I am obsessed with figuring out various ways that any business model generates revenues. From a visualization perspective, I am working on setting up the components of a business model using a Lego-type modeling approach in order to make it easier to combine, mutate and re-combine your own business models. In some respect, this is copying nature's DNA structure and applying it to business modeling.
If your startup or business doesn't have a business model roadmap of how you're going to make money, the only hope you have is to gather enough eyeballs and flip your venture to someone who wants to reach those people with a business model you have not incorporated. Whether your intent is to flip your business or grow it to generate revenues, the roadmap is critical because it forces you to answer the one big question I ask entrepreneurs before investing: How do you make money in your business?
The current state of business models in the social media sector, is similar to the first Internet revolution. Acquiring eyeballs was of critical importance to any startup. The theory was, if you get enough eyeballs, sooner or later, the revenues would kick in after you've figured out the business model. Ten years later, the market conditions are different, but I am astounded at how many entrepreneurs do not spend enough time figuring out their business model and how to make money. There are many components to the business model but one critical dimension of any business model is the revenue building blocks.
Three Revenue Vectors
There are three revenue vectors in any business model for any company in any sector:
As an investor, I see many entrepreneurs making rocket science out of business modeling, but the basic components are actually simple — especially in the revenue vector equation. I carefully consider all possible combinations and additional vectors that can come about. But no matter how you slice it, these three vectors are the basic Lego-type components of any business model. The art and science of business modeling, using these vectors, is figuring out how to make them work in combination; which one of them should be used to spearhead the revenue stream and how they should evolve; and in what combination and re-combination.
Evolution of the revenue vectors
When entrepreneurs pitch me for money, I enjoy going through their business model to see how they see these three revenue vectors playing out in the startup phase and growth stages. I pray they don't tell me all three come into play at once because business models focused on all three revenue vectors simultaneously don’t play out easily in the marketplace.
Whatever your business, think about how these three revenue vectors play out and in what particular sequence. Start with one revenue vector then, as your business evolves, roll out the others at the appropriate time. Sure, there are exceptions to every rule, but the key is to not confuse the customer. Make it simple for anyone to understand. Which revenue vector you should focus on first depends on your market sector, sub-sectors, your product strategy and many other variables such as your capital requirement to fund the business.
One way to determine which revenue vector will work best for your venture is to analyze how your competition makes money in terms of the percentage of usage of the specific revenue vector. If your competition makes money primarily through advertising because that is the industry norm, for instance, then the natural approach for you might be to do the same. On the other hand, a better business modeling strategy might be to turn the revenue vector model upside down by focusing on another vector such as transactions.
If your competitors depend on advertising to make their money, then ask yourself if you can make money with transactions or subscriptions. Yeah. This requires thinking — hard thinking. I'm going through the exercise myself in one startup venture, to the point that I'm exhausted from thinking about all the possible revenue vector scenarios. Obviously, if you go the subscription route you need to understand why any customer, including current ones, would shift to paying you on a monthly basis. Your value proposition would need to be incredibly unique because, if your competition offers their products or services at a lower cost or zero cost, your revenue vector won't work. So it's back to the drawing board.
Where does Freemium fall in the category of the revenue vectors?
One big question I had for myself while analyzing revenue vectors is how the freemium vector plays out in the scheme of the overall business model. In other words, is freemium a separate revenue vector? Or does it fall within the other three standard vectors I mentioned? I've spent more than a few hours thinking about the freemium revenue model even though no money is generated. It's actually very simple.
Freemium, if you don't know the term, is a strategy used by high-tech companies where they offer a product or service for free to their consumer. The business theory is that once the user gets sucked into using a free service or product, they will migrate to some of the other revenue vectors. For instance, the company would be able to generate money through advertising because of all the eyeballs aggregated through the freemium offers.
The classification of the freemium.
What do you think? Do you think freemium should be considered a separate vector or do you think it should be considered as part of the advertising vector?
After much agonizing, I decided to classify freemium under the advertising vector because a freemium is a continuous sales promotion of the product or service. Yeah, that's it. I am embarrassed I didn’t immediately think about it in those simple terms. To go further, a freemium is nothing but a continuous sales promotion in the form of sampling. Proctor and Gamble, the Fortune 500 consumer goods products company, has been doing free sampling for more than 100 years. Nearly everyone, at one time or another, has received a free sample of their soap or toothpaste.
Now that I realize that freemium is a continuous sampling sales promotion, I can analyze how other companies in various sectors have used sampling strategies and promotions to acquire customers and then how they converted them into paying customers. As a result of the classification, freemium becomes a classic study of consumer products marketing. If you plan to use this strategy in your business, you should read up on sampling case studies under the sales promotion umbrella — which is part of the total marketing strategy to acquire customers at the lowest cost. The objective is to turn as many freemium customers as possible into paying customers through transaction and subscription models — unless your strategy is to become the advertising pimp of consumer eyeballs like many high-tech companies — including FaceBook and Twitter.
Freemium works in many scenarios. But once you aggregate a substantial number of eyeballs, you have to evolve your business model by using other vectors. From this perspective, a great evolution of the business model in terms of using the three revenue vectors is LinkedIn — they offer free services to anyone, making money on advertising and subscriptions. LinkedIn evolved their freemium business model by gathering as many eyesballs as possible, then once the networks effects and liquidity kicked in to give them market leverage, they introduced other revenue vectors.
The beauty of the Dropbox business model.
Dropbox uses a beautiful revenue vector scheme within their business model because they offer the consumer a free service and at the same time offer subscription choices to medium or heavy users. In addition, they use a licensing strategy for corporate customers. The natural evolution for Dropbox is to incorporate the advertising vector into their overall business model too.
Dropbox raises another business model revenue question: Is the licensing revenue stream a separate revenue vector or is it part of one of the other three vectors? We'll discuss licensing in various industries in one of the future business model discussions.
© 2013 entrepreneurdex
An entrepreneur and investor, with more than 25 years experience, he's worked with ventures in the technology, internet, media and publishing, entertainment, energy, and manufacturing sectors raising more than $300 million in capital for various companies and investing more than $50 million into startup and emerging ventures. He's sat on the boards of 11 companies, served as editor-in-chief of Futuredex, a private equity magazine. Follow Damir on Google+