This is the second of a three-part series. Read Part I and Part III.
The following are some examples of business models that are used by various businesses. The list is by no means exhaustive and is designed to give you a feel for some of the models that exist (business models evolve constantly).
In many instances, the names can vary as they are not typically universally defined.
The Add-On model
In this instance, the core offering is priced competitively but there are numerous extras that drive the final price up so the consumer is not getting the deal they initially assumed. If you have recently tried to buy an airline ticket or car insurance, you will have spotted that the number of extras you are offered can almost reach double figures!
Add ons model
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The Advertising model
The advertising model became popular with the growth of radio and TV where the TV stations earned revenue indirectly from people looking to promote services to the audience they attracted, rather than via consumers paying radio and TV stations for the consumption of their TV programmes.
Some Internet businesses derive revenue predominantly as a result of being able to offer advertisers access to highly targeted consumer niches (often in the absence of revenue from selling their goods or services). So if your website is about a narrowly defined topic, it is likely to attract a highly defined niche audience who could be offered complimentary products or services with a higher probability of success than blanket mass market advertising.
However, this business model is increasingly difficult to justify if it is your main revenue stream. For a start, the landscape is extremely competitive and advertisers are spoilt for choice. Building brand awareness and translating that into site visits is a very difficult and costly challenge. Successes such as Facebook are very much the exception to the norm.
If this model is being considered for your startup, it is worth noting that nowadays most savvy investors ignore ‘vanity metrics’ such as Page Impressions/Visitor numbers and want to understand whether the underlying business proposition is profitable. Examples such as YouTube illustrate how hard it can be to monetise free content even when you have significant visitor numbers. In short, this model is in decline for most businesses.
The Affiliate model
An affiliate is simply someone who helps sell a product in return for commission. However they may never actually take ownership of the product (or even handle it). They simply get rewarded for referring customers to a retailer when they make a sale. Again this business model has been a huge success given the ease with which the Internet facilitates it.
The Auction model
The auction model is synonymous with eBay, these days, but of course auctions have existed for hundreds and hundreds of years. The tulip market in Amsterdam is one of the more famous examples. There are numerous different types of auction, from English, to Dutch, Vickrey, Sealed Bid, etc., and they all share certain characteristics: the price of the good is not fixed; each individual assesses the value of the good independently; final value is determined via competitive bids. This business model has become very popular in recent years as the Internet has helped to broaden its appeal.
The Bait and Hook model
This is essentially the razor blade analogy listed above, where disproportionate amounts of the value are captured on components, refills and the like. Anyone who regularly buys ink cartridges for printers will recognise this model where customer lock in and switching costs result in monopolistic pricing on the component side. The mobile phone business also grew rapidly on the back of this model as handsets were often supplied free of charge when you signed up for a contract. Nowadays with SMART phones, such is the level of demand for some that consumers have to pay hundreds of pounds for the phone and in many instances minimum contracts are 18 months.
The Direct Sales model
While direct selling was initially the primary ‘route to market’, production efficiencies coupled with improvements in transportation meant producers could reach a much bigger market and this resulted in the pre-eminence of the retail distribution model for many years. However the emergence of the Internet as a distribution channel meant that producers could disintermediate costly resellers and sell direct to customers themselves, in effect going the full circle. The PC manufacturer Dell is a great example of a company who is very focused on the direct sales business model.
The Franchise model
Opening a franchise is essentially buying a working business model in a particular industry. You pay royalties for the privilege but get access to a winning recipe, a support network and an established brand. Two famous franchise business models are McDonald’s and Subway.
The Freemium model
This is where the business gives away something for free in return for your personal details so they can then market to you and hope to build up a relationship so that you buy from them in the future. It is typically used in service-based businesses where the lifetime value of the average customer is high and is increasingly popular with Internet services such as Spotify, Skype, or Flickr. Many of these offerings have similar cost structures where the marginal cost of serving an additional customer tends towards zero. The core free offering then acts as a gateway to the paid service. For example, with Spotify, the free version comes with adverts, the paid does not.
The Internet Bubble model
At one point, ‘unique visitor’ numbers to a site had a large perceived value. Many businesses offered free Internet services and businesses were valued on the basis of potential rather than underlying profit and loss metrics. There are still remnants of this today, and some spectacular examples like Twitter.com, where the notional valuation of the company is considerable even though existing revenue streams are negligible. The actual business model is in effect getting lost in the media hype and proliferating user numbers, and it is more a case of ‘figuring the business model out at a later stage’ than up front. Naturally this is a highly flawed strategy and rarely works.
The Low-Cost model
The low-cost model can be summed up in one word: ‘Ryanair’. This is an extremely well established business model, where the aim is to drive significant volumes of customers (at a low customer acquisition cost) and by charging a very low price. In return, revenue is earned from a whole host of ancillary sources – these include:
The model is not simply about trying to extract a whole myriad of extra cash from consumers, but also configuring every single aspect of their business model so as to drive out cost. Examples include buying oil futures to manage oil price fluctuations, having destination tourist boards pay for newspaper advertising, having staff pay for their own uniforms and training, and so on.
The Pay as You Go model
With this model actual usage is metered and you pay on the basis of what you consume. Some mobile phone contracts operate on this basis i.e. the user can buy a phone card which gives them credit. Each call is metered and the credit is reduced as the ‘minutes’ are consumed (in contrast to subscription models where you pay a monthly fee for calls).
The Recurring Revenue model (Subscription model)
With the recurring revenue model, the aim is to secure the customer on a long term contract so that they are consuming your product or service well into the future. Given that the cost of customer acquisition can be high, retaining customers is a primary goal for most businesses. It is also becoming synonymous with ‘subscribing via direct debit’. Most utilities providers operate under this model. Magazine publishers have also been looking to expand this portion of their business for some time, offering heavy discounts to subscribers (who buy all issues directly), rewarding them over individual discrete purchases (bought on an ad hoc basis from various third parties).
The Somali Pirate Business model!
Business models do not just apply to legitimate businesses as this post, The Somali Pirates’ Business Model by Mark Leon Goldberg illustrates!
As the above illustrates there are numerous business models that can be considered and the number is growing on a regular basis. For example in the gaming industry alone, David Perry, COO of Acclaim Games Inc list 29 business models for games that he is familiar with.