The Five Primary Online Business Models ExplainedBy Joseph Carroll
In the world of buying and selling online businesses, the term “business model” is used to describe the way in which a company generates revenue, as well as which types of goods and services it specializes in providing. In short, business model describes the overall blueprint and makeup of a company’s operations.
Business models influence the time, skills, and experience required to successfully run and grow an online business, and they are usually at the crux of the acquisition criteria provided by investors using the Dealflow platform to buy internet companies.
This article explores each of the five primary online business models, delving into business model specific valuations and due diligence topics, as well as tips on identifying which model is the best fit for you as an internet business investor.
So, what are the five primary online business models?
There is often a bit of subjectivity to each model and some overlap, but in general, we break online business models down into each of the five categories described below.
- Software as a Service (SaaS) – Revenue is generated from the sale of software on a subscription basis, which can be accessed by the customer as long as the subscription remains active.
- eCommerce – Revenue is generated from the sale of physical and / or digital products directly to customers via the internet.
- Content – Revenue is generated by monetizing visitors, usually through advertising and / or affiliate sales.
- Services – Revenue is generated from the sale of services directly to customers via the internet.
- Transactional / Marketplaces – Revenue is generated by facilitating a transaction between two or more users on an online platform in exchange for a commission.
Can I buy a business which utilizes multiple business models?
When a company utilizes multiple business models, we typically refer to the company as having a ‘hybrid’ business model. An example would be a tech news blog (content) which has an integrated web store allowing users to purchase popular tech themed merchandise (eCommerce). Surprisingly, the hybrid model is quite rare, and in cases where the business does employ a hybrid business model, there is almost always a single underlying model.
Now, we’ll explore each model individually, and note down common valuation considerations, due diligence items, buyer profiles, and what qualifies as a strong business vs. what qualifies as a weak business.
1. Software as a Service (SaaS)
SaaS is an online business model whereby software is sold to customers on a subscription basis and then accessed via the internet. When the subscription expires, the customer’s access to the software is withdrawn.
It’s important to draw a distinction between the SaaS model and the software eCommerce model. The former, as we just noted, involves the selling of software on a subscription basis where access to the software is withdrawn when the subscription expires; whereas the latter, involves the sale of lifetime access to the software.
Historically, most software companies (like Microsoft Office in the 90’s) operated on the traditional software eCommerce model, but better technology and increasing internet speeds have given rise to the SaaS era, and digital business investors are responding favorably to this sector.
SaaS businesses are typically the highest valued of any business model. These businesses are coveted by investors because they often have reliable Monthly Recurring Revenue (MRR) streams, proprietary technology and loyal customers. This all, of course, equates to lower risk for SaaS investors and higher sales multiples if you find yourself selling a SaaS business.
Over the past few years there have been several notable instances, reported on Dealflow and throughout the industry, where established SaaS businesses have sold for 4x – 6x annual net earnings. This goes without saying, if you are interested in acquiring a SaaS business you should be prepared to complete your valuation and due diligence promptly, these businesses rarely linger on the market once publicly listed.
The percentage of customers who cancel their subscription during a given time period, known as customer churn rate, is one of the key performance metrics buyers often consider when valuing a SaaS company. If, for example, the churn rate of a SaaS business was 10% per month, that would mean the business is losing 10% of it’s customers monthly. Further, if the churn rate outpaces the rate of new customer acquisition for a given time period, then the company will have a net loss of customers for that time period.
Generally, there is an inverse relationship between churn and business valuation. That is to say, higher churn generally results in a lower valuation, while lower churn generally results in a higher valuation – all else being equal.
SaaS businesses usually require some level of technical sophistication to operate and maintain successfully. It is common for buyers of SaaS businesses to hail from a web development and product management background as a result. However, we also see buyers with minimal technical backgrounds acquiring SaaS businesses, usually because they employ a team of developers to handle this aspect of the work for them or have access to some other development resources. Needless to say, if you are planning to acquire a SaaS business, ensure you a comfortable with the level of coding and maintenance required.
Key SaaS Takeaways
- SaaS businesses are typically the highest valued of any business model
- Established SaaS businesses have recently sold for 4x – 6x annual net earnings
- Be prepared to complete your valuation and due diligence promptly
- Compare customer churn rate with the rate of customer acquisition
- Web development experience often advantageous, but not always necessary
- Digital eCommerce
- 3rd Party Marketplaces
- Subscription eCommerce
- eCommerce businesses can sell both physical and digital products
- Dropshipping is the practice of outsourcing the fulfillment and shipping of a product
- Ease of operations and ‘barriers of entry’ among the biggest influencers of value
- Demand for Amazon FBA businesses has increased as the space has matured
- Direct Ad Sales – Direct advertising typically involves the business owner selling advertising space directly to an advertiser.
- Advertising Network – Ad Networks or ad exchanges are platforms where advertisers can purchase or bid on advertising space from publishers (i.e. website owners, etc.)
- Affiliate Sales – Affiliate marketing involves promoting and advertising other people’s products, and generating a commission for resulting transactions.
- Lead Generation – Lead generation is the practice of one business generating leads for another, usually by capturing contact details through user expression of interest forms, and then selling these contact details to a third-party.
- Content may take on many different forms of digital media (images, video, etc.)
- Content businesses can include blogs, forums, directories, and online communities
- You should always evaluate the quality and sustainability of the content during initial DD
- Buyers often interested in acquiring content businesses to advertise to their audiences
- Covers wide range of sectors including internet marketing, web design, and development
- Services category tends to have lowest average valuation of all online business models
- High owner dependency & low barriers to entry common for weak service businesses
- Service businesses with stable financials, sustainable lead flows and transferable teams can make worthwhile acquisition targets
- Online marketplaces first introduced in the late 90’s by tech giants like eBay & Amazon
- Success of an online marketplace depends on its ability to create network effects
- Advise transactional / marketplace investors to enlist professional legal representation
- Often prized by strategic buyers and private equity firms
Perhaps the most widely practiced online business model, eCommerce, involves the selling of physical and digital products to customers via the internet.
High-value, sustainable eCommerce businesses tend to sell proprietary, unique products or have exclusive distribution rights and / or other barriers to entry. They also usually maintain a unique flavor of marketing, which may include customer reviews, educational content, social media promotion, paid advertising, etc.
On the flip side, eCommerce businesses are generally valued lower by investors when they sell generic or low quality products, operate in a saturated niche, maintain a high number of chargebacks or refund requests, require a large amount of owner involvement with minimal return, or are completely dependent upon a single source for traffic and sales.
For example, eCommerce businesses selling generic products with a heavy reliance on Facebook advertising do not typically sell for as high multiples as other eCommerce businesses that have diverse traffic sources and unique products. This is because Facebook dependent eCommerce businesses have low barriers to entry and can be replicated easily at a fraction of the cost of acquiring an existing business. Additionally, these businesses are highly dependent on Facebook’s algorithm, which changes frequently. Of course, Facebook eCommerce businesses have proven to be sellable, but buyers will adjust their valuations according to the increased risk and volatility.
The eCommerce business model has many variations and sub-categories. We’ll explore each below, but remember, these are all just variations of the eCommerce model!
The first important distinction to make is the difference between eCommerce businesses which sell physical products (e.g. sporting goods, furniture, auto parts, vitamins & supplements, etc.) vs those which sell digital products (themes & plugins, audio guides, software, etc.). As an example, a business selling custom guitars online is quite different from a business selling WordPress themes and plugins. Though both would be classified as eCommerce, we would further classify the latter as a digital eCommerce business.
An important subcategory of eCommerce is the dropshipping model. Dropshipping is the practice of outsourcing the fulfillment and shipping of a product to a third-party provider, so that the company itself never orders inventory. Instead, it simply places the order for the customer in real time, and the dropshipping partner handles the rest. An order will be placed by a customer on the business’s website, and the order details will then be communicated to a dropshipping partner who will fulfill and ship the order to the customer on behalf of the business owner.
Third Party Logistics, or more simply 3PL, which is similar to and often confused with dropshipping, is the practice of outsourcing one or more elements of the warehousing, fulfillment and shipping process to a third-party provider. The primary difference between 3PL and dropshipping is that, with 3PL the company continues ordering its own inventory.
3rd Party Marketplace
Another important classification of eCommerce businesses is the point of sale. Some operators sell products through dedicated websites, while others prefer selling through third-party marketplaces like Amazon, eBay or Etsy. As the sale and acquisition of businesses with a third-party marketplace becomes more common, the acquisitions industry has had to evolve and adjust.
Just a few years ago the process of selling an Amazon FBA business was poorly understood by the acquisitions industry with many misconceptions around transferability. Fast forward to 2018 and the Amazon FBA business model has become one of the most explosive sources of new business listings with well defined transfer processes and strong buyer demand.
The subscription eCommerce model works similarly to the SaaS model. The customer pays the subscription fee, and will typically receive a niche-specific product, or multiple products, in regularly scheduled intervals (ex. weekly, monthly, etc.) as long as the subscription remains active. Thousands of subscription eCommerce businesses burst onto the scene from 2012 – 2016 following the emergence of successful companies such as Dollar Shave Club and Bark Box. However, many of these companies have ultimately folded because there are simply a limited number of products that customers actually want and need coming on a regular basis.
Buyers of eCommerce businesses can hail from many backgrounds, though it is also common for eCommerce business buyers to have retail experience, warehousing and distribution facilities, or access to a large audience in the same niche as the business being sold. We have seen internet marketers with unique SEO or paid advertising skills acquire eCommerce businesses and revitalize their brands, and we have also seen manufacturers and suppliers who are moving towards vertical integration acquire eCommerce companies further down the supply chain.
Key eCommerce Takeaways
Content businesses include blogs, forums, directories, online communities, YouTube businesses and other online destinations where the primary offering to visitors is consumable content, typically offered for free, and revenue is generated by monetizing visitors through advertising or affiliate sales.
The content itself can be in the form of written content such as articles, guides, reviews, listicles, how to’s, social media posts, forum activity, and online reviews. It can also be other digital media such as videos, images, music, audio files, podcasts, infographics, eBooks, memes, animated gifs, etc.
Telltale signs of a strong, sustainable content business include highly engaging and shareable content, valuable or unsaturated niche, diversified traffic sources, backlinks from major media and / or other industry authorities, sizable newsletter lists and multiple social media accounts with large active followings.
In contrast, the risk factor for content businesses increases when the majority of their traffic is dependent upon a single source, such as a single social media account with a large following or a single piece of content. Buyers should also beware of content businesses with risky models such as arbitrage businesses, which have a higher than average failure rate. Not surprisingly buyers usually do evaluate these risks and adjust their valuations accordingly.
Before acquiring a content business, you should always evaluate the quality and sustainability of the content as part of your due diligence process. Performing duplicate content checks with tools like copyscape can help you determine if written content has been used elsewhere on the web. Years ago websites with low quality and sometimes duplicate content could earn a stable income, but these days, content businesses with large amounts of duplicate or copyright infringing content are a recipe for disaster and a potential legal nightmare.
Content based websites can be monetized in various ways, but the most common way is through advertising, and we can further categorize and classify content businesses based on the type(s) of advertising relationships they maintain.
Typically seen as one of the simplest of the five major online business models, content businesses have wide appeal and can make great acquisitions for first time buyers looking to dig their teeth into the world of online business. Buyers also commonly acquire content businesses so that they can advertise to the established audience. As an example, imagine the owner of a SaaS productivity app acquiring a productivity blog to promote his SaaS app to the blog’s readers. It is also common for those with access to existing content development teams to acquire larger content businesses, for the simple reason that, they have the capacity to operate them. For example, a buyer of a health and fitness blog who already has a team of 20 writers capable of producing 50+ health and fitness articles daily.
Key Content Takeaways
Service based online businesses cover a wide range of industries and activities where services are being exchanged for compensation on the web.
This online business model is most popularly associated with internet marketing and web design and development services such as SEO, content writing, logo design, and more. However, the services model also expands to include other traditional and non-traditional service based businesses which are primarily generating revenue online.
In the web acquisitions industry, there is often somewhat of a stigma associated with a certain class of generic internet marketing style service based businesses, and the services category in general tends to have the lowest average valuation of the five major online business models.
There are several likely causes and explanations for the lower than average valuation of this online business model. First, the value of a service based business is often closely intertwined and dependent upon the owner of that business being involved. For example, an article writing business, where the owner is an exceptionally brilliant and award winning writer who produces 100% of the current articles. In these situations, where the owner is heavily involved and seeking to sell and make a clean exit, potential acquirers will be forced to realistically evaluate how the business will continue to perform.
Additionally, many service based online businesses simply have low barriers to entry and are fairly easy to replicate with minimal investment, as there is often little if any intellectual property or proprietary technology involved. Service based businesses specializing in generic internet marketing industries with very little differentiation, or long term sustainable organic lead sources, will be hard pressed to find their businesses exceeding a valuation of more than 1x annual net income.
For example, while a business generating 90% of its revenue selling low quality SEO services on Fiverr might be able to carve out a decent return, very few, if any investors would even entertain such an acquisition.
There are certainly valuable worthwhile online business investments in the services category, there are even high-quality service based businesses in generic internet marketing verticals which are legitimate acquisition targets. For example, an SEO services business with multiple sustainable organic lead flows backed by a knowledgeable team of experts that are willing to transition to new ownership would obviously have more realistic exit prospects than the previous example given earlier. This would be especially true if it were able to show stable financial performance over a sustained period of twelve to eighteen months.
Buyers of service based businesses are often best prepared if they possess the specialized skills and expertise necessary to maintain and offer those services. Another type of buyer involves those who maintain the skills needed to manage an experienced team of service employees. Companies already operating a service based business in a particular space are also common buyers when it comes to this business model, as they usually have a strong incentive to acquire the existing customer list.
Key Services Takeaways
5. Transactional / Marketplaces
The transactional business model, also known as the marketplace model, is an online business model whereby users engage in transactions, and revenue is generated by charging these users a fee or “commission” on each successful transaction.
This model was first introduced in the late 90’s by tech giants like eBay and Amazon, and fueled by the rise in the gig economy, has since been utilized by many companies to disrupt a wide array industries.
The success of an online marketplace often depends on its ability to create network effects. Once network effects have been achieved these businesses have a low failure rate and their valuations typically soar. Buyers of transactional marketplaces should investigate user growth rates, cost of customer acquisition and lifetime customer value as they develop their valuations and perform initial due diligence.
Given the average size of these acquisitions we also often advise buyers to enlist the help of professional legal representation to perform a full analysis of the business and ensure it is compliant with laws of the jurisdictions it operates in, such as the GDPR.
Many, if not most, online marketplace startups will never get off the ground, but the ones which do often end up being very successful and lucrative. Thus, they are often prized by strategic buyers and private equity firms who are willing to pay a premium to acquire them. Stable returns, multiple avenues of growth via ancillary services, and enticing exit scenarios can all combine to drive higher than average valuations.
Transactional businesses are typically among the most advanced business models in terms of difficulty. This model often overlaps quite a bit with other online business models. For example, a successful transactional business will likely also have elements of content, eCommerce, and even SaaS and services. As a result this business model is typically suited best for qualified buyers with existing acquisition and / or online business experience. However, as with most things in the online business world, there are exceptions.
Key Transactional / Marketplaces Takeaways
Updating Your Acquisition Profile
We hope that after reading this guide you have a better understanding of each of the five major online business models, and hopefully, a clear idea of which models you are personally interested in and best suited to acquire.
The next step is to login to your account. From your user dashboard update your acquisition profile with your online business model interests. Once you have added this information to your acquisition profile, we’ll keep it on file and we can use it to match you to active listings, off-market deals, and pre-market opportunities in the future.
If you are not yet registered, and would like to set aside some time to discuss your acquisition goals with myself or one of our qualified M&A Advisors, please schedule a meeting here.