Over 37% of climate investors decide not to invest in hardware companies because of the business model and long sales cycles. These are the results of a survey, carried out by Planet A, Norrsken, and Speedinvest. The survey also highlights investors' preference for X-as-a-service and licensing business models over others. So, choosing a business model can make or break your startup.
The business model aims to determine how exactly you will make money. There are many ways for a climate tech startup to earn a buck, but not all are equal in the face of climate investors. The Stanford Precourt Institute for Energy has one of the best summaries of business models in climate tech (see picture below). But what are the specific climate tech startups, utilizing these models? What should you focus on, should you choose one? And what are the pros and cons of each? Let’s break it down.
1. Sell a Thing
Classic and timeless. Whether it’s an Apple iPhone or sustainable cement from Brimstone, this model is about creating physical products and selling them for cash. While this sounds simple, in reality, this is the hardest model to pull off in climate tech.
Tesla is probably the most well-known example of a successful hard-tech climate startup. Others, like First Solar, manufacture and sell solar panels, or like Brimstone, make and sell sustainable cement.
To make this business model work, you’ve got to master the art of unit economics—aka making sure your costs are low enough actually to make a profit. This is harder than it sounds. Scaling up manufacturing is the only way your company can grow. And once you are in making stuff, competitors will quickly pile in, so you’ll need to constantly work on differentiating your product from myriads of imitators.
The biggest benefit of this business model is its simplicity. Tangible products are easier to understand and market. The problems are numerous though. This model requires high upfront investments in manufacturing and supply chain development. And its linear scaling makes it unpopular with venture capitalists. According to Planet A, “Building and Scaling Climate Hardware: A Playbook,” hardware is “often associated with one-off equipment sales thus steady, low gross margins where enterprise value only scales linearly with volume.” Venture Capitalists like exponential value growth, and it is tough for hardware startups to jump on the exponential growth curve.
2. Rent a Thing
Not everything’s worth owning—sometimes, borrowing is all we need. U-Haul rents you trucks for your awkward cross-town move, while Renewell lets you lease what you rarely use. Similarly, car-sharing services build their business models on easy and convenient car rentals. If we search closer to climate tech, Sunrun leases solar panels to homeowners, enabling access to clean energy without the upfront costs.
This model thrives on consumption. The goal is to maximize the value of stuff that sits idle for most of the time. The higher the utilization rate – the more valuable is your business. To get there, you’ll need to make sure that your customers love renting from you. Customer experience is paramount here.
The main benefit of this model is that it generates recurring revenues, that entice investors. The rental model is also of interest to B2B customers, as it allows them to enjoy the benefits of a product without spending capital. It is often easier for corporations to approve a slight increase in operating expenditures rather than approve a large additional capital investment.
Same as with hardware sales, the rental model requires a lot of upfront expenditure on assets. This makes it vulnerable to a drop in utilization rates, should customers find the service inconvenient.
3. Take a Cut
A bit fancier term is an “enabler” or less fancy - a “fixer”. You connect two parties who have services or goods to exchange and take a cut. Platforms like Airbnb don’t own a single hotel room, yet they make billions by connecting people and taking a piece of the action.
In climate tech, the take-a-cut model is popular within the carbon credit markets. For example, Patch is a marketplace for carbon credits, enabling businesses to purchase verified carbon offsets. LevelTen Energy “helps carbon-free energy buyers, sellers, advisors, and financiers get better deals done.” CICON.App, a UK-based startup, connects fashion-conscious customers with local care products, cleaners, repairers, resellers, charities, and recyclers, charging a commission for each transaction.
The success of the model depends on GMV (Gross Merchandise Volume)—fancy talk for how much money flows through their platform. The bigger the pie, the bigger their slice. You have to get as many transactions as possible on your platform. To do that, you have to master two things. First, is trust. Market players have to trust you to find quality counterparts and deals on your platform. The second is convenience. Your platform should be easy and convenient to use.
Applying this model doesn’t require much capital and has an option of exponential growth. While this model works great for software startups, investors are known to shy away from this model in climate tech. One reason is that most of the time it is applied in carbon markets. Investors have a hard time trusting carbon markets due to their voluntary nature and absence of clear government regulation. Other drawbacks include vulnerability to competition if switching platforms is easy and the need for substantial marketing investments to build a trusted brand.
4. Charge a Subscription
Subscription is the king of software business models as it thrives on what investors value – recurring revenues. The customer may or may not use your service but still pays a subscription. This business model is ideal for services that customers regularly use. Yes, this is why you have a Netflix subscription.
In climate tech, the subscription model is also mainly found with software startups. Planet Labs charges a subscription for satellite imagery and climate monitoring data. Climeworks enables its clients to remove a certain amount of CO2 from the atmosphere by subscribing to Climeworks.
To make this model a success, it is necessary to make your platform so engaging that customers wouldn’t want to leave. In VC-speak, this is called the “retention rate”, for the share of customers who stay on your platform. However, the holy grail of all subscription services is the lifetime value (LTV) of a customer. It is the amount of money your customer brings over the time he is subscribed to your service.
This model’s main benefit is that it is the easiest for investors to understand and the most comfortable one. It provides predictable and recurring cash flow while allowing for rapid scaling with few investments. The problem is that competition is fierce, and a misstep could spike your “churn rate” – a measure of how fast customers leave your service.
5. Charge Based on Usage
This is a pay-as-you-go model. Every time you sell energy or carbon offsets, you charge your customers per unit of your product consumed. This model is popular in climate tech. Most clean power companies make money by charging per kWh of energy generated.
EV charging station startups are prime users of this model, as well as clean energy power plants. There is also an inverse model, where you get paid for reducing consumption of something, usually of energy, known as an energy service company model (ESCO).
To get ahead with this model you first need to invest in related assets, such as a charging network or a power plant. This is a classic infrastructure investment, where you need to incur large upfront costs that are later recouped through user fees. Choosing the right location is paramount to your success, as it will determine both your output capability (depending on wind, insolation, or grid conditions) and your demand (again, depending on grid conditions or customer traffic).
The advantage of the model is that you create an asset that can be used as collateral for loans to lower your funding costs and that you might have a clear vision of future revenues for the long term. The problem with this model is that it requires a lot of capital to build a power plant or a refinery. Most importantly, this model rarely enables exponential growth.
Importantly, licensing your tech frequently falls under charge based on usage. Your licensee, the one who bought your license, will usually pay you some initial one-time fee and will follow up with a specified fee for each product he makes using your license. The difference with other pay-as-you-go schemes is that your investments will be limited to R&D, your pilot, and your FOAK plant.
6. Sell a Service
Selling services most of the time means selling, well, time. All consultancy and engineering startups are service-based. They can make money only by devoting their time to solving a particular problem of their customer. Lawyers are famous for excessive billings for their hours, but climate tech has its own share of service startups.
Bright Power provides consulting and implementation services for improving energy efficiency in buildings. JR Energy Solution provides manufacturing-as-a-service, by making lithium-ion battery electrodes for their customers. Engineering-procurement-construction (EPC) companies also fall under the definition of sell-a-service companies.
The success of the model depends on your skills and marketing. You should relentlessly focus on maintaining your skills at a top-notch level. For example, making lithium-ion electrodes is an extremely difficult process, requiring highly skilled personnel with decades of experience. JR Energy Solution offers to make electrodes for aspiring battery startups or for overloaded battery incumbents.
The benefit of this model is that it normally doesn’t require much start-up capital. You just selling your time. In some cases, like with JR Energy Solution, you need a lot of capital to build a factory, which will enable you to provide your service.
The problem with this model is that it is very hard to scale. You only have so much time to sell. Sure, you can train additional staff, and charge a premium, but in the end, there are only 24 hours in any day. This is why investors tend to stay away from pure service companies.
7. Advertising
Ah, the digital gold mine of the internet age. Facebook mastered this game by turning your attention into profit. With billions of eyeballs scrolling endlessly, traffic becomes the name of the game. The more clicks and views, the more money they rake in. At first glance, this model is hardly applicable to climate tech, but a few startups are exploring the possibilities.
Project Drawdown develops and promotes educational campaigns funded by sponsorships. Trellis, formerly GreenBiz, monetizes climate-related content with advertising and sponsorships.
If you focus on the advertising business model, getting as many visitors to your platform as possible is your top priority. This is how Facebook, Twitter, and TikTok became successful. Being in the climate tech space means that you will be targeting a niche of environmentally conscious clients, so your platform will not be as big as those.
The benefits of the advertising model are first and foremost, its scalability. The marginal cost of getting your next customer is minimal. You don’t need a lot of upfront capital, and VCs love you. The problem with this model is that it is highly reliant on the volume of visitors, which may be hard to achieve in niche sectors like climate. Also, your revenue will depend on advertisers’ demand, making it less predictable, as opposed to say a subscription model.
8. Percentage of Assets
Managing other people’s money never goes out of style. J.P. Morgan and their ilk make their living by charging a small percentage of massive amounts of cash. This model involves managing a pool of assets (like renewable energy projects or funds) and earning a percentage-based fee on the total value under management (AUM).
Here, we pull a meditation trick when you “look for what is looking.” The best example of this model in climate tech is climate VCs and climate-related investors. They collect money from investors, invest in climate tech startups and projects, and earn a fee based on the assets under management. Pooling of assets is another way. CleanCapital manages solar energy portfolios and takes a percentage of returns.
AUM (Assets Under Management) is the key metric for this business model. The more capital you handle, the fatter your fees. To get them, you have to prove that you can deliver reliable returns to keep investors and clients satisfied. The other ingredient to success is the ability to grow the asset pool to increase revenue without proportional cost increases. Finally, investment is always about reputation and trust, so it is crucial to build credibility through transparent operations and strong track records.
The benefits of this model are that the revenues are predictable as your AUM grows, and long-term contracts provide stability. The main drawback is that you cannot influence how the assets are really managed, so your revenue is tied to external market conditions.
Conclusion
The amount of information may seem a little overwhelming, so let me summarize the key aspects of business models in a small table for you:
Model | Key Metric | Pros | Cons | Examples |
Sell a Thing | Unit Economics | Tangible products, easy to understand/market | High upfront costs, linear growth, tough competition | Tesla, Brimstone, First Solar |
Rent a Thing | Utilization Rate | Recurring revenue, accessible to customers | Asset-heavy, vulnerable to drops in utilization | Sunrun, Renewell, car-sharing services |
Take a Cut | GMV (Gross Merchandise Volume) | Low capital needs, potential for exponential growth | Competition, trust-building, vulnerable in unregulated markets | Patch, LevelTen Energy, CICON.App |
Charge a Subscription | Retention Rate, LTV | Predictable recurring revenue, scalable | Fierce competition, churn risk | Climeworks, Planet Labs |
Charge Based on Usage | Volume of Consumption | Clear revenue visibility, asset-backed growth | High upfront investment, limited exponential scaling | EV charging networks, clean power companies |
Sell a Service | Billable Time | Low initial capital (for most cases), skill-dependent | Hard to scale, revenue limited by available time | Bright Power, JR Energy Solution, consulting firms |
Advertising | Traffic Volume | Highly scalable, minimal marginal costs | Niche markets limit audience size, revenue depends on advertiser demand | Project Drawdown, Trellis |
Percentage of Assets | AUM (Assets Under Management) | Stable, predictable revenue, long-term contracts | Revenue tied to external market conditions, reputation is crucial | CleanCapital, climate-related VCs, asset managers |
In my experience, the most common business models for cleantech startups are charges based on usage (including licensing) and sale of a product. Later, innovative service-based startups started to emerge, offering manufacturing-as-a-service or commissions. Advertising or subscription-based services are rare, as climate is still a niche market.
This might explain why climate tech has fewer investors than say, AI. Advertising and subscription business models can scale exponentially, leading to the kind of returns that VCs are looking for. Hardware sales, manufacturing, project-based, and carbon credit funding are much less interesting for investors.
Knowing the differences in business models is one thing, but how do you choose which one is suitable for you? There is a way. Next week I’ll be publishing my framework for choosing a business model for your climate tech scale-up.