prices of their products, it can be an expensive, time-consuming process as well. Hewlett-Packard and General Electric are two famous companies that use this revenue model.
This model generates money by offering customers a product or service they pay for over an extended period of time (often monthly or annually), explains the Founder Institute. “Subscription” is a blanket word that covers a wide variety of services, from “item-of-the-month” clubs to streaming services such as Spotify and Netflix. While the model has the advantage of being able to generate automatically recurring revenue, it also requires a large customer base to be successful. Therefore, this model is useful only if business owners are confident that subscription rates will remain high.
This model offers customers its basic services for free, but charges for premium features, extensions and content. The Freemium model is useful for giving customers a chance to sample products for which they may pay later on. However, it requires a considerable amount of time and money to reach audiences, as well as convert free users into paying customers, explains the Center for Innovation and Entrepreneurship. The Freemium revenue model is used in companies such as LinkedIn and Dropbox.
While numerous revenue models exist, one size clearly does not fit all. To choose a successful revenue model, companies must assess which model will ultimately work best for their current needs and future goals.
Revenue Models as a Part of Understanding Business
Understanding revenue models and their respective characteristics is a key part of gaining a comprehensive grasp on business practices. Those seeking to learn more can benefit from earning an online MBA from Concordia University Texas. Obtaining an MBA opens up new career paths in the ever-evolving world of industry and entrepreneurship.