Co.Design

Want To Upend An Entire Industry? Change Its Revenue Stream

By looking at the eight possible revenue models, writes Jump's Ryan Baum, you can reinvent a business.

Imagine it’s 1997 and you’re sitting in a small room in Los Gatos, California. You’ve decided that you are going to get into the movie rental business. That’s right, you want to dethrone a huge entrenched competitor that has been dominating the industry for years, Blockbuster. How would you design the next big idea to disrupt the industry?

Most conventional wisdom tells you the next step should be one of three possibilities. You can either do some brainstorming and come up with 100 new ways to improve the movie rental experience, do some research to understand movie renters’ deepest needs, or do some accounting and find out how to build a business that operates at a lower cost than Blockbuster.

However, an oft-overlooked way for a company to reinvent its business can be found buried deep in its business plan—the revenue model. A company’s revenue model, very simply, is the way it makes money. Does the company charge a subscription to its customers like a local gym does, or does it make its money through advertising like a blog? When choosing a revenue model, most companies wait until the very end of development and simply look to what market leaders are doing, altering it slightly. But when considered carefully, the revenue model can be a very powerful tool. By changing the revenue model, a company will change its entire business.

Imagine what our movie rental business would look like if instead of charging for each rental, we charged a monthly subscription. If customers are monthly subscribers, they should be able to keep movies for as long as they want, so late fees no longer make sense. But that causes logistical challenges, because if people are holding on to movies indefinitely, how will the company manage inventory? Perhaps it could entice people to provide their preferences in advance via an online list. Then, if customers provide their preferences ahead of time, why make them come to a store at all? Why not mail them their movies?!

And thus you have designed a highly profitable and wildly disruptive new video rental service, Netflix. To be fair, Reed Hastings and his team at Netflix didn’t go through these steps exactly as above, but it’s easy to see how thinking about the implications of a new revenue model has the potential to change the whole business. And revolutionize a market.


Eight Types of Revenue Models

Any business will benefit from rethinking the implications of changing their revenue model, and doing so early in the design process rather than as an afterthought. However, the task of doing so may seem daunting due to the enormity of ways that a company can make money. Professor Andy Hargadon at UC-Davis has come up with a useful framework for revenue models.

There may be an infinite number of variations a company can use to make money, but they really all boil down into eight types:

1. Unit sales: Sell a product or service to customers. GE uses this method when they sell microwaves.

2. Advertising fees: Sell others the opportunities to distribute their message on your space. Google uses this method with its search product.

3. Franchise fees: Sell the right for someone else to invest in, grow, and manage a version of your business. McDonald’s uses this method with its stores that are independently owned and operated as franchises.

4. Utility fees: Sell goods and services on a per-use or as-consumed basis. Most electric companies use this model when they charge customers only for the electricity they use.

5. Subscription fees: Charge a fixed price for access to services for a set period of time. Gold’s Gym charges a monthly or yearly subscription fee for people to access their gym.

6. Transaction fees: Charge a fee for referring, enabling, or executing a transaction between parties. Visa charges a transaction fee to retailers each time a customer purchases a product in their store.

7. Professional fees: Provide professional services on a time-and-materials contract. H&R Block makes money by charging customers for the time it takes to prepare their taxes.

8. License fees: Sell the rights to use intellectual property. Every time a customer buys a T-shirt or a hat with the logo of their favorite sports team on it, that team makes money from license fees.


Using Revenue Models to Design a Business

Any company leader can look at the eight revenue models and brainstorm new ways to reinvent their business. Doing so early on in the design of a new business concept will not only lead to different ways to make money, it will lead to different businesses. By bringing revenue model ideation into the design process, and thinking about the implications of those revenue model changes, a company can find their own versions of "no late-fees" and "online queue" to upend their industry.

Ryan Baum applies his analytical mind and deep consulting experience to help clients develop growth strategy in a variety of industries, including healthcare and hi-tech. Ryan previously worked at both strategy and design firms, and spent several years consulting on sales and marketing strategy to the health care industry. He has also spent time helping technology and pharmaceutical startups develop the business rationale needed to raise additional rounds of venture capital funding. Ryan holds a B.A. in ethics, politics, and economics from Yale University, where he completed a thesis on urban education and tax policy.

[Top image by Pixel Addict]

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13 Comments

  • DrDanEng

    Fantastic post. Thanks for sharing! I'd like to add a suggestion for no 9: Performance fees. Fee according to the results for the client of our work. Example: a designer that suggests energy-efficient renovations measures for a building could get paid by part of the energy costs saved for the client.

  • ralph

    What about banks? Would the interest they collect on loans be a subscription fee (services for a set period of time) or a transaction fee (enabling a home purchase)? I am ignoring all the ridiculous fees and side bets of course...

  • Mike Godwin

    Why not include some of the revenue streams non-profits are accustomed to persuing: donations, grants, and bequests, for example? I'm sure Encyclopedia Britannica would concur these are viable models.

  • SECasson

    While I agree that the revenue model is an important key to Netflix success I feel it is their overall business model (distribution) that makes them the 10X change/disruptive force in the video rental biz.

  • Pete Mortensen

    This is a really good point,  . It seems to be that there are lots of different variations within each of the eight revenue models, which is why they make great prompts for brainstorming. For example, if we're doing unit sales, what are the units we're selling? For Netflix, they could have had you subscribe to a service where each month they sent their favorite movies, not yours. 

    It's not just about choosing one of the models, it's seeing how you would implement that model, and how that would change the offering itself...

  • patelc75

    Where would kickbacks fall? For example, when a financial planner receives kickbacks from the mutual fund company when he/she recommends a fund. It is a "transaction fee" but might need special recognition

  • C Todd Lombardo

    I tend to look at it through the framework of Saul Berman: (http://www.fastcompany.com/174...

    Package Model Innovation - Change the contents of the package. Think about entire songs versus ringtones (5-10seconds)

    Payor Model Innovation - Who else can derive value off the ecosystem? Advertising model is a great example: Google and Facebook are great examples. We use the service for free, but advertisers pay.

    Pricing Model Innovation - Think Freemium: a small portion of users pay a premium for a larger majority to use for free. 

    Another way to split it is to consider behavioral segmentation (this gravitates towards pricing model, but not limited)

    Cheers,
    C. Todd Lombardo

  • Lon McGowan

    It had never occurred to me to spend so much time in the onset considering different revenue models.  Really helpful having this consolidated list.  I've printed for future reference.  Thanks 

  • Pete Mortensen

    Tvrobertson, I would argue that "Shared fees" is a form of transaction fee. The revenue model of the parent company is unit sales -- they sell a good for a fixed price, and the revenue model of the sales organization is transaction fees -- they take a cut of the overall price.

  • Sean Sherwood

    Zahir, look at a subscription based model, and ask the clients about their pain points.  This will allow you to tailor the subscription around those points and bring a recurring revenue stream.  As well, sell the fact that by effectively amortizing the fixed cost over a year with their subscription, they pay less up front, ensure follow up service for a year, and have peace of mind.

  • Tvrobertson

    You forgot "shared fees" where a company provides training to people to "sell" their products or services and give them a share of the sales price in the form of a commission. A very significant revenue model in many industries.

  • Zahir Palanpur

    Have you seen unique revenue models for service companies? I have a interactive design and software development company and most clients prefer fixed estimates.