Is Your Revenue Model Right for Your Business?

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Q: How do you turn a business idea into money?

A: Design and implement the right revenue model!

Your revenue model is how you profitably match your product or service with your desired customers. No other business decision has more potential to make or break your business. In fact, your entire business will be structured around your revenue model.

The revenue model impacts marketing and sales efforts, and it also affects product and service design, which is why it’s one of the first decisions you need to make when you start a new business. I also recommend that you re-visit the model every year or so when you’re updating your strategic plan.

Let’s start with a couple of classic – and successful – revenue models.

Razor and Blade: Razor companies are actually in the business of selling razor blades. They attract customers by selling cool new razors at a good price, and then keep selling them disposable razor blades. Once they have you as a customer, they find it easy to keep you – that’s where their profitability comes from.

You may have run into a variation of this model with your laser or ink jet printer. What are the printer companies actually making their money on? That’s right – the toner and ink.

Cell phone service providers also use this model. You probably already realize that the cell service providers don’t make money on the phone they sell you – far from it! But by locking you into a service contract, they have automatically recurring revenue.

Freemium to Premium: This model is well known in the software industry, especially with cloud-based solutions where the base subscription is free or very inexpensive, and power users pay a hefty subscription fee for a much more robust product. However, the basic idea has been around for a long time in more traditional businesses as well. A variation is the free sample. For example, many grocery stores give out free food samples to shoppers, who then often purchase the product itself. This model is usually combined with another model (for example, the subscription model for a cloud based application).

Here are a few other typical models:

• Franchising: prove your concept and sell to others in order to grow; benefit from franchise fees and sometimes product sales.
• Price Segmentation: often used in business-to-business commerce; larger purchasers get better prices or advantageous terms.
• Loyalty programs: certain types of customers get better pricing; often used in retail where once a customer gets to a certain lifetime purchasing level, they automatically get a discount on all future purchases.
• Licensing: someone else markets and sells your product and you get a cut.
• Direct Sales: consumer or business to business.
• Multi-Level Marketing: you’re selling a business opportunity as well as a product.
• Affiliate Marketing: often combined with other models; benefit from the sales efforts of others.
• Internet Marketing: includes social media, email, and other ways of driving traffic; often combined with another model.
• Sticks and Bricks: traditional location-based retail, often combined with internet marketing.
• Direct to Consumer: cutting out the middleman or retailer and selling direct.
• Subscription-based: works for many different services and some types of products.
• Product Plus Related Service: a good example is automobile dealerships. A significant part of dealer profit comes from servicing what they sell.
• “Get the Spec”: become a trusted supplier of a product that is a part of another business’s product. Your customer reorders every time they manufacture their product. The sale happens once; the key to keeping the customer from switching to another provider is service and sometimes price.

So how do you choose the right model? The key is to clearly understand who your customer is and what their buying behavior is likely to be. Here are a few questions to ask:

1. What problem does my product or service solve?
2. Who has this problem and is therefore my potential customer?
3. Do they know they have the problem? Or do I need to educate them about it?
4. Where and how can they be reached?
5. Is there a typical industry standard for how they make purchases? Who makes the purchasing decision?
6. What other solutions are available in the marketplace? How are those solutions delivered?

As you work through this, you’ll come up with more questions of your own, and the answers will help you determine the best revenue model, or combination of models, to build your business around. Don’t be afraid to try more than one! Successful businesses often change their model several times before they design the one that’s the most profitable.