A business model is the logic by which a company creates value for customers and captures some of that value as profit. Every company has one, even if it's never been articulated. Understanding common business model patterns helps you think more clearly about your own venture and the businesses you interact with every day.
What a Business Model Actually Is
The term "business model" gets used loosely to mean different things: sometimes a revenue model (how you charge), sometimes a go-to-market strategy (how you reach customers), sometimes an entire business plan. More precisely, a business model describes the core logic connecting three things: the value you create for customers, how you deliver that value, and how you capture a portion of it as revenue.
Alexander Osterwalder's Business Model Canvas, nine blocks covering customer segments, value proposition, channels, customer relationships, revenue streams, key resources, key activities, key partnerships, and cost structure, provides a useful framework for mapping any business model. You don't need to complete all nine blocks formally, but thinking through each dimension is valuable for any new venture.
The Most Common Business Model Types
Product sales: The simplest model, manufacture or source something and sell it. Margin is the difference between cost and selling price. Works at any scale from street vendor to global retailer. Challenge: competition tends to compress margins over time.
Subscription: Customers pay a recurring fee (monthly or annual) for continued access to a product or service. Spotify, Netflix, SaaS software, gyms, and magazine subscriptions all use this model. The advantage is predictable, recurring revenue and high customer lifetime value when churn is low. The challenge is acquiring customers who will stay long enough to make the acquisition cost worthwhile.
Marketplace: The company connects buyers and sellers and takes a percentage of transactions or a listing fee. eBay, Airbnb, Etsy, and Uber are marketplaces. The model is capital-efficient (you don't own the inventory or the service) but difficult to launch due to the chicken-and-egg problem: buyers won't come without sellers, and sellers won't come without buyers.
Freemium: Core functionality is free; premium features or capacity require payment. Spotify (ad-supported free / premium paid), Dropbox (limited free storage / paid expansion), and LinkedIn (basic free / premium features paid) all use this model. Conversion rates from free to paid are typically low (2-5%), so the model requires a large free user base to generate meaningful revenue.
Advertising: The product is free; revenue comes from selling access to users' attention. Google, Facebook, Twitter, and most media sites use this model. The model requires enormous scale, meaningful advertising revenue requires large audiences. For independent publishers, ad revenue rarely covers costs at small scale.
SaaS (Software as a Service): A specific form of subscription applied to software delivered via the internet. Customers pay monthly or annually for software they access through a browser or app; the provider hosts and maintains the software. Recurring revenue, high gross margins, and scalable delivery make SaaS extremely attractive financially. Competition is intense.
Agency/Service: The business sells expertise and time rather than a product. Consulting firms, law practices, design agencies, and freelancers operate on this model. High-margin, low-capital, but fundamentally limited by time, you can only bill so many hours. Productizing services (creating fixed-price packages) or hiring additional people are the two growth paths.
Choosing a Business Model
The right business model depends on your industry, your customers' purchasing behavior, the capital you have available, and the kind of business you want to build. Several questions help narrow it down: Do customers make one-time purchases or ongoing use? (One-time → consider product or project model; ongoing → consider subscription.) Is your value more in a product or in expertise? (Product → product sales or SaaS; expertise → service/agency.) Do you need to aggregate buyers and sellers, or serve one side directly? (Both sides → marketplace; one side → almost anything else.)
Most successful small businesses use simple models, they sell something or they provide a service. The complexity of freemium, marketplace, and platform models is appropriate for venture-backed companies with the resources to sustain the investment required before revenue arrives. For most small businesses, the simpler the model, the better.