16 14 Tech Models that Scale Startups Make Money
Updated – June 2020. Note: As I’ve been tracking the market and the 2,600 startup companies that form this data set we have seen some changes over time. Here are some of the changes:
- Revenue models require key metrics to be valid. For that reason I’ve removed Coins and Tokens as a model – if they come back and have key metrics, I’ll put them back in.
- Multi-sided marketplaces and panel have the same basic mechanics as other marketplaces – for that reason I combined them into the marketplace model
- Metered Services – think AWS, Splunk, or Twillio. Fee’s increase with usage vs. tiered subscription pricing.
As a tech startup founder, the great thing about your startup is that your idea is unique (hopefully) but how you make money isn’t unique. You can study common playbooks for the step by step guide of how you monetize your product to become a venture scale company. For example, a SaaS or subscription is the most popular today. Some entrepreneurs are so busy with innovation, they want to create a new or different model. No need to be innovative, just copy one or two from below.
The presentation below includes both the Business to Business (B2B) and Business to Consumer (B2C) tech startup models. Some startup revenue models apply to both customer segments, some only apply to one. You can also think of revenue models as revenue streams.
Recently, I was interviewed on a podcast on the topic, if you like the audio version of how startups make money, you can listen here. We discussed how investors think about ideas, make decisions and their best portfolio investments and returns.
The data in the presentation is based on a list of top Seed stage funded companies provided by Crunchbase. Over the last five years, we have followed these 2,650 companies, in some cases calling to talk to the founders to learn how they generate revenues and profit. Where a company had died or been sold, we used the WayBack Machine to see their last cached pages.
Different business models take different amounts of time to mature from start to scale. Markets, for example selling to consumers or selling to businesses also matter in time to maturity. What we didn’t realize when we pulled the data was that Seed Rounds ranged from Seed 1 (earliest) to Seed 10 (latest) funding not based on financing amount. It represented ventures of all types around the world, overall quite a canvas of founders, management, and products.
The option you pick will be important to your enterprise valuation – or what your company is worth when you go to sell. Is it scalable? It will also determine which investors will be most interested in your company and potential success.
The deck breaks down the difference between the three parts of a Startup Business Model. The revenue model is only one part of the Venn Diagram and is part of the “delivering value” section.
- Creating Value – the product or service that you are providing to your customer.
- Delivering Value – how you market and sell (distribute) the product or service, this is the revenue model.
- Capturing Value – represents the range of the average to exceptional profits associated with your efforts. The more reasonable (lower) the profit the less likely it is to get funded, the more exceptional (higher) the more likely it is to get funded.
Delivering value is broken down into the revenue-generating activities – with the goal of generating more revenue than expenses (profit):
- Marketing – how will people find your product? It’s not enough to simply build a product
- Sales – there are four sales models you’ll need to choose from as it relates to selling your product. Inbound web direct, outbound sales, channel sales and in rare circumstances (for tech companies) retail sales. This presentation does not cover retail sales.
- Business development – BD isn’t the new word for sales, it’s partner marketing and partnerships that help you sell your product and reach new markets.
- Revenue Model – for tech companies there are really only 16 options for how your startup makes money. Some will work at the early stage of your startup launch, some will only work at scale
Here are some marketing terms you will need to understand – because they will apply to all of your choices and revenue streams. Some of these marketing metrics are universal, some are unique to the specific model. All of them are required for your technology company to be a success.
- Customer Acquisition Cost (CAC) – what is your fully burdened cost or costs of marketing and sales to get a customer to pay? That may include the cost of the trade show, travel, and staff time as an example. If you’re the founder, you’re going to be the first salesperson.
- Lifetime Value (LTV) – if you’re a new company, your maximum LTV is going to be 12 months – until you have the actual revenue data to calculate LTV. If you’re in a transaction fee business, how many transactions will your customer make in the first year? If you’re in a subscription fee business, what’re the first year’s subscription revenue (net of churn)
- Time to Close – how long will it take to go from lead, through the sales process to a paid customer?
- Pricing – the price you elect to charge for your service
- The average revenue per order/customer – again, this will change slightly on your options below. But you need to have an average revenue goal from the start.
All of these components will be required to complete a financial template. And a solid financial model is required to garner investment capital from an accelerator or venture investor. Read more about Venture Ready templates here.
If you get to a scaled startup, you have options for more than one or two revenue models. However, at launch, in your early stages of the company, you will need to focus your effort on a primary and secondary model.
First, the good news is, you just need to pick one or two and try them out. If one doesn’t work for your industry vertical, try another one. Many companies use a combination model – e.g. subscription + services.
Remember, Free is now a startup revenue model. Free is a promotional method to consider when you think about marketing.
What is Your Revenue Model?
- Services/Fee for service – when people are required to deliver the product or service.
- Commerce – the sales of a product or service, think Amazon. It could be a product that you make, but also just a product that you sell.
- Subscription – historically, a magazine subscription was an example of a business model or revenue stream. This model is now the standard for recurring revenue businesses – think Salesforce.com and Spotify
- Metered Services – Similar to subscription, they have monthly recurring elements, but in addition to a subscription, they are usage-based vs tiered pricing.
- Productize a service – this is where you charge a flat fee for a product/service that is delivered by people – however, the cost of delivery is brought down over time with tools and software. Moz would be an example of a business that started as a services company and migrated to a subscription company.
- Transaction Fee and/or Rental – Chugg is a great example of a rental business and Kickstarter is in the business of taking a transaction fee for providing their service.
- Lead Generation – is where marketers are better at acquiring web traffic cheaper than the lead buyers. Think Mint.com and CreditCards.com – they aggregate traffic and sell those leads at a premium.
- Gaming – is in the business of selling fun, not necessarily solving a problem. Pay to download was the old model and overall the trend is toward in-app purchases.
- Marketplaces – are connectors of buyers and sellers for a transaction fee. Uber’s business models are a marketplace as are other “gig-economy” companies. Like eBay, marketplaces don’t typically “own” their inventory and are distinct in that they have two customer acquisition funnels of buyers and sellers.
- Advertising/Search – Google and Facebook are great examples of the Advertising and Search Revenue stream or revenue model. If you get the product for free, you’re the product! This model only works at scale however, so plan how you’re going to make money before you get to 1M unique users visiting your site monthly.
- New Media – is the model that is referred to as “going viral” and is really a placeholder for a future advertising model. Think WhatsApp and Facebook, they have a viral coefficient of >2 users signing up for every paid user you bring in as a paying customer. This model is great because of its Network Effect. However, it doesn’t work in Business to Business revenue models
- Combinations – take two (usually) models in combination – this is difficult when you launch your product because you don’t usually have many options – however you can be a service + subscription business or a transaction fee + subscription fee. An example of this revenue model at both the launch and scale stage is SmartSheet. They do customer setup/integrations for large customers. This brings in profitable revenue and shortens the sales cycle to onboard new customers.
- Big Data – if you have big data you can definitely sell it! However, if you’re getting ready to launch your startup and don’t yet have the data it could easily take you 18-36 months to capture enough data to sell. PatientsLikeMe is an example of aggregating (and anonymizing) source data of patients to large pharma companies.
- Licensing – I mention licensing as the final model, not because it’s no longer viable, it’s simply in decline. 20 years ago when I started my first company in the Microsoft ecosystem all of their software was sold as a license. I also remember the transition stage from license to subscription and the “gnashing of teeth” at the time. Now it’s nearly all subscriptions.