Your company’s revenue model affects every aspect of your business, including growth, scalability, and value. Whether contemplating a change or selecting a model for the first time, thoughtful planning is critical. As a fractional CFO, I have helped many CEOs choose and refine their revenue models. I will explain what a revenue model is, how it impacts your business, and how to change it when needed.
What is a Revenue Model?
A revenue model is a framework that clarifies how your business will provide or sell its goods or services to generate income. For instance, many software providers use subscription-based revenue models with tiered pricing for individual and corporate subscribers.
The best types of revenue models often involve recurring revenue streams. Businesses with such models are more sustainable and less stressful than those relying on one-time sales. Yet, there is room for creativity, such as mixing and matching models to achieve your goals. For instance, software providers might combine subscription revenue models with one-time implementation services for corporate clients.
Why Does Your Revenue Model Matter?
Your revenue model is critical to your overall business model, the blueprint for running your organization and consistently delivering value to its stakeholders. Besides affecting your longevity, it impacts your cash flow, how others (like lenders or investors) perceive your company’s worth, your ability to plan, and how you market and sell. Therefore, performing market research before selecting a model and revisiting it occasionally is essential to ensure it is appropriate for your needs.
How Revenue Models Impact Planning
Once you choose a revenue model, you can develop other business model aspects, such as your cost structure, pricing strategy, objectives, target customers, and marketing and sales. Then, you can use that insight to build a financial model to analyze cash flow.
If the model shows you will earn a profit within a reasonable timeframe, great. But if you learn that you will likely experience cash-flow issues, your revenue model and cost structure may be incompatible, and you must rethink your plans.
How Models Affect Execution
Another thing to keep in mind is that your revenue model will influence foundational aspects of your business. It affects your marketing materials, the structure of your contracts, invoicing, collection practices, and even compensation packages. It will also help you establish key performance indicators (KPIs) for tracking and reporting results.
In other words, it touches everything. It provides vital information for coordinating efforts and impacts your ability to secure funding or explore opportunities like partnerships or acquisitions. Your revenue model of choice becomes core to how you present yourself as a business.
4 Common Types of Revenue Models
Below are some common revenue model examples grouped by similar characteristics. But please remember that this is just a sampling, and each approach has pros and cons, so the trick is to create the right mix for your environment.
1. Pay-Per-Use Models
Sometimes referred to as transaction revenue models or sales revenue models, pay-per-use involves direct sales to end customers with no guarantee of repeat business.
With some pay-per-use models, vendors determine price by taking the cost of the product or service and adding a margin. Then, they adjust in response to supply and demand trends. That can result in shallow profit margins and unreliable revenue, making this model less stable. Common examples include:
- Markup Revenue Models
- E-commerce Revenue Models
In contrast, sometimes vendors set prices based on the value (or perceived value) of their products and services. They may provide a luxury shopping experience, a superior product, or specialized knowledge or skills. When that is the case, profit margins are more generous. Examples include those above, plus:
- Project-Based Revenue Models
- Commission Revenue Models
Vendors using pay-per-use models typically generate more income in other ways to create stability. Common tactics include upselling, offering complimentary products or services, or encouraging loyalty by making buying easier (i.e., Amazon Prime’s free shipping).
2. Recurring Revenue Models
Any model that delivers a predictable source of income could fall in the recurring revenue category. Investors and lenders prefer these models, but they often involve high upfront costs, so you must be able to show that your cost structure is sound. Getting funding could help you float that investment until you generate revenue, but you need a clear path to a return on the investment. These models include:
- Subscription Revenue Models
Customers pay a set fee every month or year. The subscription approach appeals to customers because fees are usually relatively low, and there is less commitment, while sellers like them because of the predictable income stream. Software as a Service (SaaS) revenue models typically fall under this category. - Consulting Models
Many consultants offer services on a retainer basis (a set number of hours or deliverables for a monthly fee). Such arrangements are mutually beneficial. Providers get a steady income, and customers get valuable skills while keeping their headcount low. Like the employer/employee relationship, finding the right fit isn’t easy, but once you do, these arrangements can work well for quite some time.
The trick with recurring revenue models is to make your product “sticky,” so customers stick around, even if their usage ebbs and flows. For instance, one way to make a product sticky is to make the customer’s life increasingly easier, so switching to a competitor is no longer appealing.
3. Advertising Revenue Models
The advertising revenue model often supports news and entertainment-related content and has done so since well before the age of digital media. Content providers sell space to advertisers who want access to their audience in whatever venue they control – streaming services, movie theaters, websites, YouTube, search engines, podcasts, billboards, etc. These models include:
- Pay-Per-Click, View, or Impression Revenue Models
Display advertising, where you earn fees based on viewer behavior. - Affiliate Revenue Models
Content providers earn commissions for personally promoting products.
The advertising model is great because you can earn money purely from giving others access to your audience. But first, you must build that audience and earn (and maintain) their trust. That typically means a significant investment in educational, informative, or entertaining content and a commitment to strict standards.
4. Passive Revenue Models
Another type of revenue model involves creating or acquiring something valuable and allowing others to use or buy it indefinitely. It’s a “passive” revenue model because once you invest, the result is mostly margin, but there will likely be ongoing costs for upkeep. Therefore, like every revenue model, ensure you understand precisely how the business operates before diving in. These models include:
- Royalty Revenue Models
Income from the use of intellectual property (manuscripts, designs, or formulas for which you have a copyright, patent, or trademark). - Digital Product Revenue Models
Create courses, eBooks, apps, etc., once, then sell them for as long as you like. - Membership Revenue Models
Provide access to communities, resources, and exclusive opportunities for a fee. - Rental Revenue Models
Buy property, then charge others for using the space.
How to Change Your Revenue Model
Changing your revenue model isn’t easy because it is integral to many aspects of your business, but sometimes it is necessary. For example, perhaps you want to offer new products or services. Or maybe your current model has become less profitable due to technological advancements or customer sentiment changes. When that happens, explore options and develop plans by asking yourself the following questions.
1. Why do we want to make a change?
How will changing your revenue model affect your business? Will it make selling your products or services easier, help you manage costs better, create a new revenue stream, or something else? Consider the risks and opportunities, capture them in writing, and ensure team alignment.
2. How does the proposed approach compare to what our competitors are doing?
Would the change bring you up to speed with what your competitors are doing? If so, it may be unavoidable. If, however, you are considering something unique, you must weigh the costs and benefits. It might become a valuable differentiator, but it could also make it harder to compete in certain situations.
3. What will our customers think of the change?
Will it make your customers’ lives easier, or will they need to adjust their behavior or incur extra costs? Naturally, the latter scenarios are less appealing. If you are unsure how they will respond, consider running surveys so you can make an informed decision.
4. How would external stakeholders (like investors or lenders) view the model?
Sometimes, a change of this nature will result in customer attrition, but you might be ok with that if it will make your company more valuable in the long run. Resurface the financial model we discussed earlier and rerun the numbers to ensure you can defend any proposed changes when speaking with stakeholders.
5. What steps must we take to adopt a new revenue model?
Some changes are simple. For instance, adding a premium offering to your subscription-based service may be manageable, requiring little more than tweaks to your solution, new marketing materials, and small billing changes. However, shifting from a cloud-based to an on-premise solution is likely another ballgame. Still, it might be worthwhile if it will make your business stronger financially.
The Bottom Line
Choosing a revenue model for your business is a big decision with lasting effects, so you are right to be cautious. It impacts every aspect of your organization and its future opportunities. If you would like to discuss your unique situation, please reach out, and I would be happy to talk.
