The economics major in me is always trying to figure out the different ways startups make money. Getting a billion users and downloads is impressive, but it doesn’t pay the bills. Even venture-backed Silicon Valley startups have a master revenue plan, though they might not have tested it yet. These days, it’s not just enough to have a great idea and execute it well. You need to have a scalable revenue model. Scalable meaning you can handle a growing amount of customers and/or web traffic.
For some startups, it’s pretty straightforward. If I give MailChimp $10 a month, then Mailchimp lets me send unlimited emails to my 500 subscribers every month. For others, it’s not as intuitive. If I click through an Ebates link to Kohls.com, Ebates will cut me a check for 5% of my purchase. But what’s in it for Ebates?
Here I’ve outlined the 95% of the ways startups make money. You’ll probably recognize some of the traditional revenue models at the beginning and maybe learn something new by the end of the list.
Ways Startups Make Money
Products for Sale
Sell goods, make money. Pretty simple, right? The two ways of going about this are either inventing something new or finding a cheaper way to make or sell existing goods. For inventions, patents are key. Kickstarter can be great way to test proof of concept before investing money into a prototype. Once startups find a manufacturer, they can even begin pre-selling the product like TurtleCell’s tangle-free earphone case and Protean’s bluetooth credit card.
Startups like Chalkfly and Warby Parker are trying to disrupt existing industries. By setting up partnerships with suppliers and cutting out the middle man by shipping products directly, they create their own market niche. Which also leaves room to do good, as both Chalkfly and Warby Parker have give back programs for school supplies and eyeglasses, respectively.
Not all products come cheap and in some cases, it might be cheaper to rent. Rent the Runway allows its customers to rent designer dresses for a fraction of what they would have to pay full-price. Similarly, TernPro and Wedit rent out cameras to people who want to shoot video without purchasing their own equipment. Rental businesses can pay for themselves over time, but the key is getting enough capital in the beginning to purchase a large inventory. This deters others from entering the market (first-mover advantage!).
Magazines may be a thing of the past, but getting goods like makeup and candy shipped monthly still delights users. Venture capitalists love the monthly model because of its predictable recurring revenue. To make this model work in the long term, companies like Birchbox and Bocandy need to keep their current subscribers happy, minimizing churn (lost customers) while always bringing on new ones. The marketing strategy tends to be social-focused. Word of mouth via YouTube reviews or Twitter shout-outs can work wonders when trying to scale a subscription model. Watch the video that made Dollar Shave Club famous below.
Advertising helps keep products free to users, which makes it easier to get them to sign up. But beware, making money from advertising only works for websites with an insane amount of web traffic (>100,000 views/day), so this isn’t a viable business option for most. There’s also room for creativity in advertising.Tinder recently experimented with advertising when fake profiles for characters from The Mindy Project appeared in its matchmaking app.
Software as a Service (SaaS)
Often SaaS companies will offer a free version (or trial) of their platform to make it easier to acquire users. The same service is sold to heavy users for a monthly fee, in what is called a “freemium model.” By selling cloud storage space to businesses, Dropbox can use some of that money to subsidize free storage for its light users.
By jumping into a two-sided marketplace as the middle man, startups like Uber can make money by taking a cut of every transaction. The hard part is getting to critical mass (the tipping point before growth becomes explosive). In order to get around the chicken and the egg problem, startups sometimes have to cheat their way into making one side of the marketplace (usually the supplier) active. Airbnb did this by spamming listings on craigslist (read more).
Selling Big Data
Big data generally isn’t the sole source of revenue for a company. It’s also usually sold in an anonymized and aggregated form. Having access to purchase and location data can be extremely valuable to companies who want to target customers based on behavior. Earlier this year, Microsoft invested $15M in Foursquare for both a licensing deal and special integration with Foursquare’s API. As more and more data is shared through new apps and sites, I can see this kind of big data selling becoming more widespread.
Affiliate Marketing/Lead Generation
Out of all the ways startups make money, this one might be the sneakiest. Affiliate businesses are rewarded when users make purchases through their marketing efforts. In the example I named earlier, Kohl’s would give Ebates a percentage of my purchase for sending me their way. Then Ebates would give me a cut of that money to make me happy. Affiliate marketing isn’t necessarily a bad thing. On the personal finance website Mint, users generally receive offers relevant to their needs (see below).
Unknown (Get acquired?)
Sometimes a product becomes so popular and robust before it’s able to find a proven revenue model. In this case, getting acquired for a high valuation might be the best option. Companies will either buy startups to add to their portfolio (e.g. Facebook acquiring Instagram), to absorb competitors (e.g. Facebook trying to buy Snapchat), or to acquire their talented team members.
As you can see, there are many different ways a startup can make money. And that’s not even all of them (LINE sticker packs, anyone?). Proving the business model is the hard part (well, after picking a good startup name).
Which models do you think work best?