Navigating Revenue Models For Startups

Defining your revenue model is one of the most important decisions for startup founders.

Your revenue model sets up how you will operate your business, from attracting leads (marketing) to sales and operations.

However, there are many different models; you’re not choosing from just two options.

So, we've put together this helpful guide to walk you through choosing a revenue model. You’ll learn:

• What a revenue model is, and how they differ from business models
• Why early-stage startups need to get very clear on what their revenue model is
• Six types of revenue models and how to choose the right option for your company 

What is a revenue model? 

Simply put, a revenue model is how your business makes money. 

How are you receiving cash (revenue) for your goods or services? How are you monetizing what you do?

It seems simple, right? You create a thing (be it a physical product, a software platform, or a service you offer like marketing consultancy), and people give you money for it.

But how you charge for that product or service can be vastly different. Take a software platform, for example.

Will customers pay upfront for ongoing access, or will they pay monthly? Those are two common options: perpetual license (also known as the transactional revenue model) and subscription-based.

Things get a little tricky when the revenue your business receives doesn’t come directly from your end customers.

Let’s explain.

Imagine, for instance, you build a mindfulness-based mobile app. It’s a free download, meaning users don’t have to pay to access your content. However, you run ads on the platform, and your advertisers pay you for your audience reach.

Don’t worry. We’ll go into more details on each model a bit later.

How is a revenue model different from a business model? 

Revenue models often get confused with business models. However, there is an important distinction to be made here.

Your business model defines what your company does. It covers three aspects:

1. What your company does (i.e., are you an app, a marketing service, an online resource, etc.)
2. Who your company serves (your target audience, your customers)
3. What value your company delivers to buyers (how you solve your customers’ problems or enhance their lives)

It makes sense, but why does it matter? Can’t we just take a “build it, and they will come” approach?

Not quite.

The value of a defined revenue model for early-stage startups

Many early-stage startups focus very heavily on product early on but neglect to consider how they will generate revenue from the thing they’re building.

This might not seem so important when you’re in the early stages of launching your startup, but soon you’ll need to understand how you plan to monetize what you do, and a well-defined revenue model will become critical.

Defining your revenue model is important for several reasons.

First, it will inform your marketing and sales strategy. 

For example, if you’re building an app and you plan to use the freemium revenue model, then your marketing will need two arms:

1. A funnel for attracting new free users
2. A lead nurture sequence for converting free users to paid ones

Secondly, as you start to raise your next funding round, venture capitalists and angel investors will ask many questions about your strategy for generating revenue.

That is, they will ask about the revenue model you’ve chosen.

Lastly, a well-defined revenue model will inform pricing and help you build budgets and financial projections to grow and scale your business.

Consider two early-stage startups in the wellness industry:

• Company A sells an essential oil-infused bracelet for relaxation
• Company B sells a subscription service for calming music

Company A’s pricing will have to account for a higher cost of goods sold (COGS), potential returns, and other expenses. 

Company B needs to account for churn, customer acquisition costs, and lifetime value, among other things.

Your revenue model is about more than just how you’ll make money. It can impact nearly every area of your business, so you must choose wisely.

Types of revenue models 

So, you’ve got your head around why you need to define your startup revenue model. Now comes the hard part: choosing one.

Let’s look at 6 of the most common revenue models.

1. Subscription-Based Revenue Model 

The subscription-based revenue model is common for software companies and is becoming more popular as the idea of recurring revenue catches on.

Netflix is a great example of the subscription model in the B2C world, and Salesforce is perhaps the most well-known example of a B2B-facing subscription business.

In this revenue model, your customers pay for your product monthly or annually. They get access to all new features as they come out (assuming they are part of the pricing tier they’ve signed up for) but lose access once their subscription ends.

2. Affiliate Revenue Model 

An affiliate revenue model is an option for businesses that are essentially reselling (or recommending) another company’s products.

Amazon has one of the most well-known affiliate networks (Amazon Associates), with thousands of sites taking advantage of this revenue model, reviewing and recommending products available for sale on Amazon’s site.

Say, for instance, you design an educational website that reviews hiking equipment.

For each product discussed, you provide a link to purchase that item on Amazon. If the user clicks through, your affiliate code is tracked, and you earn a percentage of the purchase price if that customer buys.

This graphic illustrates the entire process.

3. Transactional Revenue Model

The transactional revenue model is the most common across the board, and it’s what you engage in when you head to a retail store to buy something.

Let’s say you need a new laptop.

You head to the Apple store (or, realistically, the Apple website), find the MacBook you want, and pay with your credit card.

That’s a transactional purchase.

The transactional revenue model is common for product-based businesses, like e-commerce retailers.

4. Service-based Revenue Model 

With the service-based revenue model, you’re selling your time or expertise.

Let’s say, for instance, you’ve just started a new marketing agency.

You will charge customers for your services, such as writing content, creating ads, or web design. This might be a one-off transaction (like if they’re paying you to build a new website) or an ongoing arrangement (for example, a monthly retainer for marketing consulting).

5. Freemium Revenue Model 

The freemium revenue model is generally used by apps and software companies that offer a free version of their product to attract new customers.

The idea is simple: users start with the free version of your product and receive value from it. As their needs grow (or they learn more about the great features your paid plans offer), they upgrade to a paid version with more features and capabilities. Once the free user converts to a paying customer, you start generating revenue.

Buffer is an example of a company that uses the freemium revenue model. Businesses can sign up for their free account to access basic publishing tools for a limited number of social media accounts. They need to upgrade to a paid subscription if they want access to more advanced features.

6. Advertising Revenue Model 

The ad revenue model can be used by websites and software products to generate revenue from a third party.

Consider the free version of Spotify, which is ad-supported. Customers get access to this platform for free, but they have to listen to ads every so often. Advertisers pay Spotify to reach their audience. 

This is just part of Spotify’s revenue model. 

They also use a freemium model, as users can pay to upgrade to an ad-free plan should they choose.

Key considerations when defining your revenue model

Choosing a revenue model shouldn’t be a blind decision, like pulling a name out of a hat.

There are three key aspects to keep in mind when defining a revenue model:

1. The value of your product
2. Your customers
3. Your competition 
   

The Value of Your Product 

What is your product worth (and what did it cost to produce)? What’s the likelihood that you can receive this value with the chosen revenue model?

For instance, if you go with an ad-supported model, will you be able to generate the same revenue value through advertising as you could through a subscription model?

Your Customers 

What are your buyer’s expectations? Are they used to a subscription model in your industry, or are sales generally transactional?

In addition, what kind of audience do you serve? An app aimed at young professionals is probably better off sold on a subscription model than a transactional one, as the audience may have less disposable income.

Your Competition 

How are your competitors charging for similar products? And most importantly, do you want to follow suit (and therefore have an easier time convincing customers) or differentiate (and take a risk but potentially win big)?

Take Home Message 

While several revenue models for startups are available, only one will be the best fit for your business.

Analyze your market, competition, product, and customer needs to determine the ideal path forward, but be prepared to do some testing and development as you grow.