How do you actually make money from your product or service that is being sold to your customer segments? One of the most common mistakes people make is not knowing the difference between the revenue model and the pricing model, which are the tactics you use to set the price in each customer segment.
Let’s cover the three mistakes I see startups make most often:
They think that the revenue stream is the price they charge for their product.
They set their price by how much it cost them to produce the product.
They set the price lower than the competition (race to the bottom).
These common mistakes leave way too much money on the table. So there are a few questions you must ask yourself while setting the revenue model and pricing.
What do customers value and how much are they willing to pay for it? On day one, when you are sitting in your building, your lab, or at your desk, these questions are mere hypotheses, but when you get out of the building and talk to hundreds of potential customers, you come to understand what it is they value. This is what we will use to find out what the revenue streams and pricing should be.
How do customers pay for products today?
How much are they currently paying?
All the above leaves so much money on the table. There is a better way to figure out the revenue model or strategy and the pricing tactic. Such revenues are the lifeblood of a company. Revenue streams may have different pricing mechanisms, such as fixed list prices (i.e. Target), bargaining pricing (such as car dealerships), auctioning (Sotheby’s), market dependent (supply and demand), and volume dependent (such as food services buying in volume).
Revenue streams can result from two areas: 1) one-time customer payment, or 2) (my personal favorite) recurring revenues where ongoing payments deliver a Value Proposition or after-sales services to a customer (monthly recurring fees). Companies continually research the answers to such questions as: What are customers willing to pay for what value? How are they currently paying, and are they satisfied doing so? How much does each revenue stream contribute to overall revenues and profits?
Revenue Model (Streams) – can be generated in many ways:
This is the sale of ownership rights to a physical product. Ford sells automobiles, which buyers are free to drive, resell, or dispose of. A consumer goes into a Wal-Mart and buys household products. A customer goes into a hardware store to purchase tools.
These fees are proportional to the usage of service. Examples are Verizon cell phone, Amazon Web Service, Fed Ex shipping, and electric power. I use this in my company, Credit Justice Services (www.creditjusticeservices.com), where I charge a per-trade-line fee to correct the inaccurate or unverifiable information on people’s credit reports. The more trade lines I work on, the higher the fee.
These fees are for continuous access to service. At Salesforce.com you pay for the continuous use of their product, at Netflix you stream all the videos you want, and my gym yearly membership fee is good for however often I choose to go. At my restaurant chain, Bella’s, we found a company that would charge one fee for my electricity and take over the bill. This was a very beneficial arrangement because the electric bill is now a fixed cost.
These fees are for temporary access to a good or service. The revenue stream is created by granting someone the exclusive right to a particular asset for a fixed period of time in return for a fee. Lenders receive recurring revenues, and lessees pay a fraction of the full cost of ownership. We used to think leases were only for houses or cars but what about Chegg, the textbook rental store, borrowlenses.com, which rents out camera equipment, and monthly furniture rental companies?
This is a fee for the use of someone’s Intellectual Property (I.P.). Microsoft, Electronic Arts (EA), and Apple are just a few of the companies you use to license software. At the University of Virginia we have a division that just concentrates on I.P. protection and licensing called the Licensing Venture Group (http://lvg.virginia.edu/about/lvg). Here the content owners retain copyrights while selling licenses to third parties.
Intermediation or Brokerage fees
Often found in marketplaces of various types, this is a fee for bringing together two or more parties involved in a transaction. The most notable examples are brokers and real estate agents who earn a commission each time they successfully match a buyer with a seller. A relatively new company in this model is called Airbnb. They don’t own all the apartments and homes that are available for short term rent, but receive a cut of the daily fee. Match.com brings people together on their dating site for a fee. At Credit Justice Services we bring credit-challenged clients together with attorneys from around the country for a lead-generation fee.
These fees are paid by brands and companies aiming to get in front of potential clients. Newspapers, and the media industry in general, rely on this approach, which has spread to companies like Google, Facebook, and Twitter, all of whom sell advertising on their sites. These companies draw massive amounts of users, monetizing their product or service.
Pricing Types and Tactics – There are two types of pricing — Fixed and Dynamic.
Fixed Pricing – This could be as simple as Cost + Markup, but the one thing that is missing from the equation is the value to the customers you’ve been talking to. Now that you know what your customer desires, you can price on value for each customer segment, or feature what your customer needs. A list price is what is stated in the store or brochure, but could be subject to discounts depending on the number of items purchased or service required.
Dynamic Pricing – By contrast, dynamic pricing moves, depends on market conditions, and is subject to the power and negotiating skill of the purchaser. The price depends on the inventory and time of purchase (as in Expedia or Hotels.com). Price in real-time markets is dynamically established by supply-and-demand conditions. Prices at auction also result from competitive bidding.
Inside of each revenue stream you might have different pricing tactics. A few I have used in my companies are illustrated below.
Bella’s Restaurant Chain –www.bellas-restaurant.com Meat Ball Mondays, 1/2 price bottles of wine Tuesdays, 15%-off date night on Wednesdays. These are tactics that attract customers when the restaurant is normally slow.
Credit Justice Services – www.creditjusticeservces.com Make a one-time payment and receive a 20% discount, make two payments and get a 10% discount. This approach allows me to receive cash up-front for a discount to the client. While increasing short-term cash flow you decrease long-term income. We are also the only credit repair company in the country with attorneys who will take your case for FREE if you’ve been wronged – this is another valuable tactic.
Bisenti Technology – www.bisentitech.com So many startups are being ripped off by American programming companies who hang a shingle outside their door and claim to be technology experts. We just ran into such a client and after further review we found a 21-year-old kid who took our clients’ money and became overwhelmed with the project and ran. Our standard at Bisenti Technology is pay for performance. We do not get paid unless we perform. This makes our job more challenging but our clients LOVE it. We are also 1/6th the cost of any other local or national programming company.
For more information about starting a company or new product development please feel free to contact me at firstname.lastname@example.org.
Blanks, S. (n.d.) Business Model Canvas, Retrieved November 13, 2015, from www.udacity.com