What is an online platform?
It is fair to clarify this concept because nowadays online platforms are basically everywhere, and everybody is launching a new one. I myself co-founded an online platform for small businesses, and I am well aware of the interest in this industry.
Technically, an online platform is a digital place where some form of exchange occurs between third parties.
What does that mean?
Well, let us say that you buy Office 365 from Microsoft. What happens is that you pay Microsoft in exchange for the usage of the latest version of Office, including cloud storage and other features.
This is what is generally referred to as software as a service, or SaaS.
Now let us make the same example with YouTube. You love watching videos and you pay YouTube Premium. But are you really exchanging with YouTube? In reality, you are not paying YouTube in exchange for a service. You are paying because you want to get rid of the annoying advertising.
The real exchange is between you and the person who uploaded the video, who receives compensation from YouTube.
Why do entrepreneurs gravitate toward online platforms?
It is important to make this distinction because it clarifies the main feature that makes online platforms so popular among entrepreneurs:
- They are capital-light, meaning that they do not require plants and equipment to start up.
- They are infrastructural businesses: there is no real product or service to be developed and marketed, just the digital infrastructure.
While the first point is common to most digital services (also Microsoft does not need a factory to code its software), the second one is specific to online platforms: if you do not like the latest version of Office 365, you can probably move to a competitor service such as Google Docs (maybe that is not the best example given Office 365’s high switching costs, but you get the idea).
That is not possible with YouTube. Think about it: where would you go? Vimeo? Plus, YouTube does not need to provide any service, only to make sure that the interaction between the different users on its platform works out smoothly.
That is the beauty of online platforms, at least in the startupper’s mind: they are easy to launch and less likely to fail than SaaS.
What do you need to succeed?
You just need one thing to succeed — users.
When the number of users reaches a certain critical mass, goes the theory, the platform will grow thanks to the self-reinforcing network effect. At that point, the platform is ready to become mainstream and will have an intrinsic value of itself.
Now, there is some truth in this common belief: indeed, investors tend to reward platforms that experience exponential growth in the number of users. The problem is, with all the platforms that are launched in even the most exotic industries, the chances that your platform will get the lead are extremely low.
Unfortunately, you run the likely risk of not growing fast enough and not making any money either. There is no fun in this.
Therefore, instead of focussing obsessively on adding users, entrepreneurs that are planning to launch an online platform should make sure that they are building a resilient business first.
To do that, they need to target a market niche and develop their platform so as to acquire clients, i.e. people that enjoy using the platform and are willing to pay for it. I will be honest with you: making money with an online platform, especially during the first years, is no easy task.
What revenue models are best for your online platform?
While I leave to you the marketing effort to acquire clients, I will suggest to you the possible revenue models that you should consider for your platform to start making money as soon as possible.
I believe that there are four ways in which online platforms can make money: how realistic each of them is for your platform will depend eventually on the type of business you are in and the maturity of your startup.
Once upon a time, people used to buy the software in a physical box from a physical store; they installed it on their PC and that was the end of the story. Nowadays, the entire tech industry has shifted to a business model whereby users have access to the software through the company’s web application.
As such, users do not pay the software in bulk anymore, rather they subscribe to the service and make regular payments. For businesses, subscriptions mean regular income; for customers, they mean recurrent costs. It is no secret therefore that subscriptions are the best revenue model for online platforms but also the most difficult to achieve.
The reason lies in how online platforms create value.
SaaS creates value through the service they offer. The value is somehow intrinsic to the service itself, and it will be for the customers to decide whether the price that they have to pay is reasonable compared to the value they get from the use of the service.
Online platforms do not work like that. They do not create value through the tool, rather through the network. Therefore, in order to have the bargaining power to charge subscription fees, an online platform must have a network of users that is both large and valuable.
2. Subscription example
A good example is LinkedIn.
Let us say that you are a sales manager of a small or medium enterprise, and you are paid on commission (or commissions represent a significant part of your salary).
How much value does LinkedIn Premium create for you?
a) Contact a large number of the world’s businesses; and
b) Those businesses may all be potential clients.
Of course, there is massive value creation here.
3. Listing fees
A narrow definition of listing fees is of fees that users must pay in order to post a product offer.
The platform that comes to mind using this revenue model is of course Craiglist, and the general idea is that listing fees are only suitable for marketplaces. In a broader sense though, listing fees are the price that users must pay to highlight their product or service offer.
If we consider them this way (which in my view is the correct one), listing fees can apply to any platform.
Listing fee example
Take Facebook for example. Anytime you see a sponsored post, that is a listing fee. The fact that it is a data-driven sponsored post, i.e. it is being highlighted only to certain users, does not change the nature of the revenue model.
I write this because, if we consider instead listing fees only in a strict meaning, they are quite hard to implement. I mean, you want your platform to grow as fast as possible, right? So, why on earth would you limit content creation by charging users for posting?
It can be successful only for marketplaces like Craigslist, which work:
a) With a massive network; and
b) With huge volumes, so that they can charge little per post and still make a fortune.
Yet, listing fees intended as sponsored posts are a great revenue model for online platforms.
In fact, if used moderately (you do not want your users to move in a minefield of ads), listing fees can provide immediate cash flow with no significant impact on growth or usability. There is a catch though: users may be willing to highlight their posts only if they feel they need to do that to achieve what they want.
Take the case of dating sites where there is a decent number of female users, like Tinder for example.
Male users may have a strong incentive to pay for having their profile promoted on the platform if:
a) They know they can reach a relatively large number of girls;
b) They know they have massive competition (even on the best websites the gender ratio is 70% men, 30% women in the U.S.) that they must put behind them to have a better chance of finding a partner.
Therefore, yes, you can use listing fees as soon as your platform is ready, but you will need a large network to make them work.
Commissions are by far my favorite revenue model: they do not hamper growth, can be implemented immediately, and can bring a significant amount of cash.
Have you ever used Airbnb?
You go to the platform and you search for the accommodation of your dreams, all for free. Once you find it and immediately book it, Airbnb charges you a small percentage of the entire amount.
You pay; you go on holiday and have the time of your life; then you return home and will think about AirBnB next year.
From this purchase process we can realize the great advantages of commission-based revenue models:
They do not require a large network to work
Sounds unbelievable for a platform but it is true. Of course, users must find what they look for. And they need to trust you (that is paramount). But, once they find what they want, they will buy it. They do not purchase because of the network effect, they purchase because they like what they buy: even for online platforms, sometimes quality beats quantity.
They do not hamper growth nor annoy users
As I wrote before, you can use Airbnb once a year, or every month, basically whenever you want. This means that on the user side (the «guest» in Airbnb), there is no commitment in the form of a subscription. On the other side, there is no need to charge providers (the «hosts») either, as the platform will make money anyway out of their posts.
They allow the platform to make good cash flow
For posting an apartment for rent in NYC on Craigslist, you pay $5. For your $1,000 holiday, Airbnb gets $150. In marketing jargon, commission-based revenue models allow online platforms to become «high-ticket», i.e. to make good money from a single sale. This reinforces the idea that you do not need a huge network to charge commissions on your platform.
So, if commissions are so great, why are they not in the first place?
Because first, they only work with marketplaces; second, and this is a big one, they are feasible only if the platform can control the transaction. Alas, that is no easy task, for most platforms, it is almost impossible.
That happens because people do not like to pay commissions. As soon as the two parties know each other, they will immediately move out of the platform and close the transaction privately. You can try to force them to stay, but you have no idea how many tricks people can come up with to avoid paying what they see as extra costs.
The winning move is to give people a reason to stay: that could be insurance, safety, or a secure payment system.
In a word, trust.
Uber is a good example of that: you do not want to jump on a random car at the outskirts of a big city when the sun is down. To achieve that, you must have massive technical and financial infrastructure: perhaps you do not need a huge network, but you do need strong investors.
This is where most startup platforms will end up. I will not lie: interaction fees are less effective than the other mentioned revenue models. However, they have one big advantage: flexibility.
First of all, what are interaction fees?
Well, have you ever landed on a platform where everything is free, but as soon as you start clicking here and there, panels pop up saying that this costs this, this other costs that, or that you must spend (therefore buy) credits in order to proceed?
Ok, those are interaction fees.
Essentially, users are free to do whatever they want, but they must pay for certain features, generally when there is interaction with other users.
Moreover, you can stagger your fees as much as you like: a certain action may cost X, whereas another may cost 2X because it is more valuable for the user and you want to earn more as well.
This way you can make your revenue model resemble one based on commissions.
Another possibility is that users are not charged dollars but credits (though they must spend dollars to get credits in the first place). This way you get even more flexibility: you can give users free credits to let them become accustomed to the platform, and then charge them. You can make them earn credits if you perform actions that are valuable to you, for example inviting their friends to join the platform (such schemes are usually referred to as gamification).
Why not use interaction fees?
At the end of the day, interaction fees can be modeled to have some features of listing fees and commissions: what is not to like about them?
Just one word: complexity.
People on the internet do not have a lot of time, for sure not for you and your fee structure. If they do not understand it, they will not buy. Therefore, you can be flexible in setting your fees only up to a certain point.
Interaction fees example
Take the example of Thumbtack, a successful startup platform connecting customers with local professionals. We looked at this company as a source of inspiration for setting our own revenue model because they were using so many types of interaction fees that we took something from them here and there.
At one point they even had a video explaining their fee structure.
Now a part of it reads like this:
Here’s how the credit packs work:
- You buy one of three available credit packs when you sign up.
- The credit you purchase is added to your Thumbtack balance.
- When you get a lead that matches your preferences, the lead cost is deducted from that credit.
- Once you’ve spent the credit, the cost of each additional lead will be charged to the card you added to your account.
Did you get everything?
It is a far cry from just saying «$50 per month», or «$5 per post», or «$150 fee», is it not?
Nevertheless, interaction fees are probably the best revenue model when your startup platform is still growing.
Which revenue model is right for your online platform?
It is up to you to set and explain your revenue model to your customers so that they can easily understand it.
In the table below I recap the four revenue models and the requirements that your platform should have to make them work realistically.