Weekly Accelerator Updates

Week 6: Revenue Models & Pricing

Week 5 Recap: Midpoint Check-In & Entrepreneur Self-Care

Congratulations! You are more than halfway through the accelerator!

Midpoint Check-in and Retrospective

Last week, you created or updated your one-page Executive Summary, your 5-minute venture pitch, and discussed your #1 strategic issue with your advisors.

You also did a midpoint retrospective where you reflected on the following:

  • What worked
  • What could have gone better
  • What you might do differently in the second half of the summer

We hope that you take the time to recognize and celebrate the progress you have made since the start of the summer. With this body of work as a baseline, you are poised to accelerate your progress towards the finish line for the accelerator, 5 weeks from today.

Entrepreneur Self-Care

While making progress on your venture is important, taking care of yourselves is important too. Burnout is real. Make sure to create rituals and routines for rejuvenation for yourself and your team.

Some people are not great at taking care of themselves. You might find yourself running fast, and then burning out, cyclically. If that sounds like you, you may be a “catalyst”. Read “Move Fast, Break Shit, Burnout: The Catalyst’s Guide to Working Well” by Tracey Lovejoy and Shannon Lucas. Then create one new rejuvenation routine for yourself this week. Your brain, your team, and your venture will all thank you.

Week 6 Focus: Revenue Models and Pricing

This week we will focus on how you charge for your products or services.

  • How does your customer pay you for your solution?
  • How much do they pay and how often do they pay?
  • How long do they keep paying you?
  • How much did you spend to acquire them?
  • What should you set your price at?
  • How do you test the price?

Why build a revenue model?

A lot of entrepreneurs are reluctant to talk about money.

  • Startup entrepreneurs might say: “Facebook did not start with a revenue model. We are going to do the same. We will raise money to build a huge user base without charging them, and we will figure out how to make money later.”
  • Social entrepreneurs might say: “We are a non-profit. We don’t spend much money and we don’t charge for services. We don’t need to understand money.”
  • Creative or performing arts entrepreneurs might say: “We are artists. We do not understand how to make money.”

For startup entrepreneurs looking to raise money from VCs: Remember that Facebook was founded in 2004. The world has changed since then. The bar is much higher for aspiring entrepreneurs to raise money and build a business. The barrier to entry, especially for software ventures, is so low that even seed stage investors expect to see revenue and sustained month-over-month growth before taking that first meeting with an entrepreneur.

For social entrepreneurs or creative / performing arts entrepreneurs: While talking about money may feel alien and uncomfortable, understand that cash is oxygen. Cash enables you to hire people, implement programs, make grants where you can fund other people to fulfill their dreams. Without cash, your reach and impact will be compromised.

Cash needs to be raised or earned

For a new venture, unless you self-fund it from savings, you do not typically start with a lot of cash. You cannot save your way towards having cash. Cash needs to be raised, or earned.

Raising money from angels or VCs (for startup entrepreneurs), philanthropists (for non-profits) or applying for grants (which can apply to both) is a long, slow process that you have limited control over. With earned revenue, your venture is getting compensated for the value that you deliver. You have far better control. Therefore, earned revenue is a really excellent source of cash.

Types of revenue models

A revenue model is the framework with which you will earn money from your paying customers. Some common revenue models include:

  • Transactional (your customer pays you for the product or service)
  • Subscription (your customer pays a fixed fee every month/year)
  • Usage based (your customer only pays for what they use)

Why ad-based revenue is rarely a significant source of cash for new ventures

Some first time entrepreneurs believe that they can put up a new website or mobile app and generate revenue through ads or affiliate marketing. While you can certainly do that, know that these two sources of revenue are almost never a significant source of cash.

Let’s say you created a new website. You spend 6 months perfecting your SEO (search engine optimization) and creating great content. You join a major ad network like Google Adsense. You will be extraordinarily successful if you are able to make $1000 per month in your website’s first few years.

The reason is that website owners make very little money per 1000 clicks. Google Adsense, a common way for website owners to earn revenue through ads, offers an explainer article on “Revenue Per Thousand Impressions (RPM)” in which they provide examples ranging from $4 to $6 per one thousand clicks. Therefore, to make money from ads, you need hundreds of millions of visitors per month. This takes years to build. According to a recent article by Hubspot, 46% of all websites get less than 15k visitors per month.

You can quickly see why we encourage you to think about other, more substantive and more quickly achievable revenue streams when you are just starting out.

When your end user is not your paying customer

It is important to note that the paying customer is not always the end user of the product or service. In fact, in enterprise sales, sometimes they are not even from the same company.

This is especially true for social enterprises where the beneficiaries are often in a financially disadvantaged situation. In these situations there often can still be an economic buyer – they are often corporations with a social mission that is aligned with the services you provide. Look back on the Stakeholder Mapping discussion from Week 5, and get creative about brainstorming possible sources of revenue and possible paying customers.

The “Unit” in “Unit Economics”

The revenue model is where you determine how your customer pays and how often they do so. This is the architecture of your revenue model. For your business to be sustainable, there is a new concept to consider: “Unit Economics”.

Unit economics is concerned with the analysis of the money you make / lose per each sale to an acquired customer. The “Unit” is where we look at what constitutes a paying customer.

For example, if you are selling an educational intervention, you can sell directly to consumers (business to consumer – B2C or direct to consumer – DTC). In that case, the “unit” is a family, and what you charge is a lower annual fee that family pays every year.

If, instead, you sell this intervention to a school, you will become a business to business (B2B) business, selling to schools. Your “unit” is the school, and you typically can charge a far higher fee per school than you can charge each family.

Life Time Value (LTV) versus Customer Acquisition Cost (CAC)

Within “Unit Economics”, there are two more concepts to consider: the Customer Life Time Value (LTV) and the Customer Acquisition Cost (CAC), also known as the Cost of Customer Acquisition (COCA).

In the simplest terms, the LTV refers to the total amount of money you will make off of each acquired customer. It depends on how much you charge them, and if there is additional payments to come over time, how much and how often, and for how many years. The larger the LTV the better off you are as a business.

The CAC refers to the total amount of money you will spend to acquire one customer on average. Rather than do a bottom-up analysis where you attempt to find each expense tied to each customer, the better way is to sum up all the sales and marketing expenses over, say, a year, then divide that amount by the total number of customers acquired during that same year. It always comes up higher when you do it this way, but for a new venture this is more conservative and helps to keep you honest.

Long term LTV:CAC = 3:1 or better

When you first start selling your product or service, you are not well known in the market and your CAC will typically be very high. Most of the time it is higher than the projected LTV (i.e. losing money for each sale). You are doing evangelical sales. You will do all sorts of non scalable things to learn from the customer and to build traction. This is ok.

As your business matures, however, eventually you do need to develop strategies to drive down CAC and drive up LTV. A healthy ratio of LTV : CAC is 3:1 or better. This will not be achievable in the beginning, but it is important for you to think about how you would get there in a few years. The assumptions and strategies will drive what you will do in the next 1-3 years to put your business on track to become a profitable enterprise in years 3-5.

Pricing Strategies and Price Testing

If the revenue model is the architecture of charging customers for your products or services, then pricing strategy is the thought process with which you actually pick a number to charge.

Be thoughtful about your pricing strategy

First time entrepreneurs often under-invest in this process. They pick a number and move on – and they almost always lowball themselves. This is not optimal. The better way is to be thoughtful about picking one of the many options for pricing strategies, and make sure you don’t fall into the trap of cost-plus mentality, and instead use value-based pricing to capture the full value that your customer thinks you have delivered to them.

Price testing with surveys is not a panacea

Once you pick a number, you have to see if your prospective customers are down for paying that price for your solution. There are lots of ways to do price testing, including Monadic surveys, sequential Monadic surveys, the controversial Van Westendorp Pricing analysis, conjoint analysis and more.

However, people are not held to what they say in an interview or a survey. These results are just directional but not a great predictor of purchase intent or pricing preference because your respondents do not have skin in the game.

A better way to test: Offering to sell vaporware

The only real way to test a price is to offer to sell your solution at that price. You can do this without having built the business! Simply create a description of your product or service. Then you can do all sorts of experiments (digital or otherwise) with this description.

For example, you can run a landing page test. You can either offer your solution for pre-order, or failing that, you can offer to sign them up to be notified when your solution is available. Or if you are able to, you can offer to sell them a limited beta, and actually collect money from them. Any of these ways are better than surveys because you have captured an observable behavior that truly indicates purchase intent.

Additional Resources

Following are some resources that will help you accelerate your progress this week.