Note: This article was written several years ago, when PayPal.com was a humble startup, Eudora Pro was still a leading desktop e-mail client, and cameras still used film.
Q: Many people say that they want to see your business model. What exactly do they mean by that? Do they want to know your target market and strategy, or do they need financial information as well?
A: A business model is quite simple: it is a brief statement of how an idea actually becomes a business that makes money. It tells who pays, how much, and how often. The same product or service may be brought to market with several business models.
Here are several sample real-world scenes, showing how similar products can have very different business models.
Consumer Reports vs. TIME Magazine
Consumer Reports makes money solely from grants and subscribers . It has a subscription-based business model.
TIME makes money both from subscribers and from advertisers. It has more of an advertising-based business model.
The difference in business models tells you a lot about the two businesses. Consumer Reports is going to concentrate on selecting content which will be of high enough value that people are willing to pay a subscription fee. Since it doesn’t depend on ads for income, no one but the editorial staff influences the articles.
TIME Magazine, on the other hand, also must take advertisers into account. TIME needs content for its readers, but it is largely concerned with growing a demographic for the advertising it sells. Since TIME makes most of its money from ads, an advertiser’s threat to pull advertising may put pressure on the magazine to pull or rewrite a story that the advertiser finds objectionable.
Movie Theaters
During the first several weeks of a movie’s run, almost everything in a theater’s box office goes to the film’s distributors and producers. The theater makes its money from the concession stand! The business model: sell tickets at cost, and make profit on refreshments.
This model implies that staffing the refreshment stand should be high priority. When the theater is crowded, bring in extra staff to keep refreshments flowing. Since that’s where the money is made, losing sales from too-long lines is losing the only profitable sales the theater makes.
A theater near my house rents second-run movies that have been out long enough for the theater to be able to keep most of the ticket revenue. They make much more of their money on ticket sales, and put far less emphasis on the refreshment stand.
Razors vs. Shavers
Gillette is happy to sell you their Mach III razor handle at cost, or even below cost. Because they then sell you the profitable razor cartridge refills. Again and again and again… Their business model is virtually giving away the handle and making their money from a stream of razor blade sales.
Electric shavers have a different model. They cost a lot more than the Gillette handle. They cost enough that the manufacturer makes all their money up front, rather than from the stream of blade refill sales (electric shaver blades do wear out, but it takes a much longer time).
Digital vs. Film Cameras
Traditional film cameras cost a bunch of money. And then, you buy roll after roll of film to take pictures. Then you spend even more getting the pictures developed. If you’re using a Kodak camera, Kodak film, and Kodak developing, then Kodak will be very happy. Their business model makes them money from camera sales, film sales, and processing fees.
Digital cameras eliminate film sales and processing fees. Kodak needs to find a new business model before the cameras catch on more widely. And they are working on it. They are establishing digital printing centers, where you can have your digital camera pictures printed on genuine Kodak paper. The business model that was based on film sales and processing is becoming a model based primarily on photograph printing.
paypal.com … who knows?
Sometimes a business’s business model is not obvious. The web site www.paypal.com allows you to send money to a friend via e-mail. The money is either charged to your credit card or taken in cash from your cash account at paypal.com The intriguing twist is that paypal takes no commission on the transfer.
How do they make money? What’s their business model?
I don’t know, yet. From interest, perhaps? If enough users deposit money with paypal before paying it out, they collect interest on that money until the recipient finishes the transfer. If this is their business model, then they should concentrate on increasing float: getting more interest on their money, encouraging people to fund their paypal accounts long before they will send money to friends, and encouraging people to leave the money sent to them in their account just a bit longer.
Other models they could use:
| Charge a fixed transaction fee on each transaction. Resulting business goals: encourage lots of small transactions. |
| Charge a transaction fee that is a percentage of the transfer. Resulting business goals: encourage large transfers, since they make as much as many smaller transactions, but without the overhead of doing many transactions. |
| Or, since electronic funds transfers are cheaper for banks than processing check, paypal might have banks give them a percentage of the savings from doing transfers by EFT rather than by check. |
Brick-and-Mortar Brokers vs. E*Trade
Traditional brokers make money by charging a commission on purchases and sales. The commission is a percentage of the transfer amount, so brokers may be happy with clients who trade infrequently, as long as they buy and sell enough at a time to generate a nice commission.
E*Trade charges a low, fixed amount per trade. Their business model is to attract high-trade-volume customers. The customers are more likely to trade often when commissions are fixed and low, and E*Trade is pushing to make up in volume what the traditional brokers make by charging a percentage.
Adware: take your choice
First pioneered in the late 1990s by Qualcomm’s e-mail program Eudora Pro, some software lets the customer choose the business model! A customer can install and use the software for free, and ads will be shown as they use the program. Or, they can pay full price and install the program without the ads.
For users who elect ads, the business model is that Qualcomm provides software for free to build an audience, and then gets income from advertising. They must spend their time selling ads and distributing their software widely to create the audience.
For users who pay for the program, the business model is the same as for any shrink-wrapped software: Qualcomm gets paid up front for a product which the customer can use forever. Qualcomm then spends their time coming up with later versions which they hope will entice customers to upgrade, sending more money into Qualcomm’s coffers.
Retainer vs. Hourly Consulting
Some freelancers charge by the hour for services delivered. Others charge a flat fee retainer which entitles a client to a certain amount of the freelancer’s time. Once again, they deliver the same service, but the different business models will result in their negotiating businesses, administering their business, and controlling costs in a very different way.