Common business models that venture capital firms invest in, explained

Business models are unequivocally the most important part of a business, as they tell the story of how the enterprise works.

Business models allow us to hone in on who exactly the customer is, what the customer values, and how the company founders make money in this business. They are descriptions of how businesses function and are structured, and through this foundation, businesses are able to scale and innovate.

SaaS, marketplaces, metered services, direct to consumer — if you’ve ever wondered what these business models entail, as well as pros and cons of each, read on. Below, you will find detailed explanations and descriptions of these common business models that venture capital firms invest in.

SaaS

SaaS, or software as a service, is a business model in which a software can be used by customers through subscription plans that vary based on services offered. SaaS businesses are responsible for databases (and data), services, and sometimes offer multiple applications in their product.

SaaS business models often depend on monthly recurring revenue, or MRR, meaning the founder needs to worry about receiving payments monthly as opposed to just once. Since the business model relies on a service and consistent payment, accounting for revenue can be difficult.

SaaS business models are heavily reliant on customer retention. Since revenue depends on complete terms of service (typically one year), if a customer leaves after four months, the founder loses nine months of recurring revenue. Because of this, SaaS businesses must cultivate relationships with customers and offer a unique service in order to maintain membership. Through easily measurable metrics, SaaS businesses can experience quick traction.

SaaS companies have an advantage in that they can provide smaller and frequent updates to their software in order to preserve customer loyalty. Software businesses can continually update their product based on customer feedback and system vulnerabilities when communicating with their customers.

• An example of a D.C.-based SaaS company is Aquicore. Founded in 2012, this company offers a platform for commercial real estate owners and operators to manage their portfolio. The service offers intelligence, analytics, and process automation solutions for their users, so they can make the best decisions for their businesses.
• An example of a national SaaS company is Salesforce. The CRM solution allows businesses to aggregate consumer information, prospects and leads in one location. Employees can access data (if granted access) at any time and through any device. Salesforce says it boosts customer sales for businesses by an average of 37% through its SaaS platform.

Read more about the SaaS business model here.

Marketplaces

Marketplace business models essentially connect supply with demand through their platform by offering a space for vendors to sell their product or service to clients.

Marketplaces generate revenue through various streams, such as membership fees, selling fees or commissions. As a standard, gross merchandise value (GMV) and take rates can help determine revenues.

Companies that charge commissions through transactions are at an advantage because they get a piece of all transactions through their platform, but these companies need to provide a unique offering to both the supply and demand side on their platform. Commission sizes are also dependent on the size of transactions, offerings and invoicing methods.

• An example of this sort of business is Uber; the supplier, or driver, only pays Uber when they make money.

Membership fees is a model in which some or all users are charged a recurring fee to use the marketplace. Both the demand and supply side are convinced that this fee is ideal because it saves costs. The issue with this model is that if the marketplace fails to provide suppliers with consumers, or vice versa, the system becomes lopsided, which could cause one side to churn more frequently.

• An example of this are dating sites such as OkCupid and Match.com; users pay the fee for quality matches on these apps.

Finally, selling fees, or product listing fees, are common for marketplaces. The supplier is charged a minimal fee to list their product on the marketplace platform, and this often varies based on the business focus. Although this is a straightforward approach for most sellers, it might not be suitable for all industries and requires significant traction.

• An example of this is Craigslist. People can sell anything they want, but in some categories (such as job and apartment listings), they’re charged fees for listing.

An example of a D.C.-based marketplace company is SwitchPitch. Through its marketplace platform, this company connects Fortune 500 companies with startups that can help with the bigger company’s projects.

Metered services, or pay-per-use

This business model is used by companies that offer customers unlimited resources, but only requires the customer to pay for what they specifically use. Some might assume this is similar to the subscription-based business model. However, the metered services model does not use a fixed monthly fee or pricing tiers like subscription models do.

Customers may find this model highly beneficial since they only pay for what is necessary, and there are no other operational expenses associated. However, customers may be dissuaded when the cost of using the service is higher during frequent use periods. For suppliers, they may find this advantageous since they can determine their value propositions through what is frequently used. However, suppliers must create a profitability model that considers fixed and variable costs, as well as per-use frequency.

• An example of a metered service or pay-per-use company is Amazon Web Services. AWS offers a pay-as-you-go pricing method for over 160 cloud services. Users pay only for the services they need and don’t require long-term contracts.

Direct-to-consumer (D2C)

Traditional business models sold their products to retailers who then sold those products to consumers. With the advent of ecommerce and reduced reliance on physical store experiences, use of that traditional business model has diminished. Now, customers can directly purchase products from a company, eliminating the need for a middle-person.

D2C business models have significant advantages in that the supply chain is at least one link shorter, which reduces time-to-market; suppliers are able to bring their products to market at faster rates than before. In addition, businesses are able to develop deeper relationships with their customers.

Since D2C brands rely immensely on website traffic for sales, these companies have massive marketing efforts that are focused on the digital realm. This sort of advertising is highly targeted.

• An example of a D2C company is Warby Parker. Through its home try-on program, pricing, marketing and value proposition, Warby Parker has gained momentum in the eyewear industry. Warby Parker made the process easier; it simplified the eyewear purchase process by eliminating the middle vendor.