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This post from Nora Ghaoui takes a look at revenue models that work for smart products with a digital service.

Making a smart product needs more than adding an app. You need to cover the costs of the digital service or risk losing money. Which revenue model can you use? And why would anyone pay for this service?

The revenue model for a digital service needs to cover the costs of running it

Let’s consider the options for a new B2C product, for example a smart refrigerator. To be able to run the service, you need to add hardware and software to the product. The hardware costs and upfront software development costs can be covered by a higher price for the fridge. It has extra features, so a higher price is expected.

The digital service costs continue after the sale. They include providing feature and security updates, storing and analysing customer data, providing customer service, and so on. You can estimate for how long the service needs to keep working, then add X years of its costs to the purchase price.

If the service needs to keep working “indefinitely” then the incremental costs of maintaining it may exceeded the revenue you earned at the time of sale. If you do not balance these, the service will be loss-making for the company.

Using new sales to pay for the service

While sales are growing, you can cover the costs through new sales, subsidising the costs for earlier products that are still using the service. This delays the moment when the service becomes loss-making but does not prevent it. 

This “new sales to cover costs” model is why software makers keep making new versions of their products (e.g. MS Office, Windows). Once everyone has the product, you need to give them a reason to buy a new one. This model fails when the product is already good enough (e.g. Windows XP, then Windows 7), so software makers have switched to the subscription model (e.g. Office 365, Adobe Creative Suite).

Key points include:

• A service that meets customer needs
• Eight possible revenue models
• The need to beat “free”

Read the full post, Which revenue model works for a smart product with a digital service?, on LinkedIn.