Revenue and Costs (Business Modeling Course- Part 6)

Part 6: Finances
Revenue Streams and Cost Structure

In this last part, we discuss the finances of the Business Model, including Revenue Streams and Cost Structure.

The full lecture is now available as a video recording for a step-by-step process with explanation and examples. Make sure that subtitles in English are set for best results.

Revenue Streams

To be successful, a business must generate revenue. Revenue Streams describe how this happens. Revenue is a rather broad term, and refers to income that a business generates. A revenue can be classified under two main categories:

• Operating : Revenue from doing the core business functions.
  Example: A plastic factory produces plastic bottles and sells them for profit.
• Non-operating: Revenue from outside the core business.
  Example: A plastic factory sells some of its old machinery and equipment for profit.

A clear distinction should be drawn between Revenue and Profit.

Revenue method used can also be impacted by the pricing mechanism employed.

Fixed pricing: Pricing does not change, and is set based on various variables including product features, customer’s willingness to pay, or volume of sales.


Dynamic pricing: Pricing changes based on market conditions, or other factors such as in auctions or real-time stock markets.

Methods to Generate Revenue

Revenue could be generated using one (or more) of several methods:

• Asset sale
• Usage fee
• Subscription
• Leasing
• Licensing (Vs. Franchising)
• Brokerage
• Advertising (Internet Marketing)

Asset sale

The oldest and most common method of revenue generation is selling physical goods and items (assets). Such as a car manufacturer building and selling cars.

Considerations for choosing this method: In general, creating assets requires making them, which usually needs a rather large capital. When choosing this method, early-stage entrepreneurs should be careful of the costs associated.

Usage fee

Here, assets are significantly costly or difficult to maintain, so the business offers a way to use them. Also called “Pay-per-usage”₁. Could be used for products or services. Example: Cellular companies provide the access to their network of telecoms for a fee by the minute.

Considerations for choosing this method: Businesses following this method may have less costs associated since they don’t have a production line, but the initial investment for the infrastructure is usually significant.

Subscription

Similar to the Usage-fee method, a business offers a product or service and charges customers for its usage. The main difference is that a subscription is more of a commitment with the customer for a certain amount of time, while the Usage-fee method involves no such commitment. Such as a gym that offers annual and monthly subscriptions.

Considerations for choosing this method: Similar to usage method considerations. It is also common for businesses to use both methods: Usage-fee and Subscription.

Point of interest: Monthly Recurring Revenue Subscription is favored by many businesses, especially those working in the online world, as it provides a steady stream of income. Check a full description of MRR

Leasing

Leasing (also known as renting or lending) is giving the exclusive right for the customer to use a service for a certain amount of time. Could be used for products and services. Such as a car leasing business that offers daily and monthly car leases.

Considerations for choosing this method: Similar to Asset sale method, to lease something valuable you need to have access to it which also requires a significant investment (financial or intellectual).

Licensing

Licensing is more geared to wards business customers, where it revolves around giving rights to access and use a certain intellectual property to create revenues for the customer. Example: A design studio purchases a license for a design software to use it to work with other clients.

Considerations for choosing this method: Licensing has two main considerations: the value that will be licensed, and the nature of this license.

Licensing Vs. Franchising₂: Franchising is similar to Licensing in that it offers rights to access and use an intellectual property, where the Franchiser maintains a certain degree of control over the Franchisee who pays a certain cut of revenues for the Franchiser. In this method, a Franchisee is usually considered an affiliate of the Franchiser.
A good example is KFC franchises its brand and operations to those who want to open KFC outlets around the world given that they fulfill certain requirements.

Brokerage

Generating fees from working as an intermediary between two or more parties. Here, a business does not necessarily have its own product, as it focuses on having a Multi-sided Platform (see lecture 2 on Market Segments), such as Alibaba as it offers goods from vendors to customers around the world.

Considerations for choosing this method: While easier to utilize than other methods, Customer traction is key. Brokerage requires considerable sales for it to work (as each sale generates a small fee).

Advertising

Getting paid for showing advertisements (Ads) for other businesses, such as a news website generates income by showing ads on its page.

Considerations for choosing this method: The Ads method is very popular in businesses operating online (websites, apps, software) and for a good reason: it is easy to utilize and can generate revenue quickly without significant investment. Still, revenue from this method is usually limited for new entrants.

Internet Marketing: Internet Marketing is a significant industry that follows the Advertising method online. Here, advertisers have many ways to determine how to pay (pay per click or per view/impression). Internet Marketing involves many methods, including:

• Affiliate Marketing (driving visitors or traffic for the advertiser so that they can buy their products or services for a fee).
• Email and Drip Marketing
• Referral marketing
• Content marketing
• Among others…

Example:

A summary on the final look of the Business model (including costs and revenue streams) is shown below. For more detailed examples check the PDF lecture slide found at the bottom of this page.

Cost Structure

Resources and production activities in businesses require money. Businesses have two ways to handle this:

• Cost-driven structure:
  It only makes sense to want to keep that cost to a minimum, so this classification is trying to minimize cost whenever possible (using low-price value proposition). This is like purchasing low-cost thread to produce textiles for resale.
• Value-driven structure:
  For businesses targeting Niche markets, it maybe possible to focus on the value provided more than costs as profit margins from customers will compensate. A good example is luxury club that offers a premium high-cost service at a high price.

Cost Structures can have the following characteristics:

• Fixed costs
• Variable costs
• Economies of scale
• Economies of scope

Fixed Costs

The basic operating expenses linked to running the business itself that cannot be avoided and should be covered by the sales of products and services (in addition to variable costs) for the business to become profitable.

Fixed costs include: (rent, salaries, taxes, utilities). More details on Fixed Costs can be found here

Variable Costs

The costs associated with producing products and services. They can change depending on the amount of products/services being produced, and should be covered by the sales of products and services (in addition to fixed costs) for a business to become profitable.

Variable costs include costs linked with the production itself and depend on the nature of the Value Proposition. For example, a bakery may have the following variable costs: (flour, yeast, water). More details on Variable Costs can be found here

In large companies that have lines of production, costs can be reduced for each unit produced when the volume of production is large enough. This video on producing a sandwich for $1,500 clearly shows the impact of “Economies of scale”.

Similar to Economies of Scale, here a business is so large that it can benefit from its assets and resources in other areas. There is a direct link between this method and the targeting of Diversified Markets (See part 2 of this course for details).

Files for this lecture:

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Business Model and Value Proposition Canvases here

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