Business Models

A business model is a method of doing business. All business models specify what a company does to create value, how it is situated among upstream and downstream partners in the value chain and the type of arrangement it has with its customers to generate revenue. – Michael Rappa

Software+Services and SaaS models have been discussed for while, mostly called utility computing. We’ve started to see the rise of utility computing services like EC2, App Engine and Reddog, along with storage including S3, CloudFS, and SSDS. Less traditionally thought of utility computing options include mapping, contacts, mail, among other services pushed in to the cloud. Michael Rappa described [PDF – 141kb] the characteristics of a successful utility as:

  • users consider the service a necessity
  • high reliability of service is critical
  • ease of use is a significant factor
  • the ability to fully utilize capacity is limited
  • services are scalable and benefit from economies of scale
  • exclusive rights are granted for providing service in a given area

Rappa also provided a detailed breakdown of the different business models of traditional utilities. The models are really great building blocks for startups to think about the problem they are solving, where they fit in value chains and the relationship they have with their customers to generate revenue.  Rappa presents 9 unique business models:

  1. Brokerage model
    Brokers charge a fee or commission for each transaction it enables. Think eBay, PayPal, EventBrite, esellerate. The formula for calculating the fee varies based on the vertical. Models include exchanges, demand collection systems and auction houses.
  2. Advertising model
    The advertising model is an extension of a traditional broadcast model where the broadcaster is the content hub or web site. Sites provide content and essential services like search, email, groups, etc. Think Live, Google,, Yahoo, etc. This mode works best with either high traffic volume or with highly specialized/focused user groups. 
  3. Information-intermediary model
    Data about customers and their consumption habits are very valuable. This is the premise of behavioural analytics aimed at analyzing users to improve advertising targeting. Firms like comScore, Google, Quantcast, Compete, Coremetrics, and tonnes of others.
  4. Merchant model
    Rappa describes merchants as “wholesalers and retailers of goods and services”. Very familiar ecommerce examples include virtual retailers like Amazon, traditional retailers with online storefronts like Chapters or Banana Republic, catalogue vendors like LL Bean, or electronic bit vendors like Gartner or NielsenNorman selling digital products.
  5. Manufacturer Direct model
    The maker of a product or service sells directly to the consumer. This is the most difficult option for me to understand in the context of cloud computing. But traditionally, it is where software developers or hardware manufacturers sell their products to consumers. This can be seen with smaller software providers like ecto, TextMate, TopStyle, etc.
  6. Affiliate model
    The affiliate model provides purchase and transaction opportunities to people on the web. It is a pay-for-performance model used in banner exchanges, pay-per-click, pay-per-transaction, and revenue sharing often seen with carriers and mobile applications. This is often seen with Adsense, Amazon Associates, and can be seen with Mint who earns fees from customer referrals.
  7. Community model
    Rappa describes the community model as based on user loyalty, where loyal users invest their time and emotions in a business, and revenue is generated on the sales of their ancillary products and voluntary contributions. This is the basis of the “open source” computing model with companies like Canonical and Redhat have leveraged the efforts of the community to build desktop and operating systems.
  8. Subscription model
    Users are charged a periodic fee for access to a service. Subscription fees are incurred regardless of usage rates. Most SaaS solutions fit this model, customers pay the developer of a software solution directly. Basecamp, Salesforce, NetSuite and others. This is a very common model that often uses a freemium pricing as a marketing decision to attract customers.
  9. Utility and hybrid model
    The utility model is based on metering usage, it is a “pay as you go” approach. Unlike subscription services the billing is based on actual usage rates. For example, traditional and VOIP long distance minutes that are billed for usage. Storage in the cloud using services like S3 or CloudFS. Often utility models are combined with a subscription model, think cell phones where there are fixed subscription fees for voicemail, caller id, and utility billed services for data and long distance. 

The Business of Sofware by Michael Cusumano

These models are different than enterprise software company models presented by Michael Cusumano in The Business of Software: What Every Manager, Programmer and Entrpreneur Must Know to Thrive and Survive in Good Times and Bad where companies exist on a spectrum between a pure products company to a pure services company.

  • A pure product play
  • A mix of products and services
  • A pure service play

Looking at the business models derived from traditional public utilities, provides a richer classification for both the product end of his description. Cusumano’s services refer to people powered services, not a utility or subscription model. Though you could argue that the services and maintenance mix described is much closer to a subscription model.

The question for all startups is what do you to to create value, where does that value fit in the value chain of your industry, and what type of arrangement with customers do you have to generate revenue? It’s simple really: What problem do you solve? Where does this fit with your industry? Who derives value from your solution? And how do you get paid? Answer these questions and you can get on to the hard stuff.

All business models specify what a company does to create value, how it is situated among upstream and downstream partners in the value chain and the type of arrangement it has with its customers to generate revenue.