Digital business models
What is a digital business model?
A model that leverages on the benefits of technology to improve all aspects of the organization is a digital business model. This can include aspects from how the organization attracts clients to the products and services it provides. A digital business model exists when technology improves a business’s value proposition.
Debunking some myths
Before we dive into the different types of digital business models, let’s first debunk a couple of myths about what digital business transformation really is.
Myth #1 – A new digital business model is just about the product or service
Let’s say you write an e-book and sell it online. You would be selling a digital product but your business cannot truly be defined as a truly digitally transformed business since a digital business model is not just about distributing a traditional product digitally.
Myth #2 – Digital is only about distribution
If you create a website for your business, that’s great. But, the website in itself does not convert your business into a digital business. To create a sustainable flow of customers/partners/users, you need to be able to create a website that replicates as much of a physical store as possible. E.g. it describes and displays your products/services, responds to customer enquiries, if possible allows the user to “see” how the product might look for their use (using augmented reality for example) and enables customers / partners / users to initiate and / or fulfill a transaction.
It can take several iterations
New business models made possible by technology are often combined with existing business models to create their own methods and formulae. Not a single formula, but rather a recipe with ingredients to be tested.
Often, “innovative” business models are the result of improvements, such as taking existing ingredients, copying them in different quantities and using them in the cooking process.
It could take several experiments and changes before a business arrives at a winning formula.
Netflix took decades to become an effective streaming platform. Before that, it was basically a DVD rental company.
However, as video streaming technology became technically feasible, Netflix’s business model improved, creating a different market (video streaming) for companies rather than DVD rentals.
A basic business model that offers sufficient value to a certain group of customers will sustain you through the first stage of growth. You then would need to keep looking out for ways to offer better value through the use of continually improving technology.
Amazon thought of building up a way for outside vendors like Target to assemble their web based business on top of Amazon infrastructure (called Merchant.com at the time) for advancing its mission on providing different types of products.
Over the years, the company transformed to become Amazon AWS and has become one of Amazon’s most successful business units.
To arrive at a successful digital business model, you will need to be flexible, willing to fail and learn quickly from failures in order to iterate to a different and hopefully more successful business model.
Elements of a digital business model
These are the elements to keep in mind when designing a digital business model:
- Product/service: Creating digital products/services requires a migration from the rare to potentially unlimited ideas. Digital products/services can be very costly to offer. I imagine that a platform like Google needs to spend billions of dollars to manage digital resources by investing in huge physical infrastructure (data centers). Nevertheless, those expenses often help companies gain exponential positive impacts to the business.
- Distribution: To create a digital distribution, it is important to understand the different channels that have been enabled by the World Wide Web. Also note that every few years, new channels appear so it is important to keep up to date with technological developments. Current digital channels include: email, apps, websites, digital kiosks and social media and Creative Media (TikTok) etc.
- Value proposition: The value proposition of a digital business model can often be provided by supplying positive aspects where negative aspects exist. Think of how Google maps enables you to find directions to almost any part of the world without the need to acquire and read a map for each city you visit.
NB: Technology is changing fast. Digital business models may therefore work in the short-medium term (5-10 years), but tend to be extremely fragile in the long-run (20-50 years).
In the early 2000s, we used to print directions to our destinations then have a passenger (co-driver 🤣) tell us where to turn. If you made a wrong turn, your printed directions were useless. GPS came along and now Google maps on your phone tells you where to go and even when you go the wrong way, it recalculates the route to get you to your destination. Better yet, it can recalculate the route to avoid traffic.
It is important when building a digital business to know its advantages but also its drawbacks. If you had been the business that enabled people to print directions before your trip, GPS technology would have taken you out of business if you didn’t readjust your business model to leverage on GPS.
One way to prevent digital business failure is to maintain a financial buffer. Tech giants keep huge heaps of money as buffer – for the next business model iteration that might become necessary.
Types of digital business models
Open source is licensed by various independent developer communities and is usually developed and maintained therein. While in-house, the freemium is created. Therefore, freemium provides the company that developed it with full command over its conveyance. The open source model requires commercial companies to distribute an advanced version of the open source licensing model.
The open source model releases access to the software, usually enabling the programmer community to contribute to the software. These two elements are crucial. The free-ness makes it spread rapidly. It is the community that ultimately determines its success.
Open source is not a basic model for companies to make money in building a sustainable business model. For example, companies like Red Hat charge premium subscription fees and pay for training and services related to open source software. In fact, Red Hat’s revenue in 2018 exceeded $2.9 billion. This includes $2.57 million were from membership subscriptions and from training and services $346 million. However, for making profit from open source software, Red Hat is not the only option.
Reviewing Red Hat’s annual report, Red Hat returned to the case study and described its business model as mentioned below:
Development. An open source development model has been adopted by us. The open source development model discloses the human-readable source code of the software and changes the permissions. Therefore, the investment, resources and resources of the global contributor community can contribute to the development, maintenance and improvement of the software. And knowledge can be used in combination.
Licensing. Generally, software products are distributed under an open source license that allows access to the human-readable source code of the software.
Subscriptions. Based on necessity, through our certified cloud and service providers (“CCSP”), we basically provide yearly or multi-year software memberships.
Therefore, because of the open source business model, Red Hat has the three main advantages which have been highlighted in the annual report:
- Develop qualified contributors quickly and efficiently through a global community that is not on the balance sheet of the company.
- Excellent software distribution with free software license.
- Paid subscriptions to premium customers and corporate customers.
Creating a business model based on open source is not easy. Its success relies profoundly on the ability of project developers and the community to participate in improving and truly making the source code very important.
In addition, the model can strongly market products through free services. However, this does not necessarily lead to profit for the company. For example, Red Hat spent $1.2 billion in 2018 to allocate paid subscription and marketing costs to sellers.
It accounts for 41% of absolute revenues and “mainly includes sales and marketing personnel, sales expenses, travel, public relations, marketing materials, exhibition sales and other related expenses.
Free models are very popular on the Internet. Since the launch of Netscape, the company has created great products and released them for free, hoping that once enough people adapt to them, monetization will not be a problem.
This model is very effective for fast-growing products, maintaining short term infrastructure by increasing investments and finding monetization strategies.
In this way, companies like Google and Facebook were formed. They have released free services, and the number of users is increasing. Allured by the first angel investors, and investment capitalists had to devote themselves to a fast advertising model to profit from their users so as not to be left out of money and investors.
Therefore, although free services provide an opportunity to extend the marketing phase, companies need to decide how to profit from the provided services. Usually there are several routes:
- Initial version of the product and more developed paid version (freemium model)
- Although one side avails this service free of charge, funds are obtained from the other side (asymmetric model)
- Adjacent to the core topic of the product, training materials or info products (educational model)
- Free fundamental assistance and prepaid service (usage model)
- Job board for connecting talented people and employees (job board model)
These are some examples of how to profit from the free business model.
Generally freemium is more of a growth and brand strategy than of a business model. Most users can enjoy free services, but few users transfer money to their customers through the marketing and sales goal achievement process. Free users who do not convert customers will help in the spreading of the brand.
In the past ten years, the freemium model has been very popular. The simple reason behind this is that it permits a higher growth rate of vitality. In these models, Dropbox, Mailchimp, Spotify and different similar cases have generated viral growths.
Basically, anyone with a freemium model can use the free version without any issue. Without promoting or more information, these free services require you to switch to a paid membership for availing more volume.
Spotify is a two-way commercial center where artists and music fans face each other on a solitary platform. Music based on streaming audio and video was established in 2008 with the belief that a consistent experience is needed to get music from all over the world. In 2017, sales exceeded $4 billion, of which about 90% were based on premium subscriptions, and 10% were ad-supported free services. In 2017, $378 million was the recorded operating loss of the company.
For example, a free limited assistance supported by advertising is provided by Spotify. However, if users use advanced services, they can listen to the music without any advertisement interruption or can download the music for listening to it offline.
Dropbox with a premium service enforces you in utilizing more space. Mailchimp enables you access to advanced characteristics and to deal with more customers in your email list.
When choosing this model, you need to ensure:
- A customer base of strong enterprise.
- An optimized conversion funnel for switching free users to paid membership.
- A powerful technical infrastructure to handle various free users.
We dwell in an economy based on subscription. From Netflix to Spotify to Amazon Prime, the most interesting and valuable centralized services we know today all follow a subscription model.
Because its some built-in features, this model is very powerful and advantageous:
- A user base which is loyal
- A continuous and predictable revenue stream
- A sales pipeline which is comparatively more predictable
As they can generate long-term, sustainable sources of income, many companies are “subscribing” to the model. However, remember that creating such a model is not easy job.
In fact, companies like Netflix and Spotify are spending billions of dollars to create core content that makes customers crave for updating their plans.
A subscription based service Netflix has changed the traditional way of using media. Series such as “Stranger Things”, “Narcos” and “Black Mirror Netflix” have become giants in the media industry, with more than 150k members worldwide.
Often, subscription relied models also require the necessary infrastructure investments. The services provided through this model can know exactly what to watch next on these platforms.
You also need to create a process to provide a great customer experience, thereby reducing slow speeds and improving the customer’s lifetime quality. The company will soon go bankrupt If the cost of CAC or customer acquisition exceeds the lifetime value of the customer.
With the help of the Internet, you can finally get contented at your own schedule and speed. The Internet has done things that media such as television and radio have not done. Cost based on instant necessity permits individual to access content at various time spans.
Likewise, scale is no longer understood as someone’s single product or service. The on-demand model requires to be appreciated for this.
This applies not only to content but also to other sorts of services. Netflix promoted this model when the show was ready to be released on the platform at any time.
In an on-demand model, other services such as Uber and Lyft have also been successful. The technology platform permits individual to interact and enable these types of services immediately.
In the era of technological innovation, business models are becoming more popular as followed by Uber. They are called two-way markets and have a common foundation. Create a platform with excellent user experience and gaming elements, and easily connect the two aspects of trading. This is especially true in industries where transactions between these two industries are blocked. This is because the third party obtains the greatest benefits in this industry, and the third party brings the maximum profit share to the industry. When a third party moves between adjacent markets, the platform owner charges a fee to both parties of the transaction.
From subscription to the pricing of each transaction on the platform, in many ways the on-demand model can be profitable.
The key factor is to create a smooth user experience. In this experience, you will scarcely notice that someone is creating this for you from the backend.
Peer-to-peer markets are usually platforms where both parties participate in transactions, and may be related to products (Etsy) or services (Uber, Airbnb, LinkedIn).
Peer-to-peer markets are often seen to fall into the chicken or egg trap. There, both parties need to interact in the market to be effective.
But the paradox is that a platform is needed, and the platform must generate supply and demand continuously.
Imagine the situation with Uber. As long as there are enough drivers on the road to provide riders with on-demand and convenient services when needed, the platform can work.
Drivers desire to drive at their own convenience and be adequately paid for their efforts. Therefore, peer-to-peer markets often face many challenges in ensuring that demand is met fairly.
This problem is faced by all of Uber, Airbnb and Etsy. For example, to increase the number of drivers on its platform, Uber has adopted a variety of strategies, including surge pricing which is a dynamic pricing strategy.
One peer-to-peer marketplace is the HyreCar. Here car owners can rent idle vehicles to drivers willing to earn some extra money through shared services (such as Uber and Lyft) to increase their role as a buyer’s market. HyreCar charges 10% weekly fee from the drivers and 15% from the owner’s weekly rental income.
One of the first companies to prove that people are ready to buy physical goods online was Amazon. The company started as a bookstore and soon began selling music and related products till it turned into a everything store!
In the present days, the e-commerce business model has been adopted worldwide and is one of the most commonly used digital business models.
If Amazon demonstrated that the web can turn into an everything store, an organization that changed the way media could be utilized was Google. Not only you can enter the website address in your browser, but also you can search for anything you need to find.
All Google services and applications are completely free. At the same time, it can profit from data retrieved from search engine pages through an advertising network called AdWords (now called Google Ads).
When Google launched its IPO in 2004, it demonstrated the business world how ground-breaking was the digital advertising business of it. In fact, in just a few years, Google has exceeded the landmark of $1 billion. The company’s advertising business exceeded $110 billion landmark in 2017.
It is not easy to operate and make money from your digital advertising business but it’s quite easy to start with the business. Without the dominant advertising market of Google or Facebook, and without a huge user base, advertising alone cannot make a profit.
Google initially made money through its advertising network, which accounted for 86% of 2017 revenue. Next, the another side of the business (approximately 13% of revenue in 2013) is the combination of apps, in-app activities, and digital content in the Google Play store, Google Cloud products, and hardware products. What’s left is a series of high-risk companies that are responsible for Google’s “other bets” wagering on by Google.
Generating revenue when the customers using your services are mostly unaware of the fact that you are making money is the hidden revenue generation. Facebook and Google are two examples of hidden revenue generating organizations.
Asking the average Facebook or Google user you will come to know that he or she does not know how these company make profits. This is one of the major grounds that these organizations are investing huge resources to create this sort of model.
Mobile advertising accounted for 92% of all Facebook product advertising within the first nine months of 2018. The number of monthly active users in Europe has reduced by 1 million from 376 million to 375 million. The number of users in the United States and Canada has increased from 241 million to 242 million. At the same time, worldwide average revenue per client increased. The business model for Facebook appears to be unshakable (at least for now) despite of all the ups and downs in 2018.
None of the above mentioned models is a complete business model that can be fully applied to any organization.
A business model is usually the result of a combination of multiple parts.
An e-commerce platform such as Amazon utilizes affiliates round the year to keep its flywheel running.
To arrive at a fruitful business model, successful organizations utilize multiple digital business models.
For example, some of Google’s products rely on an open source model, but use a hidden revenue model to monetize its core product (search engine). It additionally influences to make the product free to the mass public and quickly gain and create appeal and thus taking the products to a level of standard!
Therefore time, customer feedback, vision, and understanding of existing markets and potential new markets are necessary to help you discover your ideal digital business model…but always keep in mind the need for possible iterations of every successful digital business model. Everything is a prototype.