Digital Business Models incl. examples – Here is what you need to know, we explain the characteristics of digital business models and give advice on how to start and where to be cautious.
While most executives now have a basic understanding of technologies like Artificial Intelligence, Machine Learning, Big Data, IoT, and Digitalization/Digital Transformation, there is still sometimes confusion about how digital business models work. These new ways of doing business are amongst one of the most disruptive business models of our age, driven by technology and the power of networks.
As we all know, the drivers of these business models are not technology. In fact, technology only serves a secondary role. Like in digital ecosystems, the digital business models serve only the experience of the customer. So we have to ask ourselfes just one thing: How can we create value for customers while using digital tools like platforms, apps, websites, and more?
The power lies in the direct access to the customer and the data. You can get directly your offering into his hand, you send him messages into the pocket and he is immediately able to consume your product as it is easily transferred and digitally consumed.
Another big point to mention is that digital services are easily created, duplicated, and automated. This means that there are mostly no major costs involved when you are scaling your business to more customers. On the contrary, this is the sweet spot about digital business models, they are able to scale without extra effort – You can sell your product 100 times or over 1 Mio times and it doesn’t make you sweat.
What are Digital Business Models?
Digital business models are how businesses can create, deliver, and capture value in a digital economy. For this, digital business models use several digital technologies to create and deliver their products and services. There are many different dynamics to digital businesses that don’t have marginal costs, which have several implications.
One implication is that these businesses’ entry barriers are much lower than traditional businesses. This lower entry barrier is because the cost of starting a digital business is much lower, and you don’t need as much physical infrastructure. Additionally, the reach of a digital business is much more extensive since you can potentially reach customers worldwide with just a website or app.
Another implication is that digital businesses that can scale up very quickly are often based on economies of scale. This is because they don’t need as much physical infrastructure to grow, and they can easily reach more customers. Additionally, digital businesses can often be automated or outsourced to reduce costs, making them profitable at a larger scale than traditional businesses.
However, there are also some drawbacks to digital businesses. One is that they can be very competitive since it’s easy for new players to enter the market. Additionally, new technologies or customer behavior changes can quickly disrupt digital businesses. Finally, digital companies can often be less loyal to customers than traditional businesses since they usually have a shorter lifespan (also lower Customer Lifetime Value – CLV) and are less likely to build long-term customer relationships.
Companies can use various models, but they typically fall into one of three categories: product-centric, service-centric, or process-centric. Product-centric businesses sell physical or digital products to customers, service-centric companies offer services, and process-centric businesses provide a process or platform that enables other companies to create and deliver digital products or services.
Digital business models have 4 characteristics
There is often a confusion about digital offerings vs. digital business models. In generall a digital offering is just an addition to existing services or products like an app for your product, a chatbot for contacting the support or a interface to controll the product. Digital business models on the other side have certain characteristics that help to distinguish them from digital offerings:
1. The value is created using digital technologies
When the value proposition of the offered service is (solely) based on digital technologies, then we have one big indicator for a digital business model. Amazon, Alibaba, Facebook, Google, etc. wouldn’t be possible without the use of the Internet.
2. Digital business models are new to the market
One of the best examples is the difference between digital offerings and digital business models. When you are reading your energy consumption via an app, then it is a digital offering of your electricity provider. When you order transportation via an app that matches your request with a driver, then this is a digital business model.
3. Digital customer acquisition and distribution
To become a customer and to use a service you need to use digital channels. Digital business models are sometimes solely based on digital channels. This is especially important for business models that rely on early onboarding (Freemium Model) or on marketplaces (e.g. Amazon puts advertisements when you search online).
4. USP is created digitally
When the customer is willing to pay for your services and offerings which are created online, then there is a strong indicator of a digital business model as the customer value can be created digitally and also monetized.
Different kinds of digital business models
1. Free-Model (Ad-supported Model)
Everyone knows the “free” business model as it is used by two of the most famous companies in the world. Google, as well as Facebook, are good examples of how to make use of the ad-supported and “free” business model. The idea behind this business model is to offer a service for free and the user becomes then the product that is being sold. In the case of Google and Facebook, every user who is using the services is giving valuable information about himself. With this data, it is then easy to display ads that the companies can buy and target specific users.
2. Freemium Model
Especially in the software world, this is one of the most commonly seen digital business models. Users get free access to a basic version (Free) of the product which is mostly limited in some ways. If the user wants to use more features or resources, then they have the option to upgrade to the paid version (Premium).
A great example is Spotify. Everyone can use the service for free (and get advertisements) but when you want more features and higher quality, then you need to pay a monthly subscription. This is also a great example, that different business models can be mixed.
3. On-Demand Model
Similar to the “Access-Over-Ownership” is also the On-Demand business model. In this case, it is not a physical product you are owning but a virtual product or a service.
On-demand works for example via online video stores, where you get the right to consume a video for a certain period of time (Amazon Video, Apple TV+, etc.).
We also see the on-demand model in the “gig-economy”. This is an example where you book a consultant and you get automatically charged depending on how long you need help. (Upwork, UpCounsel, Fiverr, etc.)
4. E-Commerce Model
One of the first and by far most successful companies to sell physical products via an online shop and e-commerce business model was Amazon. By today it is also the best-known business model on the web and it is possible to buy almost everything on the internet today.
In contrary to a marketplace model, which is Amazon today too, pure E-Commerce models are based on a one-sided sales approach. A company is selling its own stocks to customers.
5. Marketplace Model (Peer-to-peer, two-sided marketplace)
The two-sided marketplace is something we see quite often on the internet. The sellers and the buyers use a 3rd party platform to trade their goods and services. This marketplace can involve services (Uber, Upwork, etc.) or also products (eBay, Etsy, Amazon).
The biggest issue with this business model is its complexity and dynamics. If you don’t have sellers you will never attract buyers, if the buyers don’t find sellers, you will lose the buyers. So, a two-sided platform needs to carefully scale demand and supply at the same time to keep both sides attracted.
6. Ecosystem Model
Digital ecosystems are one of the most complex but also the most powerful digital business models at the moment. Ecosystem orchestrators like Amazon, Alibaba, Google, Apple, Tesla, and many more are leveraging the customer with different services across different platforms. With the knowledge and the data, they can then upsell on existing customers and attract new ones due to the “vendor lock-in” effects their ecosystems create.
Just think about what services you are using from Google, Apple, Amazon, Alibaba, etc., and how hard it would be to leave their digital ecosystem. This lock-in effect is also a big driver for future revenues. But you don’t have to be an ecosystem orchestrator, maybe you are a user of ecosystems or you supply modules to an ecosystem. A good example of a modular provider is PayPal, which enables seamless payment to many different digital business models and ecosystems.
7. Access-Over-Ownership Model / Sharing Model
This is all about “sharing” but in a business way. This system allows you to pay for a product, service, or offering for a set amount of time without really owning it. This can be renting a car (e.g. Zipcar), renting an apartment (e.g. Airbnb), or even industrial machinery.
This was one of the most disruptive business models due to the implications it had on ownership and the resulting revenues you can generate. A car could suddenly be an income stream instead of just generating costs.
8. Experience Model
Adding an experience to products that would be not possible without digital technologies. One example is Tesla which brought a whole new digital experience to the automotive industry by adding digital services and even a digital ecosystem to their cars, which is now a major driver for their business model.
Another take on the experience model is also to combine different experiences together and create a new customer centric ecosystem.
9. Subscription Model
We all know Netflix or Office 365. These products are good examples of the classical subscription model. There the user gets access, updates, services, etc. on a monthly/annual basis. The subscription model is especially used for content, software, and memberships.
10. Open-Source Model
Firefox is one of the most successful open-source examples. The software is free to download, free to use, and open for the community worldwide to contribute. Because it’s free and a lot of people contribute it spreads fast and usually also gets a lot of (free) resources to improve the software. The business model behind Firefox is generating royalties and partnerships from search engines.
Open source itself is not necessarily a business model, as you might not be able to leverage the software for a sustainable business model. Red Hat gives out the Linux-Distribution for free and later then earns money from training, services, and hosting of the software.
11. Hidden revenue generation Model
Sometimes the revenue generation is not always visible for the customers at first sight. Due to data collection and analysis, there might be other value streams possible. As we saw with the Mozilla example, where the open-source browser gets revenues from royalties to include different search engines, we know that there might be hidden business models behind platforms and digital services.
For companies it’s very important to realize what the potentials are and if there are further possibilities to leverage an existing business model with another one to generate additional incomes. But hidden revenue generation can also backfire, especially when dealing with data and with unaware customers. Cambridge Analytica was a great example of such a backlash which led to severe consequences for both companies.
Choosing the right digital business model
It is always the answer where you have no direct answer. So what is the best/right/most profitable/most successful business model? – Well … IT DEPENDS
Every business needs to see what kind of offers they want to have and where they want to optimize. Two-sided marketplaces are extremely complex and take longer to grow, Freemium is widely adapted and can be combined with Ad-supported business models as we saw with Spotify and digital ecosystems might be the most complex and highest risk business models as it involves massive investments, big user-base and also the orchestration of many partners and streams.
When thinking about new business models it would always be good to think about the customer and the unique value proposition you want to have. Take care that you are not overthinking it and better keep it clean and easy instead of involving too many business models at the same time.
Especially for platforms, marketplaces, and digital ecosystems, it is important to note that immediate monetization might hinder the growth and can lead to a supply/demand gap. Sometimes digital business models need a critical mass and a critical base to leverage a monetization model and therefore need quite some time and investment before they can even start generating revenues. This is why there are 2 different strategies:
For earlier/faster monetization it is, therefore, better to look at Freemium, E-Commerce, or Subscription models. They are easier as the supply-side is already fixed/can be better controlled, you can generate direct incomes and can only focus on generating the demand side.
Business models which are more long-term and network effect-driven, are usually double-sided platforms, doble-sided marketplaces and especially digital ecosystems. They must grow for a long time before monetization makes sense and therefore have a long financing gap, which needs to be overcome. But on the long-run they might financially outgrow other businesses as they use the network effect, you could call it the “the winner takes it all”-effect, to dominate a market due to the size and decrease the entrance of new competitors as they first would need to catch up. (Example, Facebook and Google+ – Facebook already took the market and Google had no chance with their social media platform due to the network effect)