“How do you make money?” is one of the most popular questions investors are likely to ask you if you present your business or idea for funding. Most new startups don’t make money right from the beginning (don’t count on making money in your first year). Others generate some kind of money but not profit (not all revenue is equal).

If you don’t intend to seek investor funds, you still have to know how you intend to make money in the future, because you are a business, and all businesses are established to make money (unless you are a social business). A business revenue model answers the most important question about a new business: How will you make money?

These are three of the most popular revenue models used by greater percentage of online businesses. Billion-dollar online businesses like Facebook, Twitter, Evernote, Dropbox, Pinterest, Snapchat, Box and Spotify are using one (or a combination) of these business models.

1. Subscription based revenue model

Subscription based models or recurring revenue business models focus on a series of smaller, ongoing, subscription-based transactions. Users can consume a service or product as much as they like in an on-demand manner, as opposed to having to buy the entire offering up-front.

Rather than selling products individually, a subscription sells periodic (monthly or yearly or seasonal) use or access to a product or service.

-Why the subscription revenue model works

1. The value per transaction in a recurring revenue model are mostly lower than traditional business models. In  study by the Incyte Group, an independent research group, more than 1,000 U.S. businesses, nearly 50% had either adopted or were planning to adopt recurring revenue models.

2. Companies with recurring revenue models can capture data sets that track consumer trends and preferences on a much more granular level which in turn leads to optimization of pricing and packaging, and consequently the uptake from and retention of targeted buyers.

3. Subscription revenue models have gained enormous traction with the convergence of two major trends: businesses recognizing the financial benefits of recurring revenue, and their buyers demanding the flexibility and personalization these models provide.

4. Recurring revenue models are also built to scale as you grow out your customer base. Businesses benefit because they are assured a predictable and constant revenue stream from subscribed individuals for the duration of the subscriber’s agreement. It therefore reduces uncertainty and the risks associated with the business.

–Downsides of subscription model businesses

One of the biggest challenges of  this model is the subscriber churn/retention rate – customers could easily shift to a competitor’s business or move on to a substitute product or service. To prevent this, businesses try to lock their data (to prevent move) and try to give heavy discounts on long-term plans.

2. The Advertisement based revenue model

Businesses like Facebook and Twitter have elements of the free business model and the advertisement based model. Both  social apps are free for all of the millions of users but the apps (both web and mobile ) continues to evolve their offering to the public at no cost to the consumer.  They  can add multiple features to or change the platform in any given week or month.

In addition to fixing small issues or bugs, the company tests new products often, and different groups of users are unknowingly interacting with new features or design changes at all times.

Social business generate their revenues from ads they serve the millions of users who visit the sites daily.

Building out new features isn’t always the best way to go, however when competing against an established brand, you could better compete by offering one thing and doing it really well. Users can easily trust you with their data if they know you are an established business in that space. Once you are able to attract enough users, advertisers can easily do business with your company.

From a business standpoint, monetizing ads isn’t the way to go because it requires huge scale to generate significant revenue.

These types of ads are popular with businesses and advertisers.

1. Display ads. These are seen in most online media sites and the sides of content in popular sites. The advertiser is typically charged per instance of display (CPM – cost per thousand displays). Again, only sites with hundreds of thousands of visitors benefit from the display ads.

2. Pay per click ads. This is what Google and other search engines are using to generate revenue. The advertiser is charged only when the ad is clicked.

3. Media ads. These appear in songs played on sites or apps like Spotify.com, Pandora.com or YouTube. Usually the user is forced to listen to the ad  or in the case of YouTube forced watch the video ad before she can access the content, while it is easy to ignore the ad in the previous two variants.

4. Mobile advertising is ad copy delivered through wireless mobile devices such as smartphones, feature phones, or tablet computers. Mobile advertising may take the form of static or rich media display ads.

3. And the famous freemium revenue model. 

Give your service away for free, possibly ad supported but maybe not, acquire a lot of customers very efficiently through word of mouth, referral networks, organic search marketing, etc., then offer premium priced value added services or an enhanced version of your service to your customer base, now that’s freemium. Most companies may also start spending on advertising to promote itself in order to continue attracting more users.

What’s the catch: The longer you use the product, the more value you derive from it, and the closer you are to hitting the upgrade button.

The problem:  But by charging nothing for your service you’re actually anchoring that value in your customer’s mind, making it harder for the user to actually hit the upgrade button.

The freemium business model is quite popular with a lot of online businesses( basic service or features for free and advanced features at a cost). Most consumers prefer to use such services or apps since it offers an opportunity to actually get to use the product before making a decision to start paying for more features if it’s worth it.  Hootsuite and Slideshare  and LinkedIn have been very successful with this business model but they apply it in different ways with respect to their products or services.

In most instances where the freemium model is adopted,the gap between the free and paid version of the product (updates, feature fixes, versions, etc.) are not usually huge. Sometimes there could be as many as four different types of paid versions for users to choose from.

There are other shiny examples of successful freemium companies. With billion-dollar valuation for Evernote, Dropbox etc,  more people will point to freemium as the business model to strive for.

According to Dmitri Leonov (VP of Growth at Sanebox):

There are many benefits to having free users and focusing on hyper growth. But the decision to go the freemium route should be based on math specific to your business — not a pricing philosophy. Because the reality is, the freemium model doesn’t work for the majority of companies who try it.

–On  Developing Your Revenue Model

The revenue or business model your new startup will adopt should be obvious right from the beginning. Your revenue model gives you a necessary understanding of your potential cash flow and needs. It’s also a way to show your potential investors how you plan to earn revenue and maximize your profitability.

Don’t just settle for a popular business model but choose a model best for your company and background with future prospects in mind. Ultimately, you want to choose a model that helps you to direct your development efforts. Your revenue model should show what is unique about  your product and the value customers will get from using your product or service.

There are lots options to consider when it comes to developing your revenue model — but not creating a revenue model is not an option. Whether you intend to charge for your product or not you should think through the business model you are adopting and why it’s the best fit for your business.

Which revenue model works best for online businesses?

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