What Is a Revenue Model?

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Revenue keeps your company in business. It gives you the cash to pay your operating expenses and invest in the future. It's easy to take revenue for granted because it is such a fundamental part of doing business, but taking a close look at your revenue model allows you to ask valuable questions and make adjustments that keep cash flowing.

TL;DR (Too Long; Didn't Read)

A revenue model is a clear picture of the way your business generates income.

Revenue Model vs. Business Model

A revenue model and a business model are so closely connected that many business owners and advisers use the terms interchangeably. However, they are not precisely the same. A revenue model focuses specifically on how your business is compensated for the products and services it provides. A business model takes a broader look at how your company operates, also addressing how you create value for your customers and how you manage expenses to net a profit.

Revenue is the top line of your income statement — the amount you bring in from sales of products and services. It would seem that a business that brings in an impressive amount of revenue would qualify as a clearly successful business. However, strong revenue doesn't automatically translate to high profit because your business may be spending too much to generate that revenue, and your bottom line may actually show a loss.

Despite these nuances, it is important to take a close look at your revenue model because it can provide the key to growing your business, even if you also must learn to manage expenses. A successful revenue model is important to a successful business model, although it isn't all it takes to make your business thrive. Your revenue model is a fundamental piece in a bigger and more complex puzzle.

Types of Revenue Models

  • Fee for service. With this type of revenue model, customers pay to have work performed. They may pay you by the hour to use skills and equipment that they need, or you may charge based on outcomes, such as installing a dishwasher. The former model works to your advantage when there are unknown variables, while the latter can be a win-win situation if your systems are streamlined, and you can deliver good value quickly.

  • Rent or lease. This revenue provides income by allowing customers to use your resources for a designated fee. A property management company rents or leases residential or office space, and a car rental company provides automobiles for rent. This type of revenue model can require you to make a considerable investment in acquiring the resources to rent or lease, but once you own them, much of the income is passive.

  • Retail sales. Buying from producers and distributors and selling to end users is a common revenue model that allows you to do business with relatively little capital investment, at least compared to a manufacturer who has to purchase heavy equipment or a property management company that needs to purchase real estate. A retail sales revenue model depends on offering an appealing or unusual product mix or offering convenience in the form of location or even delivery.

  • Manufacturing. A manufacturing revenue model makes money by transforming raw materials into finished goods that can subsequently be sold. Revenue is generated by creating or adding value and then selling the completed products to wholesalers, retailers and end users who are willing to pay for them. Manufacturing can require considerable investment in infrastructure, but financial return relative to outlay can be good once your plant is operating smoothly.

  • Online sales. While selling online is a type of retail or wholesale sales, it can differ in the delivery method and also in the fact that you may not even carry inventory. Drop shipping is a strategy where you receive orders from customers and then fulfill them by ordering from a provider who ships directly to your customers. 

Diversifying Revenue Streams

Like a stock portfolio, a revenue model should be diversified to protect you from circumstances that can threaten your financial well-being. You can diversify your revenue stream by setting up your business so you have money coming in from a range of sources, such as wholesale and retail accounts. You can also create a varied revenue structure by selling to a broad mix of accounts or customers, an approach that will insulate you if anything were to go wrong with a particular account or customer relationship.

Even if you do everything right, there will still be dips and changes within your revenue model. You may build up sales of a particular product or service that becomes obsolete because of an entirely new technology. Alternatively, your steadiest customer may run into hard times and go out of business, leaving you without the ongoing orders that have become your bread and butter.

If you derive revenue from a diverse customer list and a varied collection of products and services, you can protect yourself from some of the negative consequences of undesirable changes. It will still hurt to lose key customers and to see a decline in an important revenue stream, but you'll be able to pivot and replace at least some of the lost business by focusing on foundations you've already built up in other areas.

Cash Flow and Revenue Model

In addition to helping you ensure that your sales won't drop too dramatically at once, diversifying your revenue model can also help you with your cash flow. If you rely heavily on wholesale or retail accounts with a 30-day or 60-day billing cycle, adding in some direct cash sales will give you working capital while you wait for your slower-paying customers to write their checks.

Subscription models can also help you to achieve dependable cash flow. By accepting payment all at once and delivering products or services over time, you can continue to replenish the money in your bank account and even receive advance payments to help stabilize your cash situation.

Revenue models can be especially important for seasonal businesses, which receive most of their income during a limited season but must pay overhead and daily operating costs year round. It's best for a seasonal business to have a supplemental source of revenue during slower times of the year, such as processing for other businesses, collecting money from subscriptions or renting out equipment that might otherwise stand idle to other businesses that need extra capacity.

Amazon's Revenue Model

The online retailer Amazon created a revolutionary revenue model by aggressively expanding its sales platform, at first very much at the expense of profit. It took years for the giant to make its way into the black, largely because it expanded exponentially by reinvesting as much money as possible back into development and growth.

As Amazon grew, its share price gained value despite the early lag in profitability, creating an additional revenue model of sorts for its founders, who grew rich from their early involvement. However, the price of Amazon stock wouldn't have been a worthwhile investment in itself if the company hadn't eventually reached profitability.

As it has grown, Amazon has consistently diversified its revenue stream. It has launched subscription services, a publishing platform and entertainment content among many other ventures. Its trajectory is testament to the fact that a revenue model isn't necessarily the same as a business model, and a company cannot survive indefinitely without eventually achieving profitability.

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About the Author

Devra Gartenstein founded her first food business in 1987. In 2013 she transformed her most recent venture, a farmers market concession and catering company, into a worker-owned cooperative. She does one-on-one mentoring and consulting focused on entrepreneurship and practical business skills.