Revenue model

A revenue model is a framework for generating revenues. It identifies which revenue source to pursue, what value to offer, how to price the value, and who pays for the value.^[1]

Overview

The revenue model is a key component of the business model.^[2] It primarily identifies what product or service will be created in order to generate revenues and the ways in which the product or service will be sold. Without a well defined revenue model, thus a clear plan of how to generate revenues, new businesses will quite certainly struggle to emerge as they will face costs which they will not be able to sustain. By having a clear revenue model, a business can focus on a target audience, found development plans for a product or service, establish marketing plans, begin a line of credit and raise capital.^[3]

Types of Revenue Models

The type of revenue model that is available to a firm depends, in large part, on the activities the firm performs to add value to the product or service. When a business creates a product or service, it may use any of the following models:^[1]

• Production model, the business that creates the product or service sells it to customers who value and thus pay for it. This is the most common revenue model and a possible example would be a company that produces paper, sells it to either the direct public or other businesses who pay for the paper thus generate revenue for the paper company.
• Subscription model, the business provides a product or service to a customer who in return pay a pre-determined fee at contracted periods of time to the business. The customer will be required to pay the fee until the contract with the business is terminated or expires, even if he is not utilising the product or service but is still adhering to the contract. Possible examples are flat-rate cellular services, magazines and newspapers.
• Fee-for-service model, unlike the Subscription model, the business only charges customers for the amount of service or product they use. Many phone companies provide pay as you go services whereby the customer only pays for the amount of minutes he actually uses.
• Markup model, unlike the previous models, in this particular case the business buys a product or service and increases its price before reselling it to customers. This model characterises wholesalers and retailers, who buy products from manufacturers, mark up their prices, and resell them to end customers.
• Commission model, this model, is similar to the markup model as it is used when a business charges a fee for a transaction that it mediates between two parties. Brokerage companies or auction companies often use it as they provide a service as intermediaries and generate revenue through commissions on the sales of either stock or products.^[1]
• Licensing model, with this model, the business that owns a particular content retains copyright while selling licenses to third parties. Media companies obtain their revenues in this manner, as do patent holders of particular technologies.^[4]
• Advertising model, this model is often used by media businesses which use their platforms where content is provided to the customer as an advertising space. Possible examples are newspapers and magazines which generate revenue through the various adverts encountered in their issues. Internet businesses which often provide services will also have advertising spaces on their platforms. Mobile applications in particular use this specific revenue model to generate revenues. By incorporating some ad space, many popular apps such as Twitter and Instagram have strengthened their mobile revenue potential after previously having no real revenue stream.^[5]

Revenue Streams

A revenue stream is an amount of money coming in to a business or organisation from a particular source.^[6] A revenue model describes how a business generates revenue streams from its products and services.^[7] They are resultantly a key aspect of the revenue model. They are generated through the use of the revenue model components listed in the section above. Businesses continually seek for new ways of generating revenues, thus new revenue streams. Finding a new revenue stream has gradually taken on a distinct and specialized meaning in certain contexts to mean a new, novel, undiscovered, potentially lucrative, innovative, and creative means of generating income or exploiting a potential. This approach in particular can especially be applied to new technology and internet businesses which find extremely innovative ways of generating revenues, often ways which seemed not to be possible.^[8] As a result, technology-based businesses are constantly updating their revenue models in order to remain competitive. Advertising can be seen as a component of the revenue model, however, when the business is advertising its own products, this would result as a cost for the business which is the exact opposite of revenue. On the other hand, advertising can lead to an increase in sales thus revenue over a period of time. For the majority of businesses which will add value to a product or service that will be purchased by a customer, advertising is often a component of their business plan. Expenditure for this particular component is forecasted as it can generate greater revenues over periods of time.^[9]

Revenue Model vs. Business Model

Revenue model and Business model are often confused as people either treat them as being identical or being two completely separate models. The business model allows investors and bankers as well as the entrepreneurs themselves to have a quick way of evaluating a business. Business models can be viewed in many different ways, however they are generally composed of the following six elements:^[10]

1. Acquire high value customers
2. Offer significant value to customers
3. Deliver products or services with high margins
4. Provide for customer satisfaction
5. Maintaining market position
6. Funding the business

The Revenue model is a key component of the business model^[7] as it is an essential factor for delivering products or services with high margins and funding the business. Less than 50% of the investment required to set up a business will be used in revenue-producing areas.^[10] It can not resultantly be viewed as being identical to the business model as it does not influence all the six elements but more should we viewed more as an inner component of it. Having a well-structured business model is necessary for the success of any business adding value to a product or service for customers. This will consequently include having a clear and tailored revenue model which will ensure its financial health. It provides the owners of the business with a necessary understanding of cash flows as well as how it will generate revenue and maximize profitability.^[11] In addition to the business model, financial targets have to be forecasted when creating an initial business plan whereby expected revenues and profits will have to be presented^[12] and thus calculated through the use of revenue models applied by the business.

References