Disciplined Entrepreneurship is one of the best books that every founder should read. This book provides a framework that entrepreneurs can follow when launching new businesses.
The book has a lot of tips and tools that will help you improve your odds of making a product people want. This is not the book summary, though I highly recommend reading the book. In this post, I want to share my takeaways on business models.
Your choice of business model has a far larger influence on profitability than your pricing decisions — Bill Aulet
The business model is an important decision that will have a significant impact on your profitability. It can differentiate you from competitors and give you an advantage over them. Your competitors can’t easily change their business model to match yours. Choose wisely.
Without further adieu, here are the 16 different business models to choose from for your next business.
1. Cost Plus
In this model, the customer pays a set percentage above the cost of producing the product. This is a common business model in government contracts as well as situations where you and your customer want to share the risk of building the product.
The challenge with this model is that it requires agreement on the accounting assumptions, trusting that the numbers are correct and will continue to be correct. It can also create incentives that reward activity rather than progress, which is bad for both you and your customer.
2. Hourly Rates
This model also tends to reward activity as opposed to progress, which can be the wrong incentive. But when a project is poorly defined or very dynamic, this might well be the perfect model. This is a common business model for a services firm.
In this model, a customer pays a set amount each month or another agreed-upon time. There are several variations:
- Annual or Multi-Year Commitment: This locks the customer in and provides them with predictable lower payments as opposed to a one-time up-front payment.
- Month-to-Month Commitment: This method gives the user great flexibility, and you can charge a much higher monthly payment.
In this model, you license your IP to customers and receive a royalty. In addition, you do not have to make big investments in production and distribution capability for the product.
However, there are several downsides to this strategy. Licensing generally only works when the IP is extremely strong. Another major consideration is that you are relying on existing companies to take your IP and create new disruptive products.
5. Consumables (“razor/blade”)
In this model, the customer pays a low up-front cost, with ongoing costs based on usage, which the customer can usually control. For businesses, it reduces the friction to capture new customers and thereby reduce the CAC and also substantially increase the LTV.
A highly visible and well-recognized example is the razor/blade model made famous by Gillette.
6. Upsell with High-Margin Products (“freemium”)
Similar to the consumable business model, the core product offering is sold at a very low margin or free, but the overall margin is increased from the sale of very high-margin add-on products.
This business model is often used in new car sales or electronics stores. A camera is often sold with a higher margin add-on such as warranty extensions for one, two or three years. This is also a common business model for SaaS products.
As with newspapers and magazines in their heyday and now with websites, the ability to attract and retain desirable demographic can be monetized through third-parties who want access to the customers you have attracted. A common choice when you have a highly engaged user base.
8. Reselling the Data Collected
Reselling user data requires first attracting end-users with a free product, then receiving money from third-parties who pay for access to demographic and other information about your users. This is the main source of revenue for Linkedin.
9. Transaction Fee
Online retailers often pay or receive a commission for referrals that lead to sales. One obvious example is eBay, which receives a fee for each successful auction, paid by the seller.
This model is similar to how credit card companies work, where a percentage of each transaction goes to the credit card company. This is also a common business model in marketplace businesses like Airbnb, Uber.
This is similar to how electric utilities are metered. Cloud computing products, such as AWS, charge by the amount used. This allows customers more control over their expenses because they pay for what they use, rather than paying for extra capacity they don’t use.
11. “Cell Phone” Plan
This is a predictable, recurring base fee charged in exchange for a certain amount of committed usage. If the customer uses more than their allotted amount, there are additional charges, often at much higher rates.
12. Parking Meter or Penalty Charge
This is a very common business model for credit card companies, where you pay late fees if you didn’t pay the monthly minimum or higher monthly interest for the unpaid balance.
Microtransactions is a new successful business model that became popular with online computer games and is now tested to try to save newspapers. In this model, the customer is asked to provide their credit card and then they make a very small transaction for digital goods.
14. Shared Savings
This business model is often brainstormed but rarely used because of the complexities in implementing it. In this scenario, the customer only pays once they have realized savings or benefits from the product.
One area where this model works because the accounting is clear is venture capital, where the general partner gets around 20 percent of the profits from their investments (aka “carry”).
If you have a good idea and are able to implement but does not have the desire, skills or money to roll it out, you can use the franchise model. You get a paid percentage of sales and the initial startup fee in return for providing the knowledge and brand that has been developed.
16. Operating and Maintenance
In this model, a business might not want to really sell a product but get paid for running a plant or other operation for a fee. This model is common in the energy sector.