What is a business model?
A business model explains how a business makes money.
For a retail store, the business model consists of selling physical products to the customer either through the brick-and-mortar store or through online channels.
For a service business, the business model consists of creating and providing value to customers by selling one or more service(s).
What is a service business?
A service business is a business that sells services.
Service businesses can be found in many industries, including finance, healthcare, transportation, consulting, international trade, and education.
When selling a service, a business usually trades hours for money. A person spends a certain number of hours working to provide the service and the customer compensates them for their time.
Business models for service businesses
If you own a service business – also called a service provider – it is important to understand the various business models and how they can be used to achieve growth.
Not all service business models are conducive to growth, because not all of them can be easily scaled up. Each business model may also have varying strategies to increase profits.
Below are the most common business models for service businesses and an explanation of the pros and cons of each model.
1. The hourly model
This is one of the most common business models for service businesses and it is often used by consultants.
The service provider makes money by charging customers an hourly rate to provide a specific service.
This business model is hard to scale. One reason is that there is a limit to the number of hours that you can work per day. Whatever you do, you cannot change the fact that there are 24 hours in a day and that some of these hours are needed for other activities (like sleep).
Another reason why it is difficult to scale this business model, is because scaling requires you to increase your costs. For example, if you provide business consulting services, scaling means that you need to bring on an additional consultant and pay a salary.
It is possible to avoid this problem to a certain extent by working with freelancers, but if you cannot guarantee a certain amount of work for them, they will not be able to guarantee their availability when you need them.
**Pros of the hourly rate model
- It is well-known and can be used by most service businesses
- It is highly flexible
- It is a good way for a new customer to get to know you
- You can increase your hourly rate as your experience and expertise increase
**Cons of the hourly rate model
- It is hard to scale up
- You have to track the time you spend working for each customer
- There can be problems if the customer does not agree with the number of hours you worked
- You do not get paid until after the work has been completed
2. The retainer model
In the retainer model, the service business and the customer agree on a certain number of hours, usually per month. If the customer needs more hours than what was agreed, they buy an additional package of hours. It is similar to using credits to top up your phone or internet data.
This model is similar to the hourly rate model because the customer is paying for the actual number of hours that you spend working for them. The main difference between the retainer model and the hourly rate model is that – in the retainer model – the customer pays you in advance.
This model is also difficult to scale, for the same reason as the hourly rate model: the number of hours in a day are limited.
However, it is considered better than the hourly rate model because it gives you a better idea of how much you will make in a month. This gives you time to focus your efforts on acquiring new customers. For this reason, retainers are often offered to customers at a discount.
- One of the most common business models for service businesses
- You get paid in advance which makes it easier to predict your (monthly) income
- It works well if you provide recurring services to customers
- It is a better option than hourly rate pricing
- It has limited scalability
- You have to track the time you spend working for each customer
3. The fixed-fee or subscription model
This model can be best compared to a subscription, like for a software package or magazine.
It shares some similarities with the retainer model, mainly, the fact that the customer pays you a monthly fee for work that you do. It is also possible to require advance payment.
The main difference is that the customer does not buy an additional package if the hours you spend working for them are exceeded. The risk falls on the service business to ensure that they have correctly calculated the cost of carrying out a specific amount of work for a particular customer.
This model is best suited if you provide a range of services on a recurring basis. That makes it extremely well suited for consulting, accounting, online marketing and coaching services, but it can be used by any business where the work done repeats on a regular basis.
This model is interesting for customers because there are no financial surprises at the end of the month: they know how much they will be paying you. It is also very interesting for service businesses because this model makes it easy to manage your cash flow. After all, you know exactly how much money will be coming in per month. Based on that, you can also easily plan your business expansion.
- It is suitable for any service provider that offers repeatable services
- It is the best business model to ensure a steady and predictable stream of income
- It guarantees a steady work load
- It offers clarity and security to customers
- It lets you build a loyal customer base
- It helps you increase your prices over time after you establish yourself in the market
- You can combine it with other service models
- It may be difficult to attract new customers because you may be competing against other service businesses that already have a loyal customer base.
- It can be difficult to retain customers unless you provide a high-quality service.
4. The performance or results-based model
In this busines smodel, the money you make depends on the results that you can achieve for a customer. When charging them, you either bill them based on a percentage or a fee structure. In fact, you are working on a commission basis.
For example, if you are a marketeer running online marketing campaigns for your customer. Your compensation depends on how much money you are able to make for your customer through those marketing campaigns.
This model can work well for those service business that know how to get good results and are very sure that they can meet the goals that are set. However, it needs to be very clear exactly what results you will be paid for.
In the example of the online marketeer, results may not come in until after 1 or 2 months. Secondly, if your client gained a new customer, will only the first purchase count as a result? Or will all future purchases by that new customer also be included in the calculation of your compensation? And thirdly, there are other factors – like the size of the marketing budget or the loading speed of the website – that impact the results of the marketing campaign. The online marketeer does not control these factors but they impact how much the marketeer will be paid for the results.
Though it is one of the most common business models for service businesses, these and other issues make the results-based model very risky.
One way to avoid problems is to charge a flat fee that your customer must pay regardless of the results. The fee should be enough to cover your costs. This minimises the risk of you not getting paid at all.
Since the percentage or fee structure also applies, you can make a (very) high profit if the results are good.
- This business model can be very profitable, more than other models
- It is a good model for service providers who are sure that they can meet the targets
- You can reduce the risk in this model by charging a flat fee that must be paid at all times
- The service provider is not always in control of all factors that impact results
- It can take a long time for results to appear, which means that it can also take a long time before you get paid
- This is the riskiest business model because you may not get paid at all unless you mitigate the risk
5. The project model
The project model is best suited for work that has a clearly defined scope. For example, the design of a house, the creation of a website or the construction of a building.
The service business and the customer agree on the full price and the service business then bills the customer based on project milestones. Usually, the service provider will also receive an initial payment when the work starts.
The main challenge for the service business is how to do a correct estimate of the total amount of hours needed to complete the work. This makes it a risky business model for service businesses that are less experienced.
- This model works well if you can combine multiple services in one package
- It can generate higher revenues as compared to the hourly rate model
- It is easier to schedule your time and organise your resources
- You can upsell additional services to customers
- There is a big risk of underestimating the workload
- Conflicts can arise with customers if the scope of work is not clearly defined
- Customers may try to add additional work without paying for it
There is no quick answer to the question of how to choose the best business model for your service business.
Which business model is best suited for your business depends on many factors, including the type of services you offer, the kind of customers that you service, your experience and expertise.
It also depends on the kind of working relationship you want to have with customers and how much risk you are willing to bear.