Startups are about innovation. However, even if the offering is innovative, this doesn’t mean that each aspect of the business needs to be original – you don’t have to re-discover the wheel, especially when it comes to startup business models and startup revenue models.
Presumably, you’ll operate in a new market niche with an unsolved problem. When it comes to structuring your solution into a business, however, there are a couple of fool-proof options.
That said, not all startup business models and revenue models are equal. Some models are just harder to realize than others due to a variety of reasons like capital requirements, operational complexity, etc.
Due to their innovative nature, startups are extremely likely to fail. It makes a lot of sense to try to reduce that riskiness by trying to find the least.
The tier list below is based mainly on the difficulty to realize the particular startup business model in practice.
Table of Contents:
1. B-Tier Startup Business Models
The B-Tier startup business models have added layers of complexity, which increases the chances for the startup venture to fail. This means they are not recommended for first-time startup entrepreneurs. That said, risk is often inversely correlated to potential, so these business models have some of the highest possible upside.
1.1 Marketplace Models:
It’s not a surprise that most VPs out there want to push their startups to become a true platform because of the insanely high upside potential. Naturally, controlling a market and getting a cut of every sale is a much sweeter business model than competing in the market with thousands of other businesses. As Peter Thiel puts it, “Competition is for losers.”
For example, the main reason for Amazon’s size (disregarding AWS) is that they are not just an e-commerce business. They are THE e-commerce marketplace in the western world. They control such a large share of the e-commerce market, that if you want to sell your products online, listing them on Amazon is almost mandatory. And of course, once you sell products through Amazon’s platform, you have to give Mr. Bezos his fair share.
So, Amazon is not just a business, they are the governors of a whole industry.
With this in mind, how can the marketplace business model be low tier?
Well, a big upside is usually related to big risk. Marketplaces are notoriously hard to get going because of the notorious chicken and egg problem. A marketplace requires two types of users – buyers and sellers. Without a lot of buyers, you cannot convince sellers to use your marketplace. And without a lot of sellers, buyers have no incentive to visit your website.
There are ways to solve this problem – e.g. you can be the first big seller on your own marketplace in order to attract buyers, and then you can use the buyers to entice new sellers to register.
That said, this is much easier said than done. Generally speaking, sellers are very reluctant to try new marketplaces because they are well aware of the imbalance of power. They would much rather sell their products through channels they control, so the only reason they would willingly use your platform is if they simply have no other choice (i.e. you hold the majority of the buyers in your niche/industry).
Thinking that you’d be able to convince businesses to register to your newly-launched platform and that they’ll bring their existing customers to the platform is a delusion. On the contrary – businesses would usually be happy if they can get users off your platform because this would let them keep your cut and would enable them to keep the customers further away from their competitors which presumably are also on your platform.
And these are just the generic difficulties of taking a marketplace off the ground. There are many other problems specific to the industry you are targeting. For example, industries in which buyers are looking to form a long-term monogamous relationship with a seller (e.g. a small business searching for a bookkeeping company; a household searching for a maid) have the added difficulty that each buyer would make a single purchase and wouldn’t return to the platform again. This means that a constant, steady stream of new buyers is mandatory for the marketplace to stay valuable to the sellers.
Sometimes, new startup founders notice that an industry they are familiar with doesn’t have a dominant online marketplace, so they decide to be the first ones to build it. However, once they build the software and try to attract sellers, they hit a brick wall.
Don’t make that mistake. Marketplace/platform startups are so hard to pull off in practice that becoming a platform should be the second or third step in your growth plan. Your startup should have some other way to generate value and gain traction in the industry. Only once this is achieved you can think of ways of becoming the go-to marketplace of your niche. Of course, if you manage to reach that stage, you’d have some of the biggest upside potential of all the business models on this list.
Amazon started out as one of the first online booksellers. They became the e-commerce marketplace for everything later.
1.2 On-Demand Models:
On-demand models are a great idea for problems that are frequent but inconsistent like transportation (Uber), hospitality (Airbnb), some forms of entertainment (YouTube), delivery (Instacart), etc.
However, on-demand is a very broad term and has two important implications.
First, the difficulty of providing the service you are offering exactly when it is requested is highly variable. For example, video on demand is easy (It’s worth mentioning that this is true only because the technology solutions have evolved. Decades ago server costs for video were extremely high, which made it a huge challenge to build a profitable, sustainable VoD business.). However, any service that involves people (e.g. transportation) is much more difficult because more moving parts need to be organized. This increases costs and introduces more failure points. It also means that most on-demand services don’t have zero marginal costs (zero costs of an additional customer), which means they are much harder to scale than pure software solutions.
Second, on-demand is usually not a complete business model. You might have noticed that the examples from above (Uber, Airbnb, etc.) are all marketplaces. This is because “on-demand” describes only the demand-side relationship. The supply-side can either be fulfilled by yourself as a service provider or by other sellers in which case you become a marketplace.
Combining the difficulty to scale on-demand businesses with the imperative that marketplaces should grow very fast makes this business model one of the most difficult to pull off.
Because of this, if you are considering an on-demand model, make sure your marginal costs are close to zero. Some great examples are many of the successful startups in the online education niche – Lynda.com, Coursera, Skillshare, etc.
1.3 Ad-based Models
Your business gives users free content/service, and other companies pay in order to advertise to your users.
An ad-based model is fine for small content businesses (YouTube channels, blogs, etc.). However, to become a $100M startup based only on ads, you need to reach extreme levels of popularity. Needless to say, creating the next TikTok or Instagram is a hard task, so for most startup founders, ads need to be supplemented with other revenue models (usually a membership) to have a robust monetization in the case of more realistic growth expectations.
Ad-based businesses usually succeed on the basis of virility, which means they often rely on user-generated content. Because of this, they are ironically a type of marketplace for content creators and content consumers. This means that the difficulties of marketplace startups that we discussed above are often applicable to social-media-like ad-based startups.
2. A-Tier Startup Business Models
A-tier startup business models are more varied than the B-tier models. They could be easier to successfully realize, but usually, the upside is smaller.
2.1 E-Commerce Models
If you are producing a product, there is no excuse for not selling it online. Ecommerce is growing rapidly and can grant you access to a huge worldwide market. It is estimated that there are 2.14 billion global digital buyers in 2021, and the growth of e-commerce has been accelerated by Covid.
The technical side of e-commerce has been streamlined to a degree that lets you set up a functioning e-commerce store in a day. Frontend solutions like Shopify and backend solutions like the Shopify Fulfillment Network pretty much take care of the whole technical and logistical side for you.
What is more, if your strength is with marketing rather than with manufacturing products, you can start by dropshipping early on and by building partnerships with manufacturers later on.
The accessibility of e-commerce, however, also has a drawback. You are competing with the whole world, which means differentiation is key. There’s nothing wrong with a successful dropshipping business, but technically speaking such a venture is not a real startup due to the lack of innovation and the limited upside potential.
If you want to be able to scale as a true startup, you have to have a unique and valuable offering, otherwise, the next business with more capital might be able to out-compete you by offering the same thing as you do but at a lower price or with a higher marketing investment.
Arguably, you’re not going to become huge by being another general store that works online – this market need has been fulfilled by the first and second wave of internet startups. In order to scale, you need to produce and sell something the world hasn’t seen before, and this is a significant challenge.
Physical product startups are way more complicated to pull off compared to digital product startups, as production at scale (sourcing and dealing with suppliers, etc.) is a problem added on top of the normal startup problems. Moreover, a physical product doesn’t have the benefit of zero marginal costs.
2.2 Membership Models
A membership business is a business that provides a service or a product in return for a fixed monthly fee. Naturally, this is a very broad category, but it’s noteworthy that monthly and yearly subscriptions are by far the most common revenue model for startups nowadays. Examples are companies like the Dollar Shave Club on one end of the spectrum, which delivers grooming products to their customers each month, and YouTube and Spotify on the other, which employ a freemium model and remove ads for members.
The huge benefit of a monthly subscription is that it gives startups a predictable and sustainable revenue source while at the same time making the barrier to entry lower for customers (especially bearing in mind “get X months free” offerings).
Physical product memberships (like the Dollar Shave Club) are a smaller niche, and it has the already discussed disadvantage of non-zero marginal costs.
Digital memberships are the industry standard for all kinds of media, information, and content businesses, where the membership model is usually combined with a freemium offering with ads in the free tier. These kinds of companies are usually facing similar problems to the businesses monetizing mainly with ads. It’s hard to convince users to become paying members – the membership is usually a convenience, rather than a necessity. In order to scale, you’d need to become extremely popular, which needless to say is hard to do.
2.3 Freemium Models
Freemium is quite often listed and discussed as a business model. In reality, however, freemium a promotional tactic. The free tier acts as a demo, and the whole purpose of the business is to upsell you to the paid tier. The businesses that use freemium are usually also using a membership/subscription business model.
3. S-Tier Startup Business Models
· An S-tier startup business model is simple to implement.
· It works just fine for small-scale businesses, but it has the low marginal costs required to be extremely scalable.
· Last but not least, it doesn’t suffer from monetization problems.
3.1 SaaS Models
Software as a service companies are arguably close to membership companies, but the key difference is that they usually target businesses (or professionals), and they are more flexible in their monetization. Besides subscription tiers, SaaS companies can charge based on usage (38% of SaaS companies do that) or per user (50% charge per user).
This helps them generate a lot more revenue per client, which means you can have a very large business without needing to reach millions of users. In fact, if you are targeting enterprise-level clients, just a few clients can make your business successful.
The fact that different businesses and professionals have very different needs means that there are a lot of market niches to be satisfied by various SaaS businesses. Moreover, as long as technology evolves and there is new kind of work to be done, there will be a constant stream of new opportunities.
Since SaaS companies have the benefit of zero marginal costs, they are highly scalable and are restricted mainly by the size of their unique niche.
Moreover, the adoption statistics for SaaS solutions are great (source):
· In a study of 786 technical professionals, 94% answered that they use cloud SaaS.
· 83% of company work is done in the cloud
· Companies use an average of 34 SaaS aps.
4. In Summary
1. The success of your startup is mostly defined by the value of your offering, not by your business model.
2. That said, choosing the right business model is also very important, especially in the efficiency stage of your startup.
3. Standing out from your competition is key. One way to do that is to have a unique offering while using the industry-standard business model. Another viable way, however, is to use a new business model for the industry.
4. When choosing your business model, consider the scalability and marginal costs of your offering as well as the difficulty of successfully implementing the business model. Startup = growth, it’s hard to justify the risk of involved in a startup venture if it is not highly scalable with a large upside potential.
5. Last but not least, it’s not a coincidence that there are thousands of successful SaaS startups, while you can count the successful ad-based social media startups on your fingers. Ambition is important in the realm of startups, but it’s also important to have a sober understanding of your chances of success.