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Revenue Streams in Business Model Canvas
© 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
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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