Understanding Startup Business Models
Choosing the right business model can spell the difference between startup success and failure. That's why it's so important for entrepreneurs to understand the pros, cons, and use cases of various models. Let’s dive in!
What Is a Business Model?
Essentially, a business model outlines how your startup works and earns money. It addresses crucial questions like:
- What value do you deliver to the customer?
- How do you deliver that value?
- How does the customer pay for that value?
- How do you convert payments to profit?
The key elements that make up a business model include your unique value proposition, customer segments, revenue streams, cost structure, resources, activities, channels, and partnerships.
Your business model essentially serves as a blueprint for how all the components of your company work together to create value, attract customers, and generate sustainable revenues. It's a holistic framework for how you operate your startup.
Business Model vs. Revenue Model vs. Revenue Stream
It's important to understand the differences between a business model, revenue model, and revenue stream:
- Business Model – The holistic logic for how a company operates and creates/delivers value to customers. It encompasses everything from value proposition to resource management.
- Revenue Model – How a company makes money from each customer segment. It focuses specifically on the revenue side of the business model.
- Revenue Stream – Each specific source of revenue for a company. A business model or revenue model may have multiple different revenue streams.
For example, a ride-sharing startup's business model explains everything from matching drivers to riders to ensuring reliable rides. Their revenue model entails taking a percentage commission on every ride. And revenue streams include commissions from regular rides, luxury rides, food deliveries, etc.
The business model is the big-picture view of how a startup operates sustainably. Revenue models and streams focus just on how it generates income.
Why Business Models Are Important for Startups
Your business model directly impacts all elements of your startup operations. It determines:
- How you generate revenue and profits: The revenue streams and profit formula in your business model influence everything from your pricing to sales processes.
- Your competitive positioning: Your business model shapes your startup's value proposition and competitive advantage. It's a key differentiator from rivals.
- Your growth opportunities: Some business models lend themselves better to rapid scaling and expansion than others.
- Capital and resource requirements: Certain business models demand more upfront capital, inventory, equipment, or other resources.
- Your cost structure: Your revenue model drives cost structure decisions like whether to focus on reducing fixed or variable costs.
- Team roles and competencies: Specific business model choices determine the types of expertise and talent you need in your startup team.
8 Common Types of Startup Business Models
There are many proven startup business models to choose from. Here are some of the most common:
Examples: Netflix, Dollar Shave Club
The subscription model provides ongoing access to a product or service with monthly/annual billing. Revenue is predictable, and value stems from convenient access and membership benefits.
- Predictable recurring revenue
- Build customer loyalty/retention
- Churn risks
- Higher customer acquisition costs
Examples: eBay, Upwork
Marketplaces connect users on both sides of a transaction, like buyers and sellers. Value is created by enabling these connections, and revenue comes from taking a % fee on transactions. Examples include ecommerce, ridesharing, home rentals, and freelance service marketplaces.
- Benefits from network effects
- Attractive unit economics
- Need critical mass of users on both sides
- Vulnerable to competitors
Examples: Facebook, Google
Media sites, search engines, and social networks commonly use the ad model. These platforms attract users through free content/tools and monetize through selling ad space. Value is created through quality free services.
- Scales massively
- Small marginal costs per additional user
- Relies heavily on data collection
- Privacy concerns
Examples: Dropbox, Canva, Mailchimp
The freemium model provides a free basic product to attract users and then upsells premium features or upgrades for monetization. Value is created through free entry-level access.
- Low barrier to entry
- Potential to upsell existing users
- Slow conversion from free to paying users
Examples: Amazon Associates, Shopify
In the affiliate model, companies pay commissions to “affiliates” for generating leads, clicks, or sales on their behalf. Affiliates earn through their promotional channels, while vendors acquire marketing reach.
- Little overhead
- Leverages influencer networks
- Low control, rely on the trust of partner brands
Examples: AWS pay-per-use cloud services, Audible
The pay-as-you-go model bills customers based on actual usage or consumption rather than fixed fees. Value comes from flexible, metered pricing. Common for cloud services.
- Matches customer payment to usage, flexibility
- Complex billing and usage monitoring
Examples: Walmart, Nike
This model often involves direct, one-time engagements between the customer and the business without ongoing commitments. It's commonly found in retail or e-commerce startups, where the primary focus is on making single sales rather than building recurring revenue streams.
- Simple and clear transactions
- No long-term commitment required for customers
- Less predictable revenue
- Potentially lower customer lifetime value
Examples: Salesforce, Slack
The SaaS or software-as-a-service model provides access to software applications over the internet for a recurring fee, usually monthly or annual. Companies avoid large upfront costs.
- Predictable recurring revenue
- Churn risks
- Costly to acquire customers
How to Choose the Right Startup Business Model
1. Understand Your Value Proposition
First, clearly articulate the core value you will provide to customers. Outline the specific problem you are solving for target customers and determine if your solution is primarily product-driven or more of a platform/network. Defining this value proposition is key to determining which business models could effectively deliver that value.
2. Define Your Target Customers
Create detailed buyer personas that analyze the demographics, behaviors, needs, and values of your ideal target customers. Outline what the customer journey typically looks like for engaging with your type of product or platform. Getting very specific on your customer profile and journey will inform suitable business models.
3. Evaluate Your Market Landscape
Do thorough research on competitors and alternatives in your space. Identify any gaps, opportunities, or customer pain points not being adequately addressed. Assess the overall market size for your solution and projected growth potential. Factoring in the competitive landscape will help reveal promising models.
4. Align with Core Team Strengths
Consider if you have the right mix of skills and experience within your core team to execute on a given model. Certain models align better with specific backgrounds and competencies. Choose a model that plays to the strengths of founders and early team members.
5. Evaluate Required Resources
Assess the key resources – financial, human, technical, equipment, etc. – required to successfully execute each potential business model under consideration. Evaluate if you have access to the necessary resources or if they would need to be developed or funded. Resources required often vary significantly between models.
6. Generate Business Model Options
Brainstorm two to three potential business models that seem well-suited to delivering your value proposition to target customers in your market. Weigh the relative pros and cons, trade-offs, and risks of each model under consideration. Review which models competitors are utilizing successfully or struggling with and develop a shortlist of viable models.
7. Project Costs and Revenue
For each potential model, estimate both the operating costs as well as the potential revenue based on your pricing strategy and target customer segment. Compare the costs and earnings across models to understand profitability. Choose a model that optimizes the financials based on your current resources.
8. Test and Validate Your Model
Share and discuss the two to three potential business models with prospective customers and people in your network. Gauge their feedback on what resonates or causes concerns about each model. Incorporate these customer insights into selecting and refining the best model. Experiment with the chosen model on a small scale first and be ready to adapt as needed based on market feedback.
Creating a Business Model Canvas
Every startup should create a business model canvas as a blueprint for their business. A canvas provides a structured way to analyze and define all key components of your business model in one place. This ensures you craft a model that covers all the essential elements required for success.
Elements of the business model canvas include:
- Value Proposition – What value you provide customers
- Customer Segments – Who your target customers are
- Channels – How you reach customers
- Customer Relationships – How you engage with them
- Revenue Streams – How you earn revenue from each segment
- Key Activities – What activities your business performs
- Key Resources – Assets required to create/offer value
- Key Partners – Outside parties you leverage
- Cost Structure – Your expense drivers
- Unfair Advantage – Exclusive edge over competitors
Overall, your canvas creates an actionable plan for your startup's business model. Revisit it often as your model evolves.