The earnings model has a lot of influence on the success of an organization.
New digital revenue models are conquering the world. What are the pros and cons of these changes?
How do these models affect organizations and the valuation of shares on the stock exchange?
This article discusses the following topics:
- What is a revenue model?
- Examples of revenue models
- Disadvantages & advantages of revenue models
- Changing earnings model
- New revenue models
- Conclusion: Importance of the earnings model
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Revenue models
What is a revenue model?
The earnings model is the way in which a company earns money from its products and activities. In order to keep more money, companies try to distinguish themselves with the earnings model.
Many successful companies manage to divide the market in such a way that they themselves obtain the most favorable position. This often means that they do not make much of the investments themselves, but still get a share of the proceeds. Think of Coca-Cola that sells syrup to bottlers, McDonald’s that largely leaves the operation of shops to franchisees, Uber that does not own any taxis or Hilton Worldwide that hardly owns any hotels.
However, there are also other successful revenue models. Subscriptions provide stable and predictable income. This was why newspapers used to do well. Now subscriptions are particularly popular with technology companies. Think of Netflix and Spotify , but also Amazon . The predictability of revenues and customer loyalty make this an attractive proposition.
Examples of revenue models
There are several ways to earn money as an organization. Below are some examples of revenue models:
- Sale of products or services against payment
- Subscription or rental with regularly recurring payments
- Pay per number of clicks or views
- Fee per hour
- Offering free services, with the option to upgrade for a fee
Many different variations are possible on these earnings and business models. For example, it is possible that companies combine different ways. The most famous description of this is the razor blade market. With razors, you usually get the holder and the like for free or for a low price, while the profit is made from the sale of new razors.
Lift manufacturers also earn more from the service and maintenance contract than installing the lift itself. In the past, before regulations no longer allowed this, many financial products were also linked to each other. When you took out a mortgage with a certain bank, you also had to arrange the insurance through this company.
However, this made the transactions very opaque and was abused with products such as the profiteering policy. We see this much less nowadays, partly due to the rise of the internet. Although banks often still want you to close the checking account with them if you take out a mortgage there.
We see the same strategy implemented in a different way in restaurants. Restaurants price the food fairly sharply with low margins, but make money from the drink. However, the business model of razor blades is better, because a one-time sale ensures several sales moments in the future.
Disadvantages & advantages of revenue models
The most common and used revenue model is that of individual one-off transactions. The advantage of this is that the transaction is very clear. The costs of the transaction are clear and there are no or few obligations after the transaction. This may make it easier to convince someone to make a one-time transaction.
This convenience also has drawbacks. For example, these transactions are difficult to predict. Customers can easily stay away and this can make revenues very cyclical. Whether this is actually the case depends on the type of product. Daily groceries, for example, are not cyclical, but large expenses that can be postponed are.
It is more difficult for a cyclical industry to use production capacity efficiently. Producers of these goods often have years in which significant losses are incurred.
A bond with the customer
In addition, these separate transactions create less of a bond. When customers pay or return regularly, a habit develops. The activities will be integrated into other activities and customers will become less price sensitive. This makes it possible to increase margins in the long term.
Another advantage of a large group of subscribers is that you can buy in bulk. These economies of scale can partly be passed on to the customer, so that the customer base grows and remains loyal. Companies such as Netflix can create a positive flywheel effect in this way.
Changing earnings model
Changes in the earnings model can also offer interesting opportunities for investors. For example, when the incoming investments receive greater certainty.
One industry that has made the transition to a new revenue model very successfully is software. In the past, you usually bought separate software licenses. The problem with this was that many people wait a long time to buy new licenses. Software companies lost income as a result. The use of old licenses also meant that software companies had to issue updates for many different versions when, for example, a leak was found. Microsoft has benefited the most from this switch in revenue model to Software as a Service (SaaS). Partly because of this, Microsoft has once again become the most valuable company in the world. Other successful SaaS companies include Salesforce , Adyen , Shopify and Adobe.
Successful switch of earnings model
Now that software is sold much more often as a subscription or service revenue model, subscribers always have the latest version, while the selling software companies suddenly receive much more stable revenues. It is also more difficult for competitors to intervene. This has ensured that the valuation of such software companies has also risen sharply.
New revenue models
Due to the rise of the internet and new production techniques, new revenue models are also emerging and products are offered through different revenue models. Examples of new revenue models are personalization and the focus on service and services.
Personalization
Through personalization it is possible to make products distinctive. In this way you can compete on other things than price alone. 3D printing is the extreme example of this, but it can also be done in many other ways. For example, personal advertisements or personal advice that is linked to a product.
Product as a service
Selling products as a service or service is also very popular. In addition to technology that makes this easier and more efficient, there are a number of other causes for this. For example, the low interest rate makes it less important for selling parties to get cash right away. A steady stream of income in the future is almost as valuable. Certainly because this makes the income less cyclical. It is also cheaper for companies to borrow money themselves against hard assets and then rent them out or sell them on installment. Consider, for example, the increased popularity of leasing and the purchase of cars on installment. Even buying houses for rent has become much more popular because of this.
Platform
In addition, these types of services often need a platform. It is precisely such a digital platform that is financially very attractive. The investments in the real products are made by someone else. Well-known platforms are for example Uber , AirBnB and Booking . They do not own cars, restaurants or hotels themselves, but link supply and demand. The internet has made it possible for these intermediaries to link many more parties and to conquer a much stronger market position.
Platforms themselves require few assets and usually receive a percentage of the turnover. This makes growth very lucrative. Especially if the margins can be increased at a later stage when a strong market position has been created.
Conclusion: Importance of the earnings model
A well-fitting revenue model can make a big difference. It can make customers more loyal and get the best product. At the same time, companies can ensure that margins increase through smart positioning and choice of business model. Revenues thus become more predictable and less cyclical.
The earnings model can also make a huge difference in the valuation on the stock exchange. Different models also offer different potential. For example, many platform companies earn next to nothing until they really become dominant in the market. Then the economies of scale come into the picture and the margin and profit shoot up further. This means that platforms seem very expensive before the profits are realized. Whether the valuation is justified will become clear in the future. When they become dominant in the market, the returns are huge, but dominance is not guaranteed. There are competitors who pursue the same dominance. Whoever wins in the end will have a very strong market position with a good earnings model. However, the earnings model is not the only thing that is important in fundamental analysis. .
Another factor is not the success of the business model, but valuation. How many shares you can buy back for a certain amount of cash has a lot of influence on the success of buying your own shares. If you want to know more about the valuation of a company, look at the EBITDA , quick ratio , solvency, liquidity or profitability, among other things .
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