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.
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.
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]