Besides simple transactions, there are many ways to generate revenue. That’s even truer for software companies: Web distribution and the nature of software create various possibilities to monetize code. Think of licensed/freemium apps, service subscriptions, and others. All of these represent a certain mechanism that specifies how a business generates revenue. The structure of this mechanism is called a revenue model.
Here's our video breakdown of revenue modelsFor those exploring the world of business strategy planning, we’ll elaborate on the definition of the revenue model, and the correlation between business models and revenue streams. We’ll also analyze different types of revenue models and look at some examples to scrutinize the pros and cons of each approach. Finally, we’ll reflect on how to choose or develop a model for your business.
What is a revenue model?A revenue model is a plan for earning revenue from a business or project. It explains different mechanisms of revenue generation and its sources. Since selling software products is an online business, a plan for making money from it is also called an eCommerce revenue model.
The simplest example of a revenue model is a high-traffic blog that places ads to make money. Web resources that present content, e.g., news (value), to the public will make use of its traffic (audience) to place ads. The ads in turn will generate revenue that a website will use to cover its maintenance costs and staff salaries, leaving the profit.
Revenue models are often confused with business models and revenue streams. To avoid any misinterpretations, let’s quickly define these three terms that form a business strategy.
Revenue model vs business modelA business model (BM) is a broad term outlining everything concerning the main aspects of the business, all of which are contained in the answers to the following questions.
- What value will we create?
- How will we deliver it?
- How will we bring in revenue?
- How will we earn profit?
A business model canvas template by AltexSoftSo the BM describes how a business will work from the standpoint of value generation. Revenue models, on the other hand, are a part of the business model used to describe how the company gets gross sales.
Revenue model vs revenue streamA revenue model is used to manage a company’s revenue streams, predict income, and modify revenue strategy. The revenue itself is one of the main KPIs for a business. Measuring it annually or quarterly allows you to understand how your business operates in general and whether you should change the way you sell the products or charge for them.
But what are revenue streams?
A revenue stream is a single source of revenue that a business has. There can be many of them. Streams are often divided by customer segments that bring revenue via a given method. The two terms – revenue stream and revenue model – are often used interchangeably, since, from a business perspective, the subscription revenue model will have a revenue stream coming from subscriptions. However, models can name multiple streams divided into customer segments, while the principle of revenue generation (subscription) will remain the same.
Revenue model typesAny start-up, tech company, or digital business may combine different revenue models. The revenue model will look different depending on the industry and the product/service type.
Here we will pay more attention to the most common revenue models used in the software industry and online business.
Transaction-based revenue modelA transaction-based model is a classic way a business can earn money. The revenue is generated by directly selling an item or a service to a customer. The customer can be another company (B2B) or a consumer (B2C). The price of the product or service constitutes the production costs and margin. By increasing the margin, the business can generate more income from sales.
Selling products or services entails using different pricing tactics. While some of them may be considered separate revenue models, these tactics are often used in pairs. Because pricing tactics can be seen as pricing plans in a software business, we can clearly define the following types.
Licensing/one-time purchase. This entails selling a software product by license that can be used by a single user or a group of users. The general idea is to offer a product that requires making only one payment for it, e.g., Microsoft Windows, Apache Server, and some video games.
Subscription/recurring payment. Unlike licensing, a user receives access to the software by paying a subscription fee on a monthly/annual basis, e.g., Netflix, Spotify, and Adobe products.
Pay-per-use. This pricing tactic is mostly used by different cloud-based products and services that charge you for the computing powers/memory/resources/time used. Examples are Amazon Web Services and Google Cloud Platform.
Freemium/upselling. Freemium is a type of app monetization in which a user may access the main product for free, but will be charged for additional functions, services, bonuses, plugins, or extensions, e.g., Skype, Evernote, LinkedIn, and many video games.
Hybrid pricing. Sometimes pricing plans are a mixture of more than one. So that freemium plan might morph into some form of pay-per-use tiered plan. After passing some limit in computation or resources, a user can be forced to use or offered another type of pricing. Examples are Mailchimp, Amazon Web Services, and SalesForce.
Various combinations of pricing tactics can be used simultaneously, which is more often seen in cloud-based products that offer multiple payment options at once. The revenue model in this case remains based on the transaction and purchases made by the customers. The difference in pricing tactics will modify how the revenue is generated and basically depends on the type of product/service you sell.
The pros. You have full control over the pricing strategy.
The cons. The cons will depend on the industry/product type and pricing tactics, as the model itself imposes a constant generation of sales with the help of advertising and marketing strategies. The only con we might mention here is the financial burden connected with sales you will carry on your own.
Transaction-based revenue model examples. Nearly any company that produces and sells its products uses this type of revenue model. Examples are Samsung, Rolls Royce, Nike, Microsoft, Apple, Boeing, and McDonald’s, to name a few.
Advertisement-based revenue modelThe advertisement-based revenue model is a plan with which businesses make money by selling ad spaces. It is one of the most standard methods of producing top-line growth, and it’s valid both for online and offline businesses. It’s often used by websites/applications/marketplaces or any other web resource that attracts huge amounts of traffic.
The pros. Having a high-traffic resource allows you to monetize the ad space nearly instantly. Often, there is a strong demand for advertising space, especially with organic traffic and platforms with the target audience.
The cons. Running advertising campaigns to gain web visibility on various platforms like social networks is a standard marketing activity with targeting instruments more precise than ever. However, advertisements are everywhere, so you might think twice about whether you want to distract a user by placing an ad in your app – even if it is a secondary revenue stream.
Ad-based revenue model examples. YouTube, Instagram, Facebook, and Google are just a few prominent examples. All these platforms generate revenue by displaying advertisements to users and charging businesses for exposure. In addition to promotion, these platforms may also generate revenue through other sources, such as premium subscriptions or licensing agreements.
Commission-based revenue modelsA commission-based revenue model is one of the most common ways businesses make money today. A commission is a sum of money a retailer adds to the total cost of a product or service.
A commission may be charged per marketplace or transaction and can be assigned as a
- flat rate, a fixed sum of money for any type of transaction, e.g., a $450/300/1500 transaction is charged with a $20 commission;
- percent of transaction size, e.g., a $100 transaction is charged with a 10 percent commission – $10; or
- tiered commission, a percent or flat rate that grows based on the transaction volume, e.g., 50,000 transactions are charged a 4 percent commission, 150,000 transactions a 7 percent commission.
The pros. Revenue is easily predictable because of the sheer fee.
The cons. There are many problems bound to the concept of a commission, but the major one goes to the scalability of a business that’s attached to a transaction size or volume. In general, dependency on the product supplier’s sales makes generating revenue require upfront investments and competitive superiority.
Commission-based revenue model examples. Airbnb is a platform that allows individuals to list and rent their homes or apartments as short-term rentals. It generates revenue by charging a commission on each booking made through its platform. The commission is typically a percentage of the total booking cost and is paid by the host (property owner). Other examples are Booking.com, Uber, Lyft, Ticketmaster, Priceline, and Upwork.
Markup revenue modelMarkup is the type of revenue model with which you buy a product at a certain cost and then sell it for a higher price: The difference between the two is your profit margin. This model is often used by wholesale, retail, and service-based businesses.
For example, a wholesaler may be a bed bank — a B2B company that purchases rooms from accommodation providers in bulk at a discounted, static price for specific dates, and sells them to OTAs, travel agents, destination management companies, airlines, or tour operators.
Pros. Markup revenue models are straightforward, allowing businesses to easily calculate their profit margins on each sale. With this approach, businesses can be flexible with their pricing by adjusting the markup to reflect changes in the cost of goods or changes in market conditions.
Cons. While markups provide a great deal of flexibility, some organizations may not have enough resources to manage revenue and apply changes to their markup strategy based on the market state. So they set a uniform markup for all of their products or services. This may lead to prices being too low or too high and businesses may not be able to fully capitalize on the value of certain products.
Markup revenue model examples. In addition to bed banks, airline consolidators leverage a markup model to earn revenue: They are brokers that book flight seats in bulk at discount rates and then resell them to travel agencies. Examples are Mondee, Picasso Travel, and Centrav.
Affiliate revenue modelThe affiliate model is similar to the commission-based model. The main difference is that, with the affiliate model, you do not sell the product or service on your own platform, but rather redirect the customer to the original provider's platform to make the purchase and earn a commission on any resulting sales. An affiliate model is a contract between a supplier of a product/service and a promoter. A promoter can be another business/media resource/blogger that recommends a supplier’s product. The earnings will come as a percentage of sales or fees for the number of registrations done via referral links.
Businesses utilizing the affiliate model include metasearch engines as a unique example. Metasearch tools can be found almost everywhere. Their main difference with retailers is that they don’t sell products directly but offer comparison and search as a value. Advertising and affiliate programs are the main revenue models used to get earnings in this case.
The pros. Just like the advertisement-based revenue model, once you have a huge traffic resource, you might apply for an affiliate program to earn money. This will bring you income without any investments because you will basically generate traffic and leads for the affiliate program provider.
The cons. Unfortunately, the percentage of affiliate programs promised to the promoter is quite low. Sometimes it fluctuates between 1-2 percent and requires a high volume of sales generated through your links.
Affiliate revenue model examples. Blogging and event-promoting platforms like Broadway.com or TheaterMania generate revenue using this model. Among other examples are Amazon affiliate websites, e.g., Cloud Living and ThisIsWhyImBroke.
Interest revenue modelAn interest or investment revenue model relates to any type of business that generates revenue in the form of interest on their loans or deposit payments. These are most often banking or electronic wallet companies that work with financial operations.
The revenue is generated by making a loan to a customer or by a customer depositing or investing money (or other resources) into the business. At the end of a return period, a percentage of the loan sum will return as revenue. Debit/credit money provided with the bank accounts also relates to this model. That’s just one of the ways financial companies can make money, combining it with transaction fees for using their e-wallet/bank account.
The pros. The interest rate provides a clear view of what revenue a business will generate, as the percentage stays unchanged until the return period is over.
The cons. The regulations of an interest rate impact both the customer and the business. Sometimes it depends on the economic environment. Think of currency rate changes that influence potential and existing borrowers.
Interest revenue model examples. Many banks, credit card companies, and other financial institutions use the interest revenue model. For example, peer-to-peer lending platforms, such as LendingClub and Prosper, generate revenue by charging interest on loans funded by investors.
Donation-based or pay-what-you-want revenue modelsThis is a revenue model based on investments made by businesses or customers on a voluntary basis. The product or service itself is free to use by default, so that’s the primary value a company brings to the customer. The revenue is generated in the form of donations, or sometimes in the form of “pay-what-you-want.”
It’s important to mention that there is a difference between a donation-based business and a charity organization. A donation-based company is still required to pay taxes.
The pros. Because of the free access to the product, some companies manage to get increasingly popular, resulting in donations becoming a major part of their revenue.
The cons. The model is never used on its own and the revenue generated by it remains a secondary source because of its random/unstable nature.
Donation-based revenue model examples. AdBlock generates revenue through donations from users who support the development and maintenance of the software. At the same time, AdBlock offers a premium version of the software for a fee, which includes additional features and support. Among other examples is Wikipedia which relies on donations as a significant source of revenue. Additionally, the platform makes money through grants and partnerships.
There are many other revenue models, and a business or project may use more than one revenue model. It is important for businesses and projects to carefully consider their revenue model as it can have a significant impact on the overall success of the venture.
How to choose a revenue model for your business?Before choosing a revenue model, you need a fully developed business strategy that will include a prepared business model with all its key instances. That means you must take a few steps prior to selecting the revenue model.
Define your value proposition. Map out your product strategy by describing what the product is and what value it brings to the customer. Not all products can be sold: Can you recall the last time you upgraded your WinRAR to a full license? Also, you can analyze the future traffic for your app to understand if you can use ads in it.
Explore the market state and customer groups. This step is to define your user persona and understand how these users usually buy things. Some markets are inclined to purchase just one product, some are inclined to ignore upgrades or in-app purchases. A good example in this field is the death of music-selling platforms that were totally replaced by subscription-based streaming services like YouTube Music, Apple Music, Spotify, and others.
You may also explore the techniques on how to market your product in our dedicated article.
Analyze competitors and their products. You’ll need to learn what mechanisms and revenue streams your competitors use and how they manage their costs. This information will probably show you the market’s pitfalls and dead ends.
Looking at this simple matrix below, we can analyze the capabilities and needs of your company to help you decide the type of revenue model to use.
How to choose a revenue model frameworkDepending on your business model, the product or service you’re presenting to the user is a subject of exchange. This is your value proposition on the market, so you are in charge of choosing what you want to get back based on the market factors, target audience, etc.
Paid value proposition. In most cases, your value proposition costs money to use. Whether it’s a service or a software product, a customer will need to pay in some form to gain access to your value. Your revenue model in this case will be based on transactions. So develop pricing tactics that will depend on the nature of the product, the type of audience you’re trying to reach, the type of deployment, specifics of product usage, etc.
Free-to-use value proposition. If the value proposition doesn’t require money to use or you choose it to be free, then you need a third party to generate revenue for you. This could be anything based on the previously mentioned types, whether it’s ad space, donations, affiliate programs, or reselling.
The combination of the two will basically present you with the revenue streams that will focus on each of the customer segments. In the case of the paid value proposition, each pricing plan will be a separate revenue stream.