Tech Companies & Startups
Making money
Choosing the right revenue model can be the difference between a company that thrives and a company that dies.
Let’s look into some common ways tech companies produce revenue.
(Note: this isn’t an exhaustive list – there are almost as many ways to make money as there are tech companies)
Table of Contents
Paid software
One of the oldest forms of tech revenue is also the simplest – selling software in a one-off transaction for a fixed price. This model powered the rise of Microsoft’s Windows operating system and early video game console games like the Super Nintendo, where customers make a one-off purchase for an ongoing license to use the software.
This revenue model is often popular with customers who like paying once for a product, but it has fallen out of favour for software companies as product expectations have changed.
Software has moved from being sold in a “completed” state (like an encyclopedia application sold as a CD-ROM in a retail store) to the world today where products are sold digitally, and customers expect ongoing development to ensure the software they use is bug-free and available to use on their latest device. This ongoing development and maintenance work can be extremely expensive (teams of programmers aren’t cheap!) so many companies have shifted to subscription-based revenue models to try and fund the ongoing activity.
Software as a Service (SaaS)
The huge growth of the internet in the late nineties led to a revenue model allowing software to be sold in an ongoing, subscription-based model known as SaaS.
Rather than downloading and running software on a local computer, SaaS products are hosted centrally (in the “cloud”) on remote servers and accessed via the customer’s web browser. You should be able to use a SaaS app as long as you have a web browser and a decent internet connection.
Customers can continue to use a SaaS product for as long as they need by paying an ongoing monthly or annual fee (the subscription). Part of the subscription fee will go towards the ongoing development and support of the product, which should help the software offer continual value to the customer. As the customer is accessing the app from their browser, not a downloaded app, they always use the most up-to-date version of the software. If a customer decides to cancel their subscription, they’ll simply lose access to the app.
SaaS is very popular in B2B (“Business to Business” – when a company sells products or services to another company) as it simplifies some otherwise complicated IT processes, like managing the installation and support of applications across staff computers and keeping track of user licensing and costs.
The software developer also has the advantage of only needing to support one version of the software, letting them avoid situations where they have to continue supporting customers who won’t upgrade old software versions.
But SaaS is not all rainbows and unicorns, there are some potential downsides. Since you’re accessing an app from a centralised “cloud”, if you lose your internet connection or the host goes offline, you’ll be unable to use the application. Some people would also prefer to pay once for a product or service simply and do not like the idea of being tied into the kind of long-term arrangement that is a fundamental part of SaaS.
Mobile Apps
Millions of small, independent software developers can thank the explosion of smartphone apps in the past ten years for providing a new way to make a living. Mobile apps are available from marketplaces like Apple’s App Store and Google’s Play Store. These markets are often “walled gardens”, where the operator maintains strict controls over the apps, content or media they allow to be hosted and sold on their platform.
In the early days, apps were limited to being given away for free, sold in one-off transactions or funded through in-app advertising. Later, the marketplaces allowed additional in-app purchases, helping to ruin the days of thousands of parents who now have to explain to their children, “No, we aren’t going to spend $20 on a mystery loot box”.
There were some other issues with the one-off model. The non-business customers that make up most of the app store’s users are notoriously price-sensitive, and most are unwilling to pay more than a couple of dollars for an app if they are willing to pay anything. And when customers make a purchase, the app stores themselves take a large cut of the purchase price, often up to 30%. Some of the largest apps like Netflix and Spotify have refused to allow people to sign up within their product’s apps, saying the “tax” or revenue split they’d have to share with Apple and Google was simply too high to work.
The one-off purchase model also runs into another issue we’ve previously discussed – it doesn’t allow for the ongoing costs to developers to continue to build and support their apps. If someone pays $1 once for an app, then they will expect the app to continue to work on future versions of iOS or Android, but it might not be in the developer’s best interest to continue working on the product over the years if it’s not continuing to bring in significant revenue.
In an effort to counter this, Apple and Google eventually allowed mobile apps to be sold using recurring subscriptions as well (while taking their cut of the ongoing revenue as well, of course).
We’ll talk about advertising as a revenue model in more detail shortly, but it’s worth mentioning that it’s an important source of revenue for many developers, especially those with apps targeting markets that do not like (or are not able or old enough) to spend money to purchase apps, like mobile gamers.
Marketplace Platforms
Marketplaces earn revenue by taking a percentage or fee in return for matching buyers with sellers of products and services.
One of the most well-known examples of an online marketplace is eBay, launched by Pierre Omidyar in 1995 as a digital auction site. EBay provides sellers with a place to offer physical products to its millions of users, and in return for each sale, eBay takes a service fee. While the individual fees are quite low, in aggregate, they are enough to turn eBay into a multi-billion dollar business.
A more recent marketplace example focused on providing services is AirBNB, which allows people to list spare rooms through to entire houses for short-term rental. Like Ebay, AirBNB’s primary source of revenue is the fees it charges on the listings made on its platform. Uber operates on a similar model, helping to match “riders” with drivers as an alternative to Taxis.
Marketplace platforms can be very tough to launch as both sides of the market (buyers and sellers) need to be in place before people can find any value – sellers wouldn’t list on eBay if it didn’t have customers waiting to buy, and Airbnb would struggle to find customers if it didn’t have any short term rentals available. Solving these chicken-and-egg-type problems takes real skill and is a top priority for early employees in product and growth roles within marketplace startups.
Advertising
Advertising may not have a lot of fans, but when executed well as a revenue model, it has provided the bulk of revenue to some of the most successful tech companies of all time.
We can split tech companies who earn revenue with advertising into those who provide the advertising (the platforms) and those who receive money from platforms in return for running their ads in front of their customers.
You could make a strong argument that Google is the king of all advertising platforms – more than 80% of Alphabet’s (Google’s parent company) revenue comes from Google ads, for a total of $147 billion in 2020. Why is their advertising so strong? Intent. When you type in a Google Search, you are specifically telling Google what you intend to look at, and Google’s customers (the advertisers) are willing to pay a lot of money to get their ads for relevant products or services in front of you.
Meta (and the companies it owns, like Facebook, Instagram and WhatsApp) are another giant advertising platform, but its ads operate in a different way, targeting users based on their profiles and interests rather than on the specific searches they are making (as people using these services tend to be scrolling through their social feeds). While Google can show me an ad that matches what I am currently looking for (a search for “Paddle Boards” will give me a list of brands selling paddle boards), Facebook’s ads are interrupting me while I’m performing another activity, so while they may also show me an ad for a paddle board if I’m not currently looking for a paddle board then I’m less likely to click through and, ultimately, purchase the board.
Advertising is not only a source of revenue for the major social platforms but also a key element for many content providers, including online news providers like the New York Times and CNN, blogs, podcasts, and video games. Many of these companies would struggle to sustain their businesses by selling their products or services directly to consumers, so they choose to run ads (usually via one of the large platforms) on their sites or apps in return for a split of the revenue.
Freemium
In the freemium model, a basic version of a product is offered free of charge, and the user can choose to “upgrade” and pay for additional features. Freemium is a fairly popular model in software, especially with consumer-focused products like smartphone apps.
One of the key advantages of this model is that it “lowers the friction” in getting new users – if there is no cost to use a product, it is generally much easier to get someone to try it.
But this swings both ways – a large user base will normally have higher support costs, but the vast majority of these users will not actually be contributing to the company’s revenue in any way. There are also some issues of customer psychology to consider; for example, if your users get used to using a product for free (they are “price anchored” to no cost), they may be unwilling to pay for extra features even if they would genuinely receive a lot of additional value from them.
Open source
Open-source software is licensed to let anyone use, change or distribute the software and its source code for any purpose. That might seem like a strange foundation to build a company, but it can work! A popular method of monetising open-source is selling consulting, implementation and/or ongoing support services to people unable or unwilling to do the work themselves.
An example is WordPress, the incredibly popular open-source Content Management System (CMS) tool that powers hundreds of thousands of websites worldwide. WordPress is made by a company called Automattic, which leads the development of free open-source software versions.
But Automattic also sells services to people and companies who do not want to manage the installation and upkeep of a WordPress site by themselves. As the literal creators of Wordpress, they are so well positioned as experts that even companies that specialise in building software, like Facebook and Salesforce, choose to pay to use them for their services rather than managing Wordpress themselves.