Internet Business Models: Avoid Turning The Startup You Love Into The Hobby You Hate
A startup without a business model is not at a startup at all – it’s simply a hobby.
The Internet has spawned many new business models by dramatically cutting the costs of distribution in order to reach potential customers, and the successful online startups are those that chose their business model carefully instead of simply building a product and assuming they could monetise the business later.
At a high level, Internet startups can be categorised into three groups: product companies, marketplace companies, and content companies. Each group is naturally suited to a couple of different business models.
The most common business model for a product company is to generate revenue through sales of your product. Just like traditional retailers your job is to find or build a product and sell it for more than it cost to create.
UK online retailer Glasses Direct, founded in 2004 by Jamie Murray Wells, sought to undercut high-street opticians by selling direct to the customer online. In its first year of business, Glasses Direct sold 22,000 pairs of glasses, and had an annual turnover of £1m.
The business model of a traditional retail business, which was based around the intermediary opticians, but moved to the online world where fixed costs were far lower allowed Glasses Direct to price significantly lower whilst maintaining a strong margin when compared to the competition.
An alternative as a product company is to generate revenue through a regular monthly or annual subscription. LoveFilm, which grew from a small startup in Harlow, Essex to become a major growth company backed by four venture capital firms before being bought by Amazon in 2011, provides DVD rentals and film streaming online to its customers, who pay a monthly subscription.
This model allows customers to subscribe and unsubscribe at any time so that they pay in line with their use of the product, which in this case is a vast library of films. Similarly to Glasses Direct’s business, LoveFilm was competing against a nationwide network of high-street stores in the form of Blockbuster. As LoveFilm grew it was able to offer a wider selection with more convenience (for instance, not charging late return fees), and with the added advantage of having far lower fixed costs.
If your startup develops business software then this model is often referred to as ‘Software-as-a-Service’ (SaaS). For instance, UK call centre software firm NewVoiceMedia sells access to use its product on a subscription basis. As Chief Strategies Tim Pickard explains, this can give significant benefits for the vendor and for the customer:
“The problem with traditional software development is that the cost of that pain – the downtime, the bugs, the patches and the outright failure – is borne not by the vendors, but by the customer.
“If a vendor develops and sells poor quality software, or issues a new feature that introduces a security vulnerability, it’s the customer who has to deal with the actual and potential consequences: system failure, roll-back, patching, breach disclosure, direct financial loss, damage to brand, reputation and so on.
“Software as a Service (SaaS) is software delivered by the vendor as a service, normally over the internet. The software is the enabler, but the customer is actually buying the service, not the software itself. This is a very important distinction because it shifts the economic burden back to the vendor. No longer can vendors consider the costs of downtime, bugs, patches an externality; these costs are now internal and directly impact the bottom line. If the service fails, the vendor doesn’t get paid.”
A further alternative worth considering for product companies is a ‘pay-per-use’ model, where customers have access to the product at all times but only pay when they use it.
One of the founders of London-based mobile app company Hailo, Gary Jackson, explained that they “wanted to create a service that offered the simplest way of getting a taxi:”
“Once you open the app within two taps on your smartphone your cab is booked and on the way to where you are.”
Hailo’s business model is to take 10% commission from cab fares, so its customers are London taxi drivers who can download the app for free and only pay Hailo when they respond to a request through the app. One of Hailo’s cab drivers claims that after signing up with the service for a matter of weeks his passenger on board (POB) rate had increased by 50%.
Online marketplace companies exist to connect one group of people to another for the purpose of facilitating some sort of interaction between individuals in each group. Well-known examples are marketplaces for products (eBay), apartment rentals (AirBnB), and dating (Match.com).
The primary decision you have to make as an online marketplace is from which side of the market you aim to generate your revenue.
Rated People, founded in 2005, is the UK’s largest online trade recommendation service and its mission is to connect homeowners with the very best local tradesmen. Homeowners who are in need of a tradesman can post jobs for free on RatedPeople.com and receive quotes from up to 3 interested tradesmen.
Tradesmen pay to access and connect with homeowners once a job has been listed, so Rated People charges the sellers in its marketplace.
Speaking in 2011, Andy Skipworth, founder of Rated People explained:
“We have been very fortunate to date. We have a great business model and create great value – more than £1 million for tradesmen every day.”
On the other hand, East London’s OneFineStay charges the buyer in its marketplace, which offers: “the chance to stay in someone’s place while they’re out of town. You get to live their life for a few days and nights.”
For sellers of OneFineStay’s marketplace, who are the owners of apartments in London or New York, they can list their places for free and receive ‘rent’ for each day a guest stays.
Online content or media companies often provide the greatest challenges when it comes to finding a sustainable business model, because sources of breaking news, opinion pieces, and articles are now so widely available across the Internet. Moreover, the vast majority of these sources are free.
One business model that many entrepreneurs sometimes naively cling to is advertising. Looking at advertising revenues from YouTube or Facebook it might seem that you can build a strong business on advertising revenues alone, but those should be seen as the outliers rather than the norm.
As Dave Chaffey at Smart Insights outlines, you need an enormous audience just to generate even quite small revenues:
“You need substantial traffic to make much money through advertising. At a CPM [Cost per thousand impressions for ad volume deals] of £10 with 2 ad units on the site, you would make just £4,000 per month even with a million page views per month for which you serve paid ads to 20% of the audience.”
The most common business model for content businesses is a combination of advertising and affiliate deals. Affiliate deals generate revenue by adding links on your website to external retailers, who pay a commission in exchange for any purchases made by your website’s users.
With the affiliate business model you may never actually take ownership of the product (or even handle it). You simply get rewarded for referring customers to a retailer when they make a sale.
UK startup Mixcloud, the ‘Youtube of Radio’, generates half its income through advertising with the other half coming from subscription payments and affiliate deals.
Personal finance content company, MoneySavingExpert.com, which was bought by MoneySupermarket.com for £87m in 2012, was generating revenues of nearly £16m from 39 million users, of which 59% was earned through affiliate referral fees from MoneySupermarket alone.
In 2010 fashion blogger, Poppy Dinsey started What I Wore Today (www.wiwt.com), a blog that shows Dinsey’s chosen outfit on a regular basis, accompanied by her own commentary. The website has details of where to buy the clothes, and for each sale directed through wiwt.com, Dinsey gets a percentage. She also gets direct sponsorship from brands that want to be associated with her during major events:
“The site kind of supports itself but at London fashion week I’m being paid by Vodafone and that sponsorship is what keeps me afloat,” she says. “The biggest outlay was £4,000 to buy the domain name because I realised if I was trying to build a global brand, it wasn’t going to work without the dotcom.”
The alternatives to advertising and affiliate revenues for content businesses are to charge your readers directly, either on a subscription basis or on a ‘freemium’ model, or a combination.
The subscription model, employed by the Financial Times amongst others, is exactly the same as the subscription model for product businesses – except in this case your product is the content on your site.
Online magazine The Kernel aims to bring “a blend of informative and entertaining comment and analysis about technology, media and business.” Although readers can access some of its content for free, for full access you have to pay to be a subscriber.
‘Freemium’ is a business model for which the majority of users pay nothing to use your product or service, and the revenue comes from a minority who pay for advanced ‘premium’ features. This is also a common business model for content businesses, such as Spotify, the music streaming service that also offers a paid version to access higher-rate streaming and mobile access.
The Internet has allowed some existing business models, such as retail, to become more efficient by accessing a huge number of customers at very low cost. It has also enabled new business models such as ‘freemium’ and marketplace businesses, which would previously have been impossible to pull off at scale.
As an entrepreneur you should be clear about which business model your startup uses otherwise you’ll be in danger of developing a product that attracts a following of users but is ultimately unsustainable.
So to determine the best business model for your business:
(1) Ask yourself whether your business is primarily a product company, a marketplace company, or a content company
(2) Ask yourself how you are going to compete in your particular market – are you trying to compete by being bigger/better/faster/cheaper like Glasses Direct or are you competing by changing the way the industry works like LoveFilm?
(3) Those competing by trying fundamentally to change the way things work in an industry are the ones that require a new business model, so pick one that makes sense given the type of company you run and make sure you can test its viability as early as possible
How did you discover your business model? What are your thoughts around business model creation? Please add your comments below..