How does your company make money?
8x Entrepreneur, Author, Customer Development Expert
A revenue model is your strategy to make money from each customer segment.
Pricing is a tactic, not a strategy and not a revenue stream.
Engineering-driven startups often make the mistake of putting every feature into the first product.
Lesson: Revenue Relationships with Steve Blank
Step #6 Revenue: How does your company make money?
Today, we are going to talk about revenue models. Very simply is, how does your company make money.
So in our last lectures we talked about value proposition, customer segments, distribution channels, customer relationships, get, keeping and growing customers. But today we're going to be talking about revenue streams. How is it that you make money?
Now, revenue models that seems incredibly simple, it answers the question, how does the company make money from each customer segment? But one of the things that we always tend to confuse, is the difference between a revenue model and pricing. That is the amount of dollars that we might actually charge for the product. And this is a common mistake. What we're really trying to understand first, is what value is the customer paying for. And the first thing we need to figure out is, what is our revenue model. What's the revenue stream. That's our strategy.
But what follows is then pricing. What is our tactics? So again, what we're going to try to figure out is, what's our strategy? Revenue streams. And what's our tactics? Pricing. And together that means, how does a company make money from each customer segment?
Let me just remind you the reason why I love this lecture is that there is a series of common mistakes that first time even experienced entrepreneurs make in thinking about revenue and pricing. And the first one is this whole idea about revenue stream. “Steve, I get it. Revenue stream, it's about the price, the dollar amount I’m charging customers.” That's a mistake.
You will see later that pricing is a tactic. Or maybe "I kind of get it. Now I understand that pricing is a tactic, but I will set the price of the product based on how much it costs me to make it." Well, how else would you set pricing. Cost me $0.99 to make it. I will charge a $1.25 and that's kind of a reasonable price. We will also see why that might be a huge mistake and leaving lots of money on the table.
And then the third common error is, my price has to be less than my competitor's price. If they are charging $5,000, the best way to enter a market is to charge $4,000. No one would pay any more than the existing incumbents. And we are going to see that's another going out of business strategy. And all this depends on your knowledge that you have just learned about the customers, their reaction to the value proposition and all the work you have been doing outside the building. You are going to have an incredible advantage in thinking about revenue and pricing.
So the two questions we are going to talk about now are what are my revenue streams? And next, within the revenue streams, how do I price the product? So let's take a look, what exactly is a revenue stream?
A revenue stream is the strategy that company uses to generate cash from each customer segment. So if you have multiple customer segments, you may have multiple revenue streams. We will go into this in some detail. But let's define pricing. Pricing are the tactics you use to set the price. How many dollars or pounds or is it free in each of these customer segments. So now let's go back and look at the revenue stream in some detail.
First couple of questions you need to answer is number one, what value are customers willing to pay for? How do you know this? Well on day one you are just sitting in your building or in your classroom or in your lab, and you’re guessing. You’re going, hey these are my customers, guess. These are the features they care about. Guess. This is the value they are going to pay for. Guess. But by now you have been in front of a ton of customers. You have talked to them just extensively, and you understand what it is they value. That is what we are going to use to figure out what the revenue streams and pricing are.
The next thing that you actually found out outside the building was how did customers pay for products today. Also you want to understand how much are they paying. So, how do they pay and how much do they pay. So, for the big picture, let's go take a look at the revenue stream choices at the highest possible level.
So in summary in revenue model for this class, the best thing that you could do is start drawing the diagram. So what I want you to do is draw the diagram of both your revenue streams and your pricing, and I want you to actually put numbers in. So let's assume this is your company over here. What you have discovered is that there are three different customer segments; look at that. Tenants, property owners, and leasing companies. I want to know if this is subscription, what is the revenue stream that you have between each one of these customer segments, and what are the pricing tactics? Then how do you make money and what do you provide. All of a sudden you can now see both the revenue stream and the pricing going back and forth.
I just really believe that if you could draw it, you have a handle on understanding it. Don't worry, on day one you start drawing and then you realize I really don't understand this stuff, that's just a signal, time to get out of the building again, talk to some more people and say, “Well, how are we going to make money here, because I can't even explain it to myself?”
So, some of the revenue model questions, what is it my customers are paying for? What's the value? What is it when they look at my company and my products? By the way, what capacity do they have to pay? They might love it. In fact, everybody who looks at a Ferrari or a Tesla model S might say, well, yes, I'd love to pay for that, but, you know what? My wife won't let me or I just don't have the money. That is, is the total available market of potential users equal to your needs for revenue. You might have built a product so expensive that the customer segment you have targeted just can't afford it.
Then how will you package your product? By package I don't mean what kind of pretty box is it in. Another mistake startups make, particularly engineering-driven startups, is putting every possible feature into the first product, not thinking that perhaps, well, wait a minute. Maybe we could kind of decompose the product, that is, take it apart, and offer these as add-ons or as ancillary products or separate products, etcetera. How you package your products should not just be an engineering functionality decision. It should be a value-based decision. As we said, the same with pricing. How will you price? What kind of tactics will you use?