If you’re looking to start a business, you’ll definitely need a revenue model. This might not be the first thing you think about when founding a company. But you better create one, or you will not know if your idea has any chance of making money and becoming sustainable.
To help you understand revenue models and get off on the right foot, we met with Troy D’Ambrosio, the executive director of the Lassonde Entrepreneur Institute. He provided insights you will want to know before getting started.
D’Ambrosio has started and supported hundreds of startup companies. He has seen some succeed and many flounder or, worse, fail. He shared the following tips from his experience to get you headed in the right direction.
1. Know What It Is
For starters, you need to understand the definition of a revenue model. You can’t use one if you don’t know what it is. Basically, it’s how your business generates money, D’Ambrosio said. “It’s a tool to analyze the viability of your business.” Often, revenue models are summarized in a spreadsheet.
Revenue models come in many types, including a one-time sale, recurring revenue (or consumables), freemium, subscription (is it monthly, yearly, or something else?), seat license, commission, and fee. Your business might be one type, or it might be three types. It entirely depends on the type of business you have and how complex it is.
2. Know Your Business Inside and Out
You must know your business to develop a revenue model. This might seem obvious, but many people want to know if they can make money before they know exactly what type of business they are creating and how it operates. You can’t create a revenue model without knowing these details.
One place to start is to ask yourself what type of business you are creating. Are you offering a product, subscription, service, or time? Something else? Or maybe a combination of these things? Knowing the answer to questions like these will help you start to understand how to make a sale, and then you can work backward to see what it takes to complete that sale.
3. Tell a Story (Then Crunch the Numbers)
When you start to think about a revenue model, you might immediately think about numbers and how you might put them into a spreadsheet. Yes, that’s something you’ll want to do. But, first, you need to tell a story.
You need to explain how your business completes a sale. “I break it down and put in my head an image of that transaction and where it takes place and who is on the other end,” D’Ambrosio said.
As you build this transaction story, think about every step it takes to complete a sale. How does a customer find you? How do they pay you? How do you get them the product or service? These are just a few of the questions you need to ask yourself.
Once you have formed a narrative for how a sale is completed, you have the building blocks to create a spreadsheet that will help you understand your bottom line.
4. Focus on Single Unit Economics
It is easy to dream about huge volumes of sales when you’re starting a company. We all want to end up there. Before that, you need to understand how a single sale happens. This is called single unit economics.
You need to ask yourself two key questions when doing single unit economics, according to D’Ambrosio. First, ask, What price you set for your product or service? When considering this, think about your customers’ willingness to pay. Second, ask, How much does it take you to make or provide it?
Television subscriptions provide a great example of single unit economics. D’Ambrosio once managed a company that sold them. To determine the monthly subscription rate and a profitable revenue model, they factored in everything included in a single transaction – marketing, sales, installation, cancellation policies, fees to production studios, and more.
How you set your price is very tricky and depends on your industry, D’Ambrosio said. Medical devices, for example, typically have an 80% markup on products to cover very expensive development and transaction costs. “Each industry tends to have a standard set of what the cost is and what they can charge for it,” he said.
5. Don’t Use a Template
When developing a revenue model for the first time, you might be eager to find a spreadsheet template. Google “revenue model,” and you are likely to find more templates than you will ever want. But beware relying too much on a template, D’Ambrosio said.
Study templates for concepts that you might want to use. Look at what fields are present, what values are being added, what is not included, and so on. Then plan to create yours from scratch. Yes, open up a blank spreadsheet, and get to work.
Templates don’t work because every business is different. “Every business is unique, in a unique time,” D’Ambrosio said, so everyone requires a different revenue model.
You should start from scratch every time, even if you have created a revenue model before, to make sure you are not overlooking anything and have a solid grasp on your business. “You will skip steps, and in some ways, it will make you lazy,” D’Ambrosio said.
6. They’re Not Static
Revenue models are not something you can write once, set aside, and not think about again. They are always changing as your business grows and adapts. You need to look at them as often as your business changes. “It’s a process that never ends,” D’Ambrosio said. “You will always be learning about your customer. Business is always changing.”
Knowing that revenue models are always changing gives you the opportunity to experiment. You can try one thing today and another tomorrow. For example, take price. Set one price today, see what happens. Then change it, and see if it makes a difference. “Run tests, and do market research on if that will make a viable business,” D’Ambrosio said.
7. You’ll Get Better with Practice
Like everything else, you’ll get better at developing a revenue model the more practice you have. At first, you might stumble and make mistakes. But keep pushing forward.
When you finally create your first revenue model, then your second, third, and beyond, you will start to see how everything fits together. At that point, you’ll have this tool mastered and will be able to use it whenever you want. D’Ambrosio said, “Once you learn the process, it empowers you to do that with any business in the future. That’s why this tool is so important.”