Revenue Model

Your revenue model can be broken down into two areas — how you will make money and how that plan will scale. In this section of our Funding Series, we'll dig into how you’re going to talk about the mechanism of how your revenue model works.

August 9th, 2022   |    By: The Startups Team

Continuing in Phase Three of a four-part Funding Series:

Phase One - Structuring a Fundraise

Phase Two - Investor Selection

Phase Three - The Pitch

Phase Four - Investor Outreach

Let’s dive in!

What is a revenue model?

Your Revenue Model is simple — how are you going to make money? More importantly, how are you going to be profitable someday? Don’t let the Silicon Valley myth of “valuable companies don’t need a revenue model” become part of your pitch. All companies need a real revenue model that can be reasonably explained and agreed upon by everyone. Well, not by everyone. By Investors. Let’s be real. Revenue streams aren't a "nice to have" — unless the company makes money, it's going to be a short-lived hobby.

You don’t want to be this Founder:

Founder: "We're going to sell dollar bills for 99 cents! It's going to be huge!"

Investor "How will you ever make money?"

Founder: "Volume!"

Investor: (laughs and exits the room)

Many businesses lose money before they make money — it takes time to build a profitable business. So your revenue model doesn't need to be an instant ATM of profits. In the near term, you're charting the path to profitability, not a reflection of current profitability. The revenue model is the compass for that path.

Revenue Models are a Two-Step Dance

Your revenue model can be broken down into two areas — how you will make money and how that plan will scale. Your Financial Projections are the detailed view of this model that you'll tackle later. At this point, you’re going to talk about the mechanism of how your revenue model works.

Step 1: How to Make Money

Describing how to make money tends to get more complex with businesses in new markets. If you're opening a restaurant, everyone knows you're going to sell food. You don't need to waste too much time here. But if you're creating a pioneering mobile app for senior dating, you'll want to spend serious time digging into the mechanics of how you will convert visitors into customers.

 The first portion of your explanation should detail each Revenue Channel.  

SaaS revenue model example:

“Our dating app will make money by selling advertising and selling monthly subscriptions. (Define the Channels)

We expect to be able to generate 30% of our revenue from selling to advertisers who want to target our specific demographic of 65-90-year-old senior singles.” (Dependency per Channel)

We expect to be able to generate 70% of our revenues from subscriptions to our mobile app, which will cost $9 per month.” (Price Point of Channel)

Now, don't think too much into this. How you make money isn’t just about the mechanism (advertising or subscription) but it’s also about the amount of revenue that channel accounts for (30% in advertising, 70% in subscriptions). This helps investors understand how reliant you are on each revenue channel. 

You don’t have to be 100% accurate with how you split your revenue channels, but more relatively accurate so that investors can see how much you are relying on those channels specifically. They need the best, clearest picture that you can give them, but it doesn't have to be exact.

The second part of that explanation is how much money you intend on generating per that channel. This is most often reflected as the “price point” of each sale. Some products with a high Cost of Goods Sold may require that you explain both items in the Revenue Model for them to make sense.  (We’ll tackle this later).  

Service Based Revenue Model Example

“For our consulting work, we charge about $100 per hour to clients and absorb $70 per hour in personnel costs to deliver our service.”

The goal here is to easily explain how you intend on making money in a short, concise manner — in this example using a "markup model." A markup model is simply where you deliver a product or service with a fixed cost to which you add a profit margin.

Revenue Stream First — profitability and revenue model optimization second

In most cases, you can focus on how you will drive revenue first, and then dig into how you will manage costs associated with that revenue stream. 

Step 2: How to Scale Revenue models

Once you've established that someone will pay something for your products, the next step is to explain why more than two people in the world care enough to part with their hard-earned dough. This is called “Scaling Revenue” and it’s just as important as explaining how you’re going to make revenue at all. The understanding of not only how we generate revenue but how we scale that via growing the company's revenue streams is key to gaining investor interest.

The finite details will be presented later in your Financial Projections, but you want to be able to add some narrative context to the numbers so investors can understand how you’re thinking about scale. If the story around the underlying business model isn't interesting or credible — your super amazing charts showing hockey stick exponential growth won't matter.

Revenue generation tends to fall into two phases — Discovery and Scale.  

Discovery is the period where you’re figuring out what revenue models and price points work as well as the associated costs. You’re proving assumptions and typically figuring out that most of what you guessed was right was totally wrong. Don’t worry, we all do it!

Scale is how you take your validated assumptions and grow your business to whatever size you’re targeting. You can’t begin to scale until you know exactly how the market reacts to your Discovery.

Business Model Discovery 

Discovery Goals are a good way to isolate and test assumptions we want to validate in our business models. They give you some time in a sandbox to adjust your forecasts to reality while explaining to investors how you plan on getting to more accurate estimates of your revenue model.

Subscription Revenue Model Example

“In the first 6-9 months of operation, we want to price test our subscription models with a variation of pricing between $5 and $30 per month as well as learn how many months a subscription recurs so that we may determine the Lifetime Value (LTV) of a paying customer.”

That’s a much healthier explanation of how you intend to adjust price points based on testing the subscription model, rather than just assuming everyone is going to pay $20 per month forever with little to no testing. Recurring revenue models have to account for "churn." Assuming that once a user signs up that they will be a perpetual revenue stream will make you look naive (and nobody wants to look like that!).

Don’t paint yourself into a corner by blindly making assumptions you can’t possibly prove about a revenue stream. It makes you look silly when you present the data because you’re making huge projections on hollow premises.  

Think of “Discovery” as the place you put all the answers you don’t know. It’s a safe, happy place. When an investor challenges you on your assumptions simply say “We don’t know that yet, but here is how we plan on validating our assumption around our subscription model.”

Business Model Scaling 

Once you’ve proven your basic assumptions for how revenue works, you’ll want to explain how you envision those numbers scaling into billions. Or millions. Or tens. Whatever numbers are wildly impressive to whom you’re trying to convince.

Your ability to show that your model can scale is directly tied to how much value the business can create for investors. If you can scale to the size of Google, you can raise billions of dollars in capital. If you can scale to the size of the largest lemonade stand in your cul-de-sac, you can raise ones of dollars in capital. (Unless it’s a really, really big cul-de-sac.)

Scale Requires Friends

The degree to which your revenue model will scale will require two friends who are inextricably linked:

Total Addressable Market - The maximum number of customers who would ever buy your product.

Customer Acquisition Plan - The plan is to acquire as many of those customers as possible.

You can’t scale the business to be bigger than your Total Addressable Market and you can’t scale beyond the number of customers you can acquire in that market. Those are super important factors which is why they have an entire section dedicated to them.  

If you were giving this pitch sequentially, you would have mentioned how big the market is early in the pitch (or in the business plan itself). You’ll likely explain your Customer Acquisition Plan after the Revenue Model, so you will be hinting at how many customers you can acquire and then explaining that in detail later. You’ll introduce your plan to scale something like this:

Example

“As we demonstrated, the Total Addressable Market for seniors who will use online dating is 115 million globally. (You've defined the maximum size of the market).

We have a plan to capture 1 million of those customers by Year Four. (You’ve defined how many of those customers your Customer Acquisition Plan can reasonably attract in a particular time frame.)

At an average price point of $19 per month and 3 additional recurring months, we would yield $76 per customer @ 1 million total customers for an Annual Revenue of $76 million.”  (You’ve flaunted your ability to use a calculator, as well as projected how big you can scale!)

Think of it like building a skyscraper and every floor requires a foundation that the next floor can be supported by. This plan, this pitch, and this idea is all supported by a series of assumptions that build toward your financial projections.

What? You’re Lost? That’s OK!

This all sounds well and good, but you’re sitting there asking:

“How could I possibly know how many customers I can acquire in Year Four or how many times my customers will recur after a single purchase?!”

You don’t. You have no idea. And nor does anyone else — and that’s OK.

It's not about being right (yet).

Your goal right now isn’t to have exact numbers, it’s to have a business model in place that allows you to plug in assumptions to help determine how big or small this opportunity might be as you discover more. No one in the history of startups has presented a plan that was accurate at this stage. But smart Founders can articulate what factors could cause the outcomes they are trying to get to. That’s what this is really about.  

Revenue Model Summary

We've looked at not only what a revenue model is, but why it's important to have one from the start and to understand the various options that exist for your company's revenue streams.

We've looked at examples of several revenue model types, which should help you determine the specific revenue model you want to consider. Selecting the best revenue model for your business is critical — so spend the time to understand other revenue models, not just the obvious and popular revenue models. Consider which one is the best revenue model not only for your business but also for your target customers. Knowing HOW your target audience prefers to consume your product or service will help you select the transactional revenue model that will best align with their needs, and help you produce reliable, repeatable revenue streams.

Outside the obvious

SaaS and the recurring-based revenue model have recently become the most popular revenue models, but they are by no means the only revenue models worth considering.

Yes, you can have more than one transactional revenue model

Don't forget — you can also have multiple revenue models. Having different revenue models can allow you to tap into different target customers. This can allow you to reach paying customers who might not resonate with your primary revenue model, giving you access to new customer segments and improving customer retention. Be sure to consider several revenue model examples when it's time to choose a revenue model. Business strategy for the win!

Additional Examples of Revenue Models

Here are a few less common revenue models to consider.

- Affiliate revenue model

An affiliate model...

- Advertising revenue model

An advertising model...

- Licensing revenue model

A licensing model...

- Donation revenue model

- Interest revenue model

- Freemium model

A freemium model is one in which free access is given initially with the intention that a customer pays after experiencing the value and eventually upgrading to a paid tier of the product or service. This is a very common revenue model for software companies operating on a subscription revenue model.

- Commission Revenue Model

A commission model is most commonly used in a direct sales environment. It can also be part of an affiliate revenue model. The company generates revenue through the sale of a product or service and commissions are paid out to a direct sales team. An example of this revenue model is a company selling ad space, with a sales team pitching media companies. Ad space could be in a primary channel or a separate revenue stream. Keep in mind, that a commission revenue model requires consideration at the pricing strategy level.

You're ready.

Okay, so we've looked at the most common revenue models as well as additional types of revenue models. At this point, you're well armed to do a great job of selecting and pitching your revenue model and understanding what it will take to scale (and we believe in you!).

But Wait, There’s More! (Costs)

Revenue is only half of the larger equation when it comes to how your business operates. There’s also the cost side, which for many businesses can have more impact and apply more innovation than the Revenue Model.

We’ll tackle that in another article — the Operating Model — which digs into what aspects of your operating costs and operations should be meaningfully considered.  

The reason we tackle these separately, and the Revenue Model first, is because if you can’t articulate that you can generate revenue, convincing folks that you have a way to manage expenses is a fruitless exercise. We need revenue streams to cover operating costs. Talking about managing production costs before we talk about generating revenue isn't a great way to convince investors we're worth a longer look.

Continue to Part 4 - Operating Model 


About the Author

The Startups Team

Startups is the world's largest startup platform, helping over 1 million startup companies find customers, funding, mentors, and world-class education.

Discuss this Article

Comments
 
Unlock Startups Unlimited

Access 20,000+ Startup Experts, 650+ masterclass videos, 1,000+ in-depth guides, and all the software tools you need to launch and grow quickly.

Already a member? Sign in

Copyright © 2022 Startups.com LLC. All rights reserved.