11 Key Business Models for Startups

A business model explains how a company creates, delivers, and captures value. It is one of the most important aspects of starting a successful business.

There are many business models, and picking the right one for you can be intimidating. Each has different advantages and disadvantages; understanding these will help you pick the one that will work best for you.

In this article, we focused on the types of business models most appropriate for your startup business, leaving aside models appropriate for other types of businesses, such as services, retail, manufacturing, etc.

1. Software-as-a-Service (SaaS)

The Software-as-a-Service model emerged with the rise of cloud technologies. It enabled products installed and managed on the vendor’s infrastructure and delivered to customers over the Internet.

Benefits

• It reduces the work on the customer side related to installing, managing, and troubleshooting the software.
• It increases the value the vendor delivers to the customer by offering infrastructure and managed services.
• Provides more flexible licensing models based on consumption and usage rather than the number of installs.
• SaaS products offer customers higher LTV (lifetime value) than perpetual license products.

Examples

Many software vendors saw the benefits of the Software-as-a-Service and started migrating their perpetual license products to the new model.

• Microsoft provided Dynamics 365 as a better version of their CRM product Dynamics.
• Adobe launched its Creative Cloud, which complements its desktop license-based products with a cloud storage service and web-based products.
• SAP traditionally sold its ERP solutions through a perpetual licensing model. Recently, they moved their ERP solution to the cloud.

Increasingly, more companies start with SaaS-first products. In each segment above, a new player disrupts the market with a SaaS product like Figma in the design space or Salesforce in the CRM category.

2. Subscription

The subscription model is tightly connected to SaaS, as most products are subscription-based. This means that access to a product or a service is granted based on a subscription for a regular fee. However, the subscription model can work with on-premise software installed and managed from the customer’s infrastructure.

Benefits

• Subscription products are more financially attractive, especially in the b2b space, as they don’t require a big upfront investment and help forecast and manage expenses better.
• The risk of acquiring a subscription-based product is lower as it can be canceled or changed at any time if the customer needs change, decreasing the long-term commitment.
• Predictable and recurring revenue is the holy grail for startups. Subscriptions provide a more predictable revenue stream.

Examples

Even though most of Adobe’s products, like Photoshop and Illustrator, are still installed on a desktop, they are now offered with subscriptions rather than buying a license.

3. Open Source

Open source is much more than a business model. It’s a movement that promotes software licensing and distribution and empowers others to use, adapt, and resell software.

Nowadays, commercial companies use open-source software as part of their product strategy.

Benefits

• The free nature of the open-source software provides an avenue for a large user base.
• For users, open-source software provides reassurance and no vendor lock-in, as they have the source code and can adjust it if needed.

Monetization Strategies

Monetization has been a big open question for open-source products that want sustainability. There are multiple options with different pros and cons:

• Software products or components with small teams (like 1-2 core members) could be funded through donations and sponsorships by others who use the product.
• For bigger companies, offering supplemental premium services in addition to open-source products is another way to create a sustainable business. Red Hat is a company that offers enterprise services in addition to open-source Linux distribution.
• Other companies use open-source products to reinforce their brand as a marketing tool that is not monetized directly but supports other products in their portfolio. Angular and React are development frameworks developed and maintained by Google and Meta. The frameworks are free and help these companies position themselves as leaders in the developer ecosystem, which helps promote their other paid products and services.

4. License-based

The license-based model is one of the oldest business models for software products. In this model, customers are licensed to use a specific version of the product (optionally, with some upgrades included) and can renew their licenses for newer versions. The licenses can be perpetual (most often) or time-limited.

Benefits

• For products that will be used long-term, one-time payment may be more economically efficient, even with a bigger upfront investment.
• Traditionally, those products are installed on-premise, which removes the vendor's burden of providing, maintaining, and supporting the infrastructure for delivering the product.
• Buying a license and owning software leads to a longer-term commitment, as the switching cost is higher than in a subscription-based model. In this case, vendors can foster deeper customer relationships and loyalty.

Examples

More and more companies are moving away from this model to other, more modern license models. Some that still haven’t migrated fully are Adobe with their Photoshop and Illustrator products or Autodesk with their CAD products.

License-based software usually complements on-premise software, and technology is still advanced enough to provide computationally intensive products on the web. The huge legacy of those software products is another reason that delays the migration, but the process is already in motion, and disrupting competitors like Figma reinforces this.

5. Freemium

The freemium business model offers the basic features of a paid product or service for free. It’s often combined with subscription products.

In the freemium tiers of a product, the functionality of the product is limited in some way like:

• Number of users
• Limited resources like files, storage, bandwidth
• Limited functionalities

A freemium model is an alternative to a product trial that allows users to test a product and decide if it’s right for them. Some free tiers are generous enough to provide enough functionality to use the product for a while, especially in a company's early stages, without paying anything.

This is one of the biggest risks associated with freemium products—giving away too much for free limits the potential to monetize.

ChatGPT and other generative AI products offer some free tiers and hide the full product experience behind a paywall. ChatGPT's free product is the older and presumably less-than-good large language model, while a paid subscription unlocks the latest and greatest LLM.

Other products like Midjourney allow the generation of content for free only when enough resources are available, which can create long waiting times for free users.

Benefits

• Easy way for a customer to evaluate a product and make a buying decision.
• This is a good way for software vendors to put their products in the hands of future customers and expand their top-of-funnel.
• Creating a large customer base of free users has the potential to create a strong network effect that, on the one hand, adds more free users and, on the other hand, pushes more users to the paid tier.

Examples

The freemium model is a strategy that Figma leveraged excellently in its early days. Figma offered three files for free, which ignited a strong network effect and created exponential growth in users and revenue.

6. Ad-Supported

The ad-supported model offers a free product or part of a product for free in exchange for surfacing ads to the user. This has been the business model for many content-based websites, blogs, podcasts, etc.

According to the Alphabet Investor Relations website, revenue from ads (including Google Ads and YouTube ads) accounts for 80% of the company’s revenue. This will be $235B in 2023. Imagine the scale of the ads market!

Benefits

• Offering a good product for free is a good way to attract a large user base that can be further monetized using other business models. More and more companies use ads not as a monetization mechanism itself but as a stimulus for users to purchase an ad-free version of the product.
• Like freemium products, ad-supported products offer users a cost-free way to evaluate a product before making a purchase decision.
• For small content creators that can attract a huge audience, ads can be the only avenue for monetization if their product is the content itself.

Examples

Spotify offers a good free ad-based tier. This allows users to test the product and invest enough in it so they don’t want to switch later. YouTube and other content platforms have also used this model to push users to their paid subscriptions.

7. In-App Purchases

The in-app purchase business model emerged with mobile phones and app stores and is one of the most popular strategies for monetizing mobile applications. The essence is to provide an application for free (similar to the freemium model) but put certain features behind a paywall. The application store facilitates the payment when the app is published, and the purchase is quick and easy for the user. It’s also a popular business model for games, and players can buy artifacts or resources to enhance their gaming experience.

Benefits

• Small, low-consideration payments can, accumulatively, generate significant revenue. It’s a good way to monetize freemium products.
• Users can decide if, when, and how much to spend on the software without upfront financial commitment.
• A customizable experience that adapts to the amount of money the user spends in the application, offering a premium experience behind a paywall.

8. API Licensing

Some software products offer programmatic access in exchange for a fee (usually subscription-based). These products might be free for end users and require payment for developers who want to integrate with them, or they might be pure backend service products without FE, like some cloud services.

Examples

Stripe is a good example of a product that is free for end-users but requires a fee for companies that want to integrate it into their products. When you shop on a website where payments go through Stripe, you don’t owe anything. The website that integrated Stripe as a payment platform pays a subscription for the service.

9. Peer-to-peer (P2P)

Peer-to-peer business models connect individuals and empower them to make business transactions, exchange value, or interact directly.

Benefits

• Fewer middlemen in the business mean fewer costs for doing business.
• It’s a business model that scales well exponentially. If you are not providing the services that the users consume but create the environment for that exchange to happen, your business scales with the number of users on your platform.
• Strong network effects are due to the high number of users that typical business models see.

Examples

Uber and Airbnb create marketplaces where two types of users—a consumer and a producer—can exchange value directly. This is a great example of the emerging shared economy in which consumers share resources they cannot utilize 100% of their capacity with others in exchange for something else (most often money).

10. Pay-as-you-go

The pay-as-you-go business model allows consumers to increase their spending on the product with usage. The more they use, the more they pay.

Benefits

• More flexibility on the consumer side and the opportunity to create a scalable unit economics that allows for exponential growth.
• The costs will be more transparent and predictable for the consumer. They can project how much they will pay based on the resources used.

Examples

Most cloud providers, like AWS and Azure, have a pay-as-you-go pricing model. The more resources you use (storage, computing, network bandwidth), the bigger your monthly bill.

11. Brokerage

A brokerage model involves acting as a middleman between a buyer and a seller, facilitating a transaction, and usually providing additional services. This model often goes hand in hand with the p2p model.

Some products just connect to individuals without managing transactions, such as Skype or Craigslist. However, being a broker for a transaction provides much more value.

Compare a posting for a short-term apartment on Craigslist vs Airbnb. You get payment exchange, insurance, rating system, etc., which come at a higher price.

Benefits

• Brokerage products often facilitate a transaction that wouldn’t happen otherwise. Imagine sleeping on a stranger's couch or having a stranger crash your couch. Unimaginable?

  What if Airbnb vouchs for both sides, offering a reliable rating system and insurance? Much more imaginable now, right?

• Being the middleman opens the door to offering additional services, like Airbnb, which offers experiences in addition to places to stay.

No matter what product you are building, your business model will probably combine the abovementioned business models. As you saw in the article, many models complement each other to create more customer value.

Also, no matter what you decide to start with - don’t think of it as a set in stone. If you find something that doesn’t work in your case, get back to the drawing board and test more options until you find the one that works best for you.