Choosing Your Path to Profit: Demystifying the 3 Leading Revenue Models for Businesses
Imagine if Henry Ford, the founder of the Ford Motor Company, had opted for a subscription-based model instead of selling cars individually. Would the automobile industry have evolved differently? The way a business generates revenue can be a defining factor in its success, and choosing the right model is crucial.
Business is “simple” (at least in theory): you just need to make more money than you spend. However, the way you choose to make your money will have implications for every other aspect of your business. Picking the right business model can make or break a company.
Fortunately, there are plenty of examples that can help in the decision making process. In this article we’ll demystify the three main revenue models:
Bonus: Freemium as a mix between them
We'll examine their advantages and disadvantages, and delve into how they impact a finance team's operations. We'll also provide examples of successful companies that have adopted these models.
Ready to explore? Let's dive in and unravel these revenue models— because getting it right can make all the difference.
In a subscription-based model, customers pay a recurring fee, typically on a monthly or annual basis, to access a product or service. Chances are you’re subscribed to at least a few of these subscription-type apps or services and noticed how easy it is to forget about them. This model is popular with software-as-a-service (SaaS) companies, streaming platforms, and online publications, among others. One of the main advantages of subscription SaaS is that you won’t have to chase users for payment once they subscribed.
Adobe (Creative Cloud for individuals and businesses)
Microsoft (Microsoft 365 for consumers and businesses)
Netflix (streaming services for individuals and business partnerships)
Salesforce (CRM platform for businesses, but also caters to individual users)
Spotify (music streaming for individuals and business background music services) [** you’ll aslo see Spotify in the also advertising category when looking at their free service]
A transaction-based model generates revenue through individual transactions, such as sales or commissions. This model is prevalent in e-commerce, marketplace platforms, and service-based businesses like real estate or financial services. Many companies choose this model when users already have a behavior that drives their transactions (e.g. a business doing Sales via Shopify; there’s no need to lock them into a subscription + revenue scales with usage). Also many high-ticket enterprises use one-off transactions for custom projects and/or large annual enterprise deals.
Amazon (e-commerce for consumers and Amazon Web Services for businesses)
eBay (online marketplace for individual buyers/sellers and businesses)
PayPal (payment processing for consumers and businesses)
Shopify (e-commerce platform for individuals and businesses)
Square (payment processing for consumers and businesses)
Accenture (high ticket custom software/consulting projects)
Ford (one-time payment for a car)
An advertising-based model derives revenue by displaying ads to users or selling ad space on their platform. Examples include social media platforms, content websites, and mobile apps.
An ads-based model is great for companies who get a lot of eyeballs from a well defined demographic/ large userbase. It will be easier to convince advertisers to pay for the service to get access to that userbase than convincing individual users to pay for the service. Honorary mention: Freemium— many platforms/apps offer a free version with ads and a premium version without ads that can be unlocked for a fee/subscription.
Facebook (social media platform with ads targeting consumers and businesses)
Google (search engine and ad platform for consumers and businesses)
Instagram (social media platform with ads targeting consumers and businesses)
LinkedIn (professional networking and ad platform for individuals and businesses)
Twitter (social media platform with ads targeting consumers and businesses)
The freemium model is a combination of "free" and "premium." In this model, a company offers a basic version of its product or service for free, while more advanced features or additional services are available for a fee. The idea is to attract users with the free version and then encourage them to upgrade to a paid version for additional benefits. Freemium models can exist without advertising, and companies can generate revenue solely through premium subscriptions or purchases.
Spotify (Advertising & Subscription)
Evernote (Free & Subscription)
If you read the article carefully you may question some of the categories for some of these companies that you know and love e.g. Amazon. While most would agree that Amazon is a transaction-based revenue model they make a considerable amount of their revenue from their Prime subscriptions. It’s not always one or the other. Especially, larger companies like Adobe, Salesforce etc will usually have multiple revenue models.
Which opens up the question of which one is best?
Choosing the Best Revenue Model
There's no easy answer to picking one model over another. What may be helpful is analyzing the pros and cons of each, keeping them in mind as you scale.
As Mark Manson suggests in his NYT bestseller, "You choose your struggle”— each model will inevitably have drawbacks. It just depends on which of these cons you may want to mitigate and feel prepared to tackle.
As a CFO or member of the finance team, a business's choice of revenue model will also have a number of implications, such as the role accounts receivable plays.
While subscription businesses may struggle more with churn, transaction-based businesses tend to experience higher friction around accounts receivable. Fortunately, there are many ways to mitigate each downside, for example, by implementing accounts receivable automation tools like Tesorio to streamline higher-friction processes in the finance department.