Business-model-canvas- revenue streams

© Entrepreneurial Insights based on the concept of Alex Osterwalder

One of the building blocks of Business Model Canvas is Revenue Streams. In this building block, we explore what revenue streams represent for the entrepreneur and how to ensure that this building block is adequately addressed. We will explore the two types of revenue streams available which are either transaction based or recurring revenues. We will look at 1) revenue streams, 2) developing your revenue model, 3) types of revenue streams, 4) pricing mechanism, 5) ways to generate revenue stream, 6) key revenue model and market questions, and 7) two case studies.

REVENUE STREAMS

This building block elaborates the earnings a business gets by subtracting the costs from the revenue generated from each customer segment. Where customers are generally considered the heart of the business, revenues are automatically likened to the arteries. Organizations must evaluate the worth of the value they provide to each customer segment. An accurate evaluation of this worth will result in multiple revenue streams being gained from a single customer segment.

It isn’t just enough for a business to cite ‘keeping customers happy’ as their business mandate. Most businesses focus just on their customer policy, resulting in incomplete canvases where revenue streams are entirely ignored. It is important to differentiate that this building block represents the cash, not the profit, that the business has flowed in, at present.

Revenue streams need to be as clearly defined as possible. Hence, it is not just enough to list the sources for your various revenue streams but equally important to specify their pricing and projected lifecycles too. The reason for listing these details is to evaluate whether it is profitable for your business even to opt for a revenue stream or not. If the cost of designing and producing a product is more than what the customer is willing to pay for it or greater than the revenues the product will rake in before its lifecycle ends, then it does not make business sense to go ahead with the product.

Many businesses hesitate to conduct a full analysis of their revenue streams because they feel unable to price it right without creating a complete prototype of the solution. However, a smarter more effective way to price a product is to understand how big a role the problem plays in the customer’s life and what they are willing to pay to solve the problem.

Revenue streams are differentiated by differences in pricing mechanisms; fixed list prices, bargaining, auctioning, market dependent, volume dependent or yield management.

DEVELOPING YOUR REVENUE MODEL

The most important aspect of understanding the revenue streams of your business is through forecasting. This is an exercise carried out throughout the life of your business because as the business climate and industry evolve, so does your forecast. Typically there are two types of forecasts being carried out by organizations; top down and bottom up. Listed below are the most important factors to consider when deciding on the revenue model your organization will follow:

Choose the Closest Fit

Select a revenue model that is the closest fit to your organization and its context. Your revenue model should essentially help set the direction of your development efforts. Hence, if your organization is characterized by a heavy presence of engineers, it may be prudent to invest in a technology model where research and development take the lion’s share of the organizational effort and focus. You can also choose between having linear projections or exponential ones.

Magnify Your Value

The revenue model you pick must magnify the value your organization has to offer. Your revenue model should highlight what sets your organization apart and how you are unique in providing value to your target consumer.

Attract the Right Investors

The revenue model you select is also key to attracting the right kind of investors to your business. When you pick development areas, it helps to know which of these areas are close to your target investors’ hearts and develop pitches around these areas. This helps cement the legitimacy of your business in the investors’ eyes. Fundamental to being successful in finding a good potential investor is to ensure that the investor takes a holistic view of the business and is in it for the long haul as opposed to the typically myopic investor looking to make a quick buck.

It is an undeniable reality that all investors are looking for when their investment will yield returns and it is just as important for the entrepreneur to know when the business will really start making money and become self-sustaining. Despite this, entrepreneurs should set a time limit on their forecasts. Any predictions that go beyond 1 to 2 years are unrealistic and represent data that cannot be depend on.

Be Flexible

Flexibility is a key characteristic of new businesses, and this extends to the revenue model. Your entire business structure may not change, but one must constantly be looking at whether the revenue model is working for the business or not, and if not, what the necessary adjustment should be done. Hence, an entrepreneur needs to spend a great deal of time forecasting and re-forecasting and looking at which permutation of the revenue model will support his business in the most lucrative way.

Your business hinges on a lot of variables and it is essential to know how these variables impact the bottom-line, and what factors have the most effect on these variables. Variables are dependent on a number of things such as your processes and lifecycle. Each variable must be looked at separately, and one way to do this is through a sensitivity graph, which will help show where the revenue improves or worsens when manipulating the variables.

It would be silly to have your head in the sand about your variables and their possible impact on your business. They are a risk and being aware of risk is key to having a successful business. Hence, as an entrepreneur your aim should be to mitigate for the variables. Mitigating for variables lends a degree of transparency to your business. This transparency is not just important for you as a business owner but is also of great interest to your investors.

TYPE OF REVENUE STREAMS

Revenue streams can be divided into two categories;

1. Transaction Revenue

These revenues are earned from the customer making a one-time payment for the product or a rendering of a service.

2. Recurring Revenue

The recurring revenues are earned from consistent ongoing payments rendered to the company for either the delivery of the value proposition of after sales care for the customer.

PRICING MECHANISM

Pricing mechanisms refer to the effect of the pricing of a product on its expected demand and supply. This is essentially a tool to match buyers to the sellers of a product. Each revenue stream in a business can have its individual pricing mechanism. The pricing mechanism selected has a significant impact on the revenues generated by the revenue stream in question. Pricing mechanisms can be divided into two types; a) fixed pricing and b) dynamic pricing.

1. Fixed Pricing

This kind of pricing, as the name suggests, remains uniform due to the lack of variability in the inputs that go into the product.

Fixed List Pricing

Fixed list pricing is the pricing mentioned by the manufacturer for a product, service or value proposition of an organization.

Product feature dependent

When a product has a number of value propositions important to the customer, it may be priced according to the amount of such features.

Customer segment dependent

This kind of pricing takes the target customer segment and their various traits into account.

Volume dependent

As the name suggests, the more quantity a customer purchases, typically the lower the price will be.

2. Dynamic Pricing

This type of pricing changes according to the variables that go into the product as well as the conditions prevalent in the market.

Bargaining

This refers to when a price is negotiated between two or more parties. The outcome of the negotiation is dependent on who holds the power at the negotiation table as well as the relative skills of the parties involved.

Auctioning

In this kind of dynamic pricing, the final price is dependent on the customers and their perception of the worth of the value the product or service holds. Usually, the product or service, goes through a process called bidding where target customers share what they are willing to pay for the product or service. The customer proposing the highest price gets the product or service.

Yield Management

In yield management, the price is completely dependent on inventory and the time of purchase. It is a kind of variable pricing where the product or service has a time limit on it, and companies use customer intelligence to create revenues. Airlines and hotels are the most common adopters of this pricing model.

Real-time market

In this kind of pricing, the onus of responsibility goes to the supply and demand for a particular product. The price keeps fluctuating depending on how much customers want the product and how much is available to sell.

WAYS TO GENERATE REVENUE STREAM

1. Asset sale

This kind of sale refers to the transfer of ownership rights of a physical product from the seller to the buyer. At Amazon.com ownership rights of a myriad of products such as books, music and electronics are sold to the buyers. Similarly, Honda sells the ownership rights of the cars it manufactures to the buyers after which the buyer has complete freedom to rent out, use or even total the car.

2. Usage fee

This kind of fee is usually charged by service providers to customers for the use of the service. Hence, an internet provider will probably charge a customer for using their line for a certain number of minutes during the day or month. A beautician may charge her customer according to the number and nature of treatments the customer undergoes while under her care.

3. Subscription fees

When a user requires long-term or continuous access to the products of a company, they pay a subscription fee. Hence, a gym may sell a yearly membership subscription to its customer. Cable providers may charge a subscription fee to its users based on the time for which they will pay upfront.

4. Lending/ renting/ leasing

Some organizations provide their customers with exclusive rights to their product for a limited amount of time for a set fee. Upon the end of this period, the organization regains ownership of the product. This kind of revenue model represents a number of advantages both for the company and the customer. The company enjoys recurring revenue from the customer for the mentioned period. On the other end of the coin, the customer has exclusive access to the product for the time he/ she require it without having to make a hefty investment. Hence, zipcar.com a popular car renting service in North America allows customers to rent their cars for a specified time period. This has become a very popular service in the cities it is available because it provides customers with the advantage of a car, without having to invest in buying one.

5. Licensing

Licensing is generally used when we are talking about products, services or ideas that fall under the parameter of intellectual property. This opens up a revenue stream for rights holders, who would otherwise have had to invest in manufacturing as well. It is common in the Technology industry for patent holders to license the use of patents to other companies and to charge a licensing fee for it.

6. Brokerage fee

When a company acts as an intermediary to ease the communication and transaction between two or more parties, they charge a brokerage fee. An example of this is when a headhunting firm matches a candidate to an organization looking for a particular skill set. The firm usually charges a percentage of the gross salary from the organization, the candidate or both.

7. Advertising

Companies that earn a fee through promoting another organization, product or service, charge an advertising fee for their service. Traditionally this kind of revenue was common only in the advertising industry. However, in recent times, with the boom of the internet and e-commerce, many websites are also using this as a main revenue stream.

KEY REVENUE MODEL AND MARKET QUESTIONS

Following are some key questions that can help an entrepreneur fill out the revenue stream building block more effectively:

  1. What benefits will encourage customers to pay more for?
  2. What benefits are customers currently paying for?
  3. How are they paying for these benefits right now?
  4. What mode of payment would be preferable to them?
  5. What percentage of the total revenue does each revenue stream represent?

CASE STUDY

Google

Google is one of the leading internet names in the world. For the purpose of this post, we will conduct an analysis of Google’s revenue streams.

As we all know, Google’s services are provided for free for the individual user. So Google’s revenues are derived from advertising that companies pay to have done to reach its bulk of online users. Google helps advertisers create advertisements through its auction-based program – Google Adwords. Advertisers then pay Google based on when customers click on the advertisements available. Google also provides advertisers with access to its network members through its Google Adsense program. Another option available to advertisers is Google’s DoubleClick technology through which audio and video advertisements are made available on Google Network member sites.

Google has generated 96% of its revenues from advertising for the past several years as opposed to Apple, that has earned 70% of its revenues through the sale of its products. Google has been experimenting with other possible revenue streams by evolving its search offerings, extending into Mobile space and attempting its hand at a Google-based operating system. It has even expanded into Enterprise based solutions. However, none of these avenues have resulted in major revenue streams for the company.

Gore Fabrics

Gore-Tex is a waterproof breathable fabric membrane that is trademarked by Gore, the company.

Gore generates revenue through the sale of laminated fabrics. Additional revenue generators for Gore is the seam sealing materials and machinery it owns. Hence, Gore sells the fabric but there is some hardware associated with the fabric that also results in sales and profitability for the company.

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Excellent case study for understanding concepts of revenue steams.