Innovative Business Models – Making a Deal that’s Irresistible to Customers


Start-ups are where a new product idea meets its business. Start-ups don’t fail because they cannot develop or produce the product. They fail because the business model doesn’t work. Entrepreneurs often struggle with this aspect of the business at the beginning. A crucial initial consideration must be, “how and when do we make money?”

Many entrepreneurs don’t know how to price their product or create an appealing offer for customers. Their first inclination is to offer the product for free and to build an audience, then they’ll figure out how to make money. A big lesson learned from the dot-com era was there is unlimited demand for free. However, free to the customer is not free to the start-up. The start-up still needs to provide support, they still need to get feedback from the customers, and this requires labor costs.

The Freemium business model is very popular with consumer Internet start-ups. It’s where some customers get the product for free while others pay a premium for more features and add-ons. Initially, there won’t be enough paying customers to cover the expenses for the non-paying ones. For these online sites, only 5% to 10% are paying customers and 90% or more are non-paying customers. Most bootstrapped and self-funded start-ups quickly determine that the Freemium model works for investor-backed start-ups where someone else is paying the bills during this period, but for them, it is not a viable option.

Pricing Should Be Based On Value Not Cost

One of the ways to make money is to simply sell the product directly to the customer for a one-time fee. A common mistake is pricing the product on costs rather than the value to the customer. Start-ups begin with the premise of a desired minimum margin and base the price of the product on the mark-up. A second way is to price the product to be in line with similar or complementary products from other providers, but this is following the leader, and it’s difficult for a small company to do business like a large player.

The Customer Problem Solved Can Be Pricing

Many start-ups have built their customer base because of their pricing models, not because of their products.  For years, software was sold on a perpetual licensing structure. This meant that the customers purchased a license that was valid forever and then they paid a small annual maintenance fee for upgrades and support.  Customers disliked this model. It meant that had to pay very large upfront fees and the cost benefit was realized over multiple projects. EDA and CAD software were such products. I can remember putting out purchase orders for millions to secure licenses and the initial license fee could easily be 25% to 33% of the first project’s budget. Along came a start-up with term licensing model – you get a license for 3 years.  It dramatically dropped the costs and customers preferred it.

Another example is summer camps for kids. Summer camps typically charge for one full week and there is no refund once registered. Parents dislike the refund policy because camps can be cancelled by the provider, but parents cannot cancel the camp even though registration is often several months in advance.  The full week can create conflicts is a child’s music, tutoring, or swimming lessons, which are usually a couple of hours a week and also require long-term contractual obligations. One camp offered a drop-in, pay by the day model with no prior reservations required.  Parents can even get a discount by buying blocks of days. If all the days in the bundle aren’t used, the parents receive a refund at the end of the summer.  Every parent loves them. They have drawn huge campers quickly and have become the largest camp in my area, drawing droves of campers away from every other camp. Instead of copying their model, the other camps responded by raising their prices substantially to reflect lost enrollment, further pushing more parents to the new camp.

Opt-Out Versus Opt-In Subscriptions

With Internet products and services, many start with an opt-in subscription model. The offer a free trial period and then ask users to sign-up for a paying subscription. Many have learned that the opt-out has a greater impact on the bottom line. In an opt-out structure, the user provides a payment method and if they are dissatisfied with the product, they can get a refund or cancel their subscriptions.  Under an opt-in subscription, 50% of customers can drop out after the free trial.  While with opt-out subscription refunds and cancellations rate can be as little as 5% and  triple the number of paying subscribers.

Advertising Schemes

Internet start-ups are quick to include advertising in their revenue stream, sometime almost exclusively. A website needs a big audience to be supported by advertisers.  Advertisers become interested when a web property has hundreds of thousands of users. It takes a million users to attract large ad firms and about three million users before unsolicited request for proposals come to the website.  It’s not just web properties that want to use advertising as their main source of revenue. I encountered a start-up that provided electric car plug-in recharge stations and their intended primary source of income was from advertising.  While advertising can complement any businesses revenue stream, it takes large volumes to support an organization and it takes time to build such an audience. Advertising is often 5% or less of total revenue.

Lock-Ins

Many businesses use a lock-in scheme to keep customers coming back. An obvious form is the contractual obligation.  Sometimes this takes the informal form of an annual membership fee, which keeps consumers not wanting to double pay when switching services. Sometime it’s an effort consideration. If your electronic database can’t be ported to another service with an easy click of a button and would have to be re-entered, then this too is a form of lock-in.

Payments and Financing

When products are considered expensive by the customer then offering a payment option can substantially increase revenue. A health start-up offered a product for $1,200 and 80% of their sales was on the installment plan. Likewise, there’s an Internet start-up that offers a service for $50 per year. Although they have a monthly payment option, 80% of their customers prefer the one time annual payment.  Similarly, online training courses are offered as 3 monthly payments of $100 per month or 3 monthly payments of $1,000 per month.

Flip Your Competitors’ Model

In most industries, a pricing model becomes traditional. The bigger players adopt a pricing model, and then everyone follows. Consider cable television companies, they give customers the set top boxes for free and make the money on monthly service fees. Unless a start-up is well backed by investors, this isn’t a feasible model. Flipping the model may work better. Ask customers to pay for the set top box and then give them free lifetime service. If the service takes off, then offering the first few thousand customers free monthly service will be insignificant in the overall revenue stream.

Mixed Revenue Stream

Many businesses get their revenue from several different sources. Some start-up will offer both products and services.  I have found that 20/80 is often the case depending on the industry, some are 20% products and 80% services, or vice versa. Internet based businesses also tend to have different mixes. For example, subscription sites will have 80% from subscriptions, 15% technology licensing, and 5% from advertising.  On line training websites get revenue from one-on-one coaching, on-line classes and webinars, advertising, and conferences – with the bulk of revenue coming from conferences and on-line classes. Membership organization have the same type of mixed structure, the IEEE trade associations receives only 9% of its revenue comes from membership with 38% from conferences and 36% from periodicals.

Growing Your Business

Start-ups need to consider how they plan on increasing revenue in the future. Is the company going to move up the food chain and increase their price? There are businesses that start as the low cost provider and then increase their pricing as they become more established. This may create difficulties as the customer who bought at the low price isn’t likely to be the same customer willing to buy at the high price, and thus a new business model may be needed. Many online marketing firms starting out by offering their service for less than $800 per month, then they increase pricing to $2,000 per month, and finally they high end of the market is the $50,000 annual fee. Instead of increasing volume, they have elected to increase pricing, but by doing so they have changed who their customers are. Yet, others grow by holding at their price point and increasing volumes. They are scaling to the same customer profile.

Revenue Killers and Enhancers

There are other considerations in building your business model. Procrastination is the biggest killer of sales. Even if your start-up has a great product that’s a perfect fit and is coupled with a superb offer, customers will delay.  Consider adding a scarcity element such as a limited time offer or a limited number of openings.  In recessionary times, price is biggest factor in choosing a product or service.  Consider reducing the risk of saying “yes” by offering a money back guarantee. Many businesses fear they will be giving back too much, but in actuality, few people will ask for a refund even if the product is not right for them.

The product itself isn’t always the reason a customer buys. Often it’s how the product is offered. Innovation doesn’t have to be about technology. The business model translates innovation to economics.

One Response to “”

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