Which Revenue Model is Best for Your Business?

Profitability requires balancing growth potential with your resourcing, cost, and customer needs and expectations. This is a difficult line to walk, even for seasoned business professionals, and your revenue model plays a key role in determining your success.

The revenue model you choose is determined by a variety of factors, including your industry, product offerings, customer base, length of sales cycles, and the ever-changing market landscape. Selecting the right revenue model is an important decision that should align closely with your business goals. It's possible to choose a revenue model that gives you the flexibility to change course, but it's vital to make a well-informed selection from the start.

What you'll learn:

• What is a revenue model?
• Benefits of a well-defined revenue model
• Most common types of revenue models
• How to choose the right revenue model
• How to develop a revenue model
• Examples of successful revenue models
• Tools and resources for building revenue models

A revenue model outlines how a business generates income by identifying the sources of revenue, pricing strategies, and the value offered to customers.

Many companies have more than one source of revenue, or revenue stream, and your company's revenue model influences which revenue streams to prioritize and how to price products or services. Selecting a revenue model is one of the first steps in a series of important decisions that can make or break a business.

A revenue model is part of a company's overall business plan, which focuses on how your company will make a profit and deliver value to customers. While a business model is related, it represents what the company sells, while the revenue model provides the framework for how your products or services will be sold.

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A revenue model provides structure and guidance for strategic decision-making while you sustain and grow your business. The more well-defined your model is, the better equipped you'll be to spot trends or make adjustments if customer or market dynamics shift.

An effective revenue model allows you to:

• Establish consistent income streams to ensure financial security and longer-term sustainability.
• Predict how much revenue to expect so you can feel confident as you plan expenses and make investments.
• Understand the costs incurred by your products or services and analyze your profit margin.
• Confidently establish a pricing strategy that generates revenue for you and provides value for your customers.
• Gain insight into how your business (and revenue) might grow over time.
• Prioritize the lines of business that generate the most revenue, and allocate resources accordingly.

It's also worth noting that you don't have to stick to a single model. By regularly monitoring market demand and how customers respond to your product offerings, you can adjust your model accordingly. Some companies may even use several revenue models concurrently, particularly if they have different channels of business. A telecommunications company, for example, might offer subscription-based cellular service, but also employ a transaction model in their physical locations, where they sell phones or accessories.

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There are many types of revenue models that may be relevant to your industry and business model, but these are five of the most common.

Companies using this model sell products or services to customers as one-time transactions, generally for a flat price, and companies earn revenue from every transaction. Many B2C companies, or consumer brands, operate on a transactional model, but B2B companies can as well. Transactional models increase cash flow for companies because revenue is earned at the time of the transaction. This model doesn't guarantee repeat business, however, so it's often challenging to predict future earnings, and future sales may be impacted by changes in the market and economy. If we look at an auto dealership, the purchase of a car is a transaction. Once the customer drives the car off the lot, the transaction is complete and the customer may choose a different brand or dealership for their next purchase. By contrast, if the customer leased the car instead, the dealership can count on earning revenue (in smaller amounts) each month for the duration of the lease.

When to use: When you offer goods or services that customers can immediately derive value from.

Subscription models produce and require companies to manage recurring revenue, since customers are charged on a recurring basis (usually monthly or annually) for products or services. This model is common with SaaS companies, streaming services, media subscriptions, or member-based businesses like fitness centers. Subscriptions provide a more predictable and steady stream of revenue to businesses because there's generally a contractual obligation to use the product or service for a determined period of time. In subscription management , ongoing revenue depends on retaining existing customers who pay on time and renew.

When to use: When you offer recurring goods or services that customers can consume or use throughout the month, quarter, or year.

With this model, businesses typically offer a basic version of a product for free and then charge for premium features or upgrades. Many SaaS companies operate on this model, relying on the free product to help build brand reputation and provide value to the customer — at least, up to a certain point. Once the customer needs to do things like scale its number of users, access more advanced features, or customize the product, then it becomes time to upsell to a premium version. For example, one leading cloud storage provider offers free storage for up to 2GB of files. Once an individual or business exceeds this limit, there's a tiered pricing model for different amounts of storage capacity. Companies that use a freemium model also, by virtue of needing to make money, employ additional revenue models for paid products and services. In the case of the cloud storage provider, customers can select a paid subscription for a larger amount of storage.

When to use: When you can offer a version of your product or service for free and earn revenue through upgrades, add-ons, or a paid version. This model has a low barrier to entry, but high potential for upselling premium features.

Here, revenue is generated by letting customers use intellectual property, such as software or trademarks, in exchange for a licensing fee. This model is most suitable for businesses with proprietary content or assets, which you often see within the entertainment industry (think: movies, TV shows, music, and podcasts). The licensing fees create a revenue stream for the owner of the content, and the company licensing the content can then use it to generate their own revenue. For example, a streaming service can attract subscribers with original content, but also benefit by licensing content from other services to provide viewers with a more complete offering.

When to use: When you have intellectual property, such as software or trademarks, or proprietary content or assets that can be licensed and used by other companies.

Usage-based pricing models generate revenue by charging for how much a product or service is utilized. Charges are typically incurred per unit of usage — whether that's hours, transactions, or volume. Usage-based pricing is more variable and dependent on a customer's patterns. Once a pattern is detected, it becomes somewhat predictable, but can still vary. Your electric company, for example, may see higher revenue during the winter, when households run heaters more frequently. By contrast, in other regions, a customer's bill may spike over summer months when they're reliant on air conditioning. In any case, revenue spikes or drops alongside usage.

When to use: When you offer products or services that customers consume at varying levels, at will.

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Ultimately, companies should choose a revenue model that supports their business model. Consider the following criteria to inform your choice:

The revenue model you choose should align with your business goals and customer needs — both now and in the future — to support long-term growth and profitability. Remember that your revenue model defines how your products or services are sold, and misalignment can occur when teams are incentivized or motivated to pursue conflicting strategies. For example, going after new business at the expense of customer retention, or over-focusing on an older product instead of pushing a new one.

It's important to understand what value your product or service brings to customers, and this begins with knowing who your target or existing customers are and what they need, want, and expect from your offering. What are their preferences and — crucially — how do they perceive the value of what you provide? Keep in mind: how you value your product or service is less important than how customers do.

Consider the market trends within your industry and the revenue models your competitors have in place. You don't need to use the same model, but this is useful to help identify gaps and strategize your own offerings. Consider, too, what might make your offering more attractive to customers, and therefore competitive.

Every revenue model is subject to different kinds of regulations — things like data protection, taxation, and any contractual obligations or agreements. Ensuring compliance is important to avoid any legal or regulatory challenges. Your choice of revenue model is not dependent on this, but it's helpful to apply this lens early in the process and understand what regulations are in place for the revenue models you're considering.

Technology supports your revenue model, or can hinder it. Take inventory of the technology you already have in place, and whether any additional technology is needed to support the revenue model. In that event, is the technology within your budget, and will you be able to execute and manage the technology? For example, usage-based revenue models require robust tracking and reporting capabilities to ensure accuracy. You'll also want to ensure that your technology can scale with your business over time.

Mapping the customer experience end to end is imperative. The revenue model you choose directly affects how customers buy your product or service, whether that's in person, online, or through ongoing interactions.

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Thoroughly researching, understanding, and defining each key area below helps ensure that your revenue model is robust and aligned with business strategy, as well as flexible enough to adapt to change. The goal is to build a model that is both scalable and sustainable.

Revenue streams are all the different sources from which businesses make money, whether through products, services, licensing, or some combination thereof. It's important to identify all potential revenue streams and understand how each one contributes to the overall business. Once you do this, you'll begin to see where and how you're pulling in the most revenue in relation to the costs incurred for each revenue stream. Your overarching model may include different revenue models for different lines of business.

Your pricing strategy determines how your products or services are priced, and revenue management can help with this. (What is revenue management? It's the practice of using data and analytics to plan and optimize your pricing and predict customer behavior.) Pricing is based on many factors, including the costs incurred to create or maintain your product or service, how your customers perceive the value of your offerings, what competitors are charging, and so on. Depending on your revenue model, your pricing strategy might include things like pricing tiers, one-time or recurring fees, or surge pricing during high-volume, high-demand time periods. To analyze your pricing strategy, you can do things like performing a competitive pricing analysis or employing a value-based pricing model.

Sales and distribution channels are another critical component of your revenue model. It's important to identify how your products or services are sold — whether directly to consumers or via self-service online, or indirectly through wholesalers, retailers/resellers or partners. Consider the potential sales revenue , strategy, and cost involved for each channel. The cost of direct sales is typically higher than self-service, for example. Take a look at your competitors and their distribution channels, too, to ensure you're not missing a key opportunity.

Identify your target customer segments and understand how each of them contributes — or could potentially contribute —to overall revenue. Similarly to revenue streams, this insight helps determine where there are market gaps or barriers to entry that might affect your strategy. To identify your target customers, perform market research and use marketing analytics to gauge engagement on your site and social media profiles.

As you develop your revenue model, avoid these common pitfalls:

• Lack of customer research: Without doing your homework, businesses can fail to understand customers or target customers. This can lead to missing the ideal pricing point. Prices that are too high won't move products, and if they're too low, your product or service may be undervalued.
• To avoid this, conduct surveys, perform market research, and/or focus group interviews before selecting your revenue model.
• Underestimating customer lifetime value (CLV): Sometimes businesses focus only short-term revenue without considering the longer-term value of customer relationships. Prioritizing short-term gains can lead to unsustainable growth and harm the business.
• To avoid this, use customer data to calculate the lifetime value of your customer segments and choose a revenue model that maximizes CLV. This might mean offering subscriptions, upselling, or investing in customer retention strategies to maintain and grow customer relationships.

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Let's take a look at a few real-world examples:

1. Global audio-streaming service: This brand's widely-adopted music-streaming service operates on a freemium model. Anyone can sign up for a free account and listen to any content on the platform. The catch? They also have to listen to ads. The company generates its largest share of revenue by upgrading customers to ad-free paid subscription accounts. Additional, smaller revenue streams include advertising and collecting licensing fees for commercial use.
2. Global leader in digital media and digital marketing solutions: This brand operates on a subscription model across several cloud platforms and product suites. Pre-cloud, customers purchased a license and a version of the company's software as a one-time transaction. Over time, and with the times, the company's revenue model shifted to allow customers to pay for its products on a monthly or yearly basis, without ever having to buy the software. Other revenue streams may include paid support and training.
3. Major total beverage company: This globally recognizable brand is known and loved for an iconic soda and generates a large portion of its revenue through a licensing revenue model. Bottling partners purchase its trademark concentrates and syrups and pay licensing fees to manufacture and sell the branded beverages. The company also bottles and produces a portion of its beverages and sells them to retailers and distributors.

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Leveraging the right tools and resources can make the process of building a revenue model more effective. A few important tools to have in your toolbelt include:

• A customer relationship management (CRM) platform that can track customer relationships from a 360-degree view, manage sales pipelines, and analyze customer data can help mold your revenue model to better fit customer needs. Leverage reports and insights from customer data on an ongoing basis.
• An omnichannel revenue lifecycle management solution that can launch flexible revenue models, incorporate pricing rules, and optimize revenue streams. Revenue lifecycle management solutions should have robust analytics and intelligence built in to allow for in-depth analysis of business data. With this data, you can understand the performance of the revenue model and adjust strategies accordingly.
• Industry reports and case studies can also serve as a great resource and provide insights into industry trends and best practices.

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Taking the time up front to research, plan, and define your revenue model(s) goes a long way in setting your business up for long-term success. Look closely at the companies you admire and others within your space to determine what they're doing well, and how you can learn from them — and do even better. Once you have a well-defined revenue model, managing revenue with a revenue lifecycle management solution makes it easy to course correct and make strategic decisions that will maximize revenue and profitability as you move ahead.

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