The whole point of starting a business is to make money. So a key question to ask before opening up shop is where will the money come from?
This might sound simple, but it’s more complex than you think. What you’re trying to figure out in this segment is the strategy you’ll use to capture the most value from your customers. Every profitable business model has to turn its value proposition into profit. Factors like the pricing of your products or services are crucial in determining your revenue streams.
Will your customers pay a monthly or recurring subscription for products or services? Are you going for a one-time transaction-based payment model? Perhaps you are thinking of availing your services for free at first as Skype did in order to entice a portion of your customers to upgrade to the paid premium product?
The revenue stream segment maps out the money that will come in versus what will go out. Keep in mind that the focus should be on the income you generate, not on profits.
So what are revenue streams? Simply put, they refer to the various sources from which a business earns money from providing services or the sale of goods. The types of revenue that your business generates depend on the types of activities.
Revenue streams can be classified as operating revenues and non-operating revenues.
Operating revenues refer to the amount your business earns from your core business operations. So, for example, LEGO makes money selling LEGO toys.
On the other hand, non-operating revenues describe a business’s money from side activities. Going back to our LEGO example, the company opened a theme park in June 1968 that generated money from purchased tickets. In its first year alone, the theme park received 625,000 visitors.
Depending on the industry, there are also different types of revenue streams your business can make money from. The most common are:
- Revenue from the sale of goods or service fees. This type falls under the core operating revenue segment.
- Rent revenue: This is the amount earned from renting out equipment, buildings, or any other property such as Amazon’s AWS cloud storage. This is usually classified as non-operating revenue.
- Interest revenue: This type of revenue stream refers to the interest earned on investments such as debt securities.
- Dividend revenue: This is revenue that your company can earn from dividends paid out. It is classified as non-operating revenue.
A revenue stream can take the form of any one of these revenue models:
- Transaction-based revenue
This is money your business makes from one-time customer payments. Nike selling their shoes, for instance, is an excellent example of a transaction-based revenue. Once customers pay for a pair of Nike shoes, they aren’t going to pay for it again.
- Transactional %
The transactional % revenue stream is sometimes referred to as ”clipping-the-ticket.” Essentially the company takes a % of the transaction made through their platform. An example of this is Airbnb which partners with homeowners who list their homes on the platform. Once a customer books and pays, Airbnb takes a percentage of the total amount charged.
- Service revenue
Revenue is usually generated by providing customer service, and the amount is calculated based on time. A great example of this type of revenue is an event planning company. They price their service according to several factors such as:
- Number of guests (price per food per person)
- The prestige of the venue (amenities)
- Additional attractions
- The provision for the event manager and other employees or 3rd party service providers
- Project revenue
Money is earned through one-time projects with new or existing customers. An event planning company would also be a great example of this type of revenue. They manage one one-time project at a time and once the project is finished they will not be receiving any more revenue from it.
- Recurring revenue
This is common with subscription-based business models like Netflix and Spotify. This is one of the most reliable ways to get revenue. It is predictable and assures the company income from subscribed customers. But it is important to mention that in the case of Spotify the subscription fees are shared between Spotify and the record labels and artists that own the rights to the music.
Examples of recurring revenue streams include:
- Subscription fees: This Revenue Stream is generated by selling continuous access to a product or service. Charges the customer monthly for the use of the product or service
- Advertising fees: The company charges the customer a certain fee to advertise a product or service using the company’s platform. This revenue stream is often available once the product or platform is already successful and has ‘high traffic.’A good example is Google’s Ads revenue model.
- Renting, leasing, or lending assets: The customer pays to get exclusive rights to use the asset for a certain period. For example if you own an office building, your company can rent out office space.
- Licensing content to third parties: Here, the customer pays to get permission to use the company’s intellectual property. Netflix, for example, makes money from licensing some of its original programming to other streaming platforms and Networks.
Essentially, the freemium model provides users with a basic version that has limited features and ads like Spotify and YouTube. The intention is to convert them into paying customers. The product must be so good that the customer feels they just have to upgrade to the premium version for this model to work. So the key activity here would be to increase the number of people that convert from the free version to the premium.
Spotify is an excellent example of this. The premium version is free of ads and users can listen to music offline as well as download it. Additionally premium users listen to higher quality audio streams.
However, one downside of the freemium model is the amount of investment that has to go into implementing this model. Spotify had to spend a lot of money paying for licensing rights. In fact, at some point, the company was facing bankruptcy because they were pouring more money into licensing than what was coming in from ad revenue and premium subscribers.
You’ll need to ask several questions to come up with a workable revenue stream segment for your business. The following are some questions you can think about.
- How will your business gain or generate revenue?
- How many clients can you serve for free to stay profitable (freemium model)?
- What revenue model are you using?
- Do you want to focus on bringing extremely high value for fewer clients (one-time payments)?
- What value are your customers prepared to pay?
- Is your pricing based on actual or perceived value?
- How would they prefer to pay?
- Also when it comes to other things, like key resources: do you have resources you paid for once? And do you have other high maintenance costs to cover? Looking at Netflix for example, the company creates original content that they can license to others or sell. Those are assets that they’ve build over the time and can monetize.
- Writing a blog is another example, when you create content once and it’s ever-green, you attract people over and over again for years.
- You can also pay partners for bringing customers, in affiliate model. So you should ask yourself if you can afford paying the commissions. It’s the whole pricing model behind it.
- What costs could you get rid of?
- One example, which is referred to in many business books, is the Southwest Airline case. They offered low-fare flights, but they could do that by getting rid of all costs that were not related to the moving people from one city to the other by plane. So the food, the luggage space, business class, space for a passenger – all of those were removed in order to pack as many people as possible, remove all the costs of managing catering, and other things that were not crucial to the transportation service they offered. This revenue model had low fares with no premium services, it was simple, yet enabled much more people to afford flights that were very much costly up to this point.
- Can you come up with a sales tunnel?
- This is a notion of having several steps a company can figure out. For example you can have free articles, samples or limited services, served to large group of people as stage 1. In stage 2 you offer more value, but the customer has to pay for it. Additionally it has to be as automated as possible, so you can serve to hundreds of people, while your operating costs remain close to zero. In stage 3, for some percentage of those hundreds of clients from stage 2, who want more value or more personal assistance, you offer one-on-one services, like tutoring, consulting, that is expensive, but the personal assistance is the most costly of all.
- So some crucial questions here would be; How automated are your customer relationships? How costly is it to automate? Can you split or differentiate customer segments so you charge one segment one-time fees? If you have a large group that uses automated services, can you charge recurring subscription fees?
Figuring out how your company will make money is a crucial step in creating a profitable business model.