What is a revenue model?
Discussions of Your Revenue Model
Put simply, no business can exist without top line revenues from sales, no matter how well the other functions are handled. Your business plan must detail how you plan to price and sell your product, and how much money you plan to make. The basics should cover three broad aspects: your selling tactics, your revenue model, and your sales cycle.
There are seven steps that can help you build your first revenue model.
1. Set your pricing objective
Pricing is the only element in your marketing strategy that produces top line revenues. It is also one of the most flexible elements. Unlike product platform features and channel commitments to business partners, prices can be changed and modified quickly as you grow. At the same time, pricing is perhaps the number-one problem for entrepreneurs, who have great difficulty in predicting demand, how to set and modify prices, and understanding what actually affects prices. Faced with these challenges, many entrepreneurs set their pricing objectives based on how they make personal purchasing decisions rather than on entrepreneurial experience; they decide to enter a market by starting a pricing battle, which is usually the first step to failure, not success.
When competing on price, especially when competing against larger, established firms with substantially greater resources and better access to stakeholders in the ecosystem, the best outcome a start-up can expect is a tie, and a tie is equal to losing. It is more important to establish a clear price objective that is connected with one of the three main marketing objectives we discussed earlier: technical, strategic, or financial.
2. Determine demand
The reliability of any cash forecast and profitability depends on the anticipated forecast of sales. In fact, the cash forecast can never reach a higher degree of reliability than the sales forecast on which it is based. We all know that forecasting demand for a new product—or what we call forecasting in a “whiteout,” where the snow is blowing so hard that one cannot see the road ahead—is close to impossible. But investors expect to see some components of marketing research and reasoning behind the numbers. Start with your domain experts and advisors, looking for insight from that will catalyze sales and build momentum. We also suggest looking to models and examples in other industries.
3. Estimate costs
Unlike trying to forecast demand, estimating costs can be done with greater accuracy as long as all the cost components are well understood. Both demand and costs should be based on the from your limited objective experimentation.
4. Review competition
This is based on your analysis. After analyzing competitors’ costs, prices, and potential new offers, consider a response to each competitive pressure and how it will affect top line sales and profitability of the proposed venture.
5. Establish a pricing method
This includes pricing options and strategies. In essence, this is where the sales team creates the venture’s first brochure, or sales sheet. It is important to consider up-front deposits, nonrecurring engineering (NRE) fees, licensing and maintenance fees, follow-on revenues, and any potential changes for terms of sale.
6. Select the first price
Remember the first rule with marketing a new product, especially during bootstrapping days: Charge what you can get. Be prepared to change the prices; in effect, test the elasticity of pricing. Realize that this will take time, especially when you are introducing a new product or service and are not sure what you can charge.
7. Rework accordingly
Likewise, look at the influence of other factors on your prices that are outside your venture, such as feedback from customers (no one is buying and they tell you why) and competitor responses. You will need to adapt the prices to each situation. This means providing new service plans, offering discounts with upgrades or referrals, and considering new terms of sale, which can include financing or extending payments.
Mapping Your Selling Process
We have found it to be very helpful for entrepreneurs to categorize and map each person they meet in their selling process into one of these seven roles.
– Initiators are typically the lead users who request something new
– Users help define product requirements in addition to sometimes initiating the request
– Influencers, related to the decision-making process, provide information for evaluating the alternatives, substitutes, and competing products
– Deciders drill down on exact specifications and/or on suppliers
– Approvers authorize the proposed actions of deciders or buyers
– Buyers play a major role in selecting suppliers and negotiating, and they have the formal authority to select and arrange the purchase terms
– Gatekeepers are basically anyone else who is in the way to others above.
Detail Your Revenue Event
Quite simply, we define the term “revenue event” as “when the check clears.” Getting to a revenue event can take a long time, and usually longer than most entrepreneurs care to admit. The most successful entrepreneurs know that figuring out the sales cycle for new products is a nerve-wracking and arduous learning experience they only care to go through once.
There are five steps for every revenue event:
– and cash!
Time and time again we have seen an entrepreneur drop the ball in a presentation before a group of potential investors, when one of them asks, “Walk me through one sales cycle—from first talks with calling on a prospect, to when you actually get paid.” Be prepared!