If you're anything like me, there are few activities you love more than modeling your business in Excel. The adrenaline rush pounding through your veins as you stare thoughtlessly at a blank spreadsheet.
Few experiences can match the intensity of such a moment.
I studied business administration in college. When I first started working with startups, I was always tasked with creating revenue models and forecasting. I have done this job on many occasions for a variety of different companies. Anything from a mobile streaming app to a marijuana grow operation.
To be honest, I've done it so many times that I find the process almost meditative; which is not weird at all.
Revenue modeling is a useful exercise as it gets you thinking about the details behind the different components of your business and how they fit together. After a while I started noticing similarities between different business types and wanted to share some of my insights with you.
At first I didn't know what the hell I was doing. I was frustrated, embarrassed, confused and scared. All things I want to help you avoid. There isn't a lot of great information out there that describes the thought process behind revenue modeling, so my goal is to create the roadmap I wish I had found when I started.
After reading this post you will better understand how to think about your own revenue model and how to prioritize important activities to generate better returns.
Why build a revenue model?
There are many moving parts within a business, and building a revenue model forces you to think about the details behind the execution of each phase of your plan.
This process will help you identify things like the number of customers you need to break even or if your price point is sustainable given expected growth rates. things you want to know. Especially if you go to SharkTank.
A solid revenue modelstarts from belowand illustrates the specific activities you will undertake to acquire new customers.
It's not enough to say, "We're capturing 10% of a $5 billion market."
Where would you start? What specific steps will you take? These are some of the questions your revenue model should answer.
That way, if you get it right, you'll have a good idea of whether the economics behind your assumptions make sense before you waste time.
Too many entrepreneurs put this off until they need to raise money, or worse, when they're trying to extricate themselves from the mess created by implementing a poorly designed business model.
I did it myself, and even one of those experiencesled to the inspiration for Poindexter, but that's a story for another post.
Ultimately, your revenue model represents the various offensive attacks in your playbook. Once things start going sideways, it will serve as a powerful tool to adapt to new scenarios and make informed decisions that push the benchmarks forward.
“You have to have a plan for even the worst-case scenario. That doesn't mean it always works; it doesn't mean you will always be successful. But you will always be prepared and at your best.”
Source of income vs. revenue model
Before we dig in the weeds, it helps to understand the difference between an income stream and an income model.
In short, a revenue stream represents one of the specific ways you make money (i.e., sales of a single product). However, a revenue model is the combined sum of all your revenue streams.
For example, if we look at Stripe's pricing model, they charge a flat fee per transaction and a percentage of the total. On theirproof of income, they might want to break them both down as two separate revenue streams. The reason they want to do this is because the flat rate tells transaction volume and the percentage fee would tell total currency volume. These revenue streams taken together would then form the revenue model.
We'll discuss the specific components behind each revenue stream and how they can differ from company to company when we get to the Transaction Type section below.
Step 1: Lead Generation
Few products can sell just because they exist. Therefore, we will first consider where, when, how and in what quantity we are likely to acquire new customers.
Pro Tip: Talk to prospectsbefore you finish the product.
Lead generation is the part of the sales model that newer entrepreneurs often least think about, but it is trueTHEmost important piece.
That's another mistake I made; this time when starting Poindexter.
It's easy to get bogged down in the development of the product, but if you don't start recruiting potential customers from day one, no one will know how to use your amazing tool and you will feel like you're trying to catch up for a long time .
Because of this, it's important to first do some research on where you're goingfind prospects.
Your strategy should consider factors such as: B. who your target customer is, where they are, how to reach them, and what you are doing to gain their trust. All of these things need to be aligned and reflected in your revenue model.
For example, at a PETA rally, it seems unwise to try to attract new customers by hosting a pop-up fashion show for a fox-skin onesie.
A lot of thought and research has to go into the strategy behind lead generation.
And remember that it can make sense at firstDo things that don't scale. This gives you the opportunity to be more active in the customer development process and to validate some of the assumptions you have made.
Start by making a list of each of the sources you are targeting; the more specific, the better.
Then,estimate how many leadsAccording to her, each month is generated for each channel. Audience size information is sometimes available. Sometimes you need to base it on a general activity level. Just start with some reasonable numbers.
Next, indicate when and for how long you think you can generate leads from each source.
It's important to be honest with ourselves. We probably won't be generating 10,000 leads a month from a single blog post about our favorite West African marine mammal for a year.
We should back up our initial assumptions with data whenever possible.
Once we've detailed all of our sources and we have a baseline number of leads forecast per month, we should have something that looks like this:
Hopefully your list is more detailed than this.
Step 2: Customer Conversion
The next step in developing our revenue model looks at the journey each lead goes through before it is converted into a customer; if they do at all.
This is where our assumptions are really put to the test, because while information may be available about how many leads we can expect from individual sources, there's often no pre-existing information about how effective our sales copy is, or whether people want our product to buy at all.
You can always throw leads at a product, service, website, or app, but if no one is converting, it's time to take a long look at where our assumptions are going wrong.
Maybe we're targeting the wrong audience, or maybe we're not highlighting the right benefits.
These situations underscore the importance of keeping an eye on conversion so that we can adjust our plans as events unfold.
Find some metrics to use as a proxy for tracking conversions, then set baseline conversion rates for each acquisition channel.
Check these assumptions regularly to see if they correspond to reality. If it doesn't, update your model and figure out what you could reprioritize based on what's working and what's not.
When we first started generating traffic for Poindexter, we found that cold emailing CFOs was getting us nowhere. Even after we finally managed to score a few meetings, it was clear our product wasn't going to be for them.
On the other hand, we fared much better with entrepreneurs, so we refocused our efforts on getting featured on startup discovery platforms, tool stacks, and app directories. This started moving the needle... slightly.
Once you start running for each customer source, if anyprioritized them by potentialYou'll probably need to reconsider your strategy when faced with reality.
We have now completed one of the most important parts of our revenue model that we need to focus on the most, at least initially. From here the structure of our modelshouldbe more stable over time.
The transaction type
One of the key takeaways I've had about different revenue models is that they're simply a combination of different transaction types. If we look at these transactions individually, they are pretty simple.
Ultimately, businesses need to be paid, and the key differences between revenue models are how, when, and why each transaction occurs.
HowIs the transaction structured? Is it a flat rate based on a percentage of volume or something else?
Ifdo transactions take place on time? Is there a free trial? Are payments recurring or is it an upfront payment?
Whydoes the transaction take place? What does it trigger? Does it support the structure of the delivered value?
Below is a general breakdown of the different transaction categories I've encountered. Most of the revenue models I've stumbled upon fit into a combination of these transaction types. That's not to say that this list covers every scenario, but it should be enough to give you an idea of how to view the monetization portion of your revenue model.
1. Direct Transactions
Description:The simplest transaction type. It occurs between two parties entering into an agreement whereby one party receives remuneration for the provision of goods or services to the other party.
Examples of revenue models:Retail, eCommerce, Manufacturing, Content Upgrades, Flat Rate Services, Project or Agency Models, Donations, In-App Purchases, Wholesale Revenue, Shipping Orders, Razor and Blade (Razor Part), 2-sided Marketplaces
2. Time-Based Transactions
Description:This transaction model is based on the idea that one party compensates another for access to goods, services, features, facilities, or other forms of property for a period of time.
Example revenue models:SaaS, subscription boxes, co-working spaces, car rental, apartment rental, leasing
3. Usage-Based Transactions
Description: Occupancy-based transactions can involve 2 or more parties, whereby the owner of a property is compensated based on another party's use of that property.
Example revenue models:Ad Revenue, Cellular Providers, Hourly Services, Cloud Service Providers, SaaS, Subscriptions, Razor and Blade (Blade Part)
4. Indirect Transactions
Description:Indirect transactions involve at least 3 parties, with a third party receiving compensation in the event of a successful agreement, interaction or transaction between the other two parties.
Example revenue models:2-sided marketplace, partner/referral commission, license income, franchise income
You will find that some example revenue models are included in more than one category. This is specifically to illustrate that they are not mutually exclusive and that there is a gray area between them. This list is intended as a general guide only.
How you provide value to your customers should be the most important consideration in your decision behind the combination of transaction types you use.
Step 3: Build your monetization model
Now we can start building our monetization model around the how, when and why of each transaction. The easiest method to demonstrate is the direct model, so we'll use that method for our example.
We start by establishing our parameters around how, when and why.
For the sake of simplicity, let's assume that every customer we refer will immediately be charged a flat rate (how) to buy a pair of eco-friendly plastic sandals (why) when they make the switch (when).
Because leads convert to customers immediately after the sandals are purchased, we can simply multiply the number of customers won each month by the price of the sandals to get our sales forecast.
To take this example a step further, let's assume that a certain percentage of these customers come back to buy another pair each month.
To accommodate this new adoption, we need to keep an eye on our customer base.
We'll create two new line items. The first of these is the “Initial Customer Base” which represents the number of customers we have at the beginning of each month. The second is the “end customer base”, which is the number of customers we have at the end of the month.
As we acquire new customers, we add them to our base at the beginning of the month to get the total customer base for the month.
Think of it like an email list. When new subscribers sign up, they are added to the total number of existing subscribers.
Finally, while it would be nice to assume that our customer base will grow indefinitely, it probably won't, so we need to introduce our final parameter called "churn". This is the percentage of our customer base that leaves each month; never to return.
Now I don't know why they're leaving. Perhaps the sandals are not very comfortable, or these customers are moving far away, or they may find that plastic sandals are not environmentally friendly. It's everyone's guess.
In any case, we need to subtract these individuals from our customer base to ensure we don't overrepresent revenue from returning customers.
We can now simply multiply the number of people in our "beginner customer base" by a certain percentage each month to see how many returning customers are likely to come back and buy more sandals.
When all is said and done, we should have something that looks like this:
Next, we just need to add up the revenue from new customers and the revenue from returning customers to complete our revenue forecast.
When we look at the other revenue models, things get a bit more complex, which means we need to add more parameters.
For example, with usage-based transactions, we need to assume some level of... you guessed it, "usage." So if we're selling razor blades, we need to figure out how many blades we're selling with each purchase and how long it takes customers to sort through those blades before they buy more.
The modeling process for the other transaction types requires a little more sophisticated knowledge of table equations, but that's beyond the scope of this post and something that some YouTube videos can cover more effectively.
I hope this has been a useful guide in providing a framework for the thought process behind your revenue model and how to tie specific activities to financial results. Now all we have to do is implement this plan.