Working with start-up and early stage companies is interesting and full of unknowns and yes that’s the fun part of the challenge! What almost all startups share is a passion for excellence, a cool idea and real business potential. Most importantly startups need to show that they have a deep understanding of their revenue models. Having a clear revenue model does not assure (or insure) success. It does however afford investors and potential investors that a business plan (a too-fast fading endeavor) has been developed.
Experienced direct marketers will know exactly to what I am referring. The marketing of services as opposed to products are very different challenges. Both require well thought-out revenue models. To boot, when it comes to the overall enterprise viability, the same rules apply, i.e. The cost of the product or service, the cost to acquire a customer, plus the cost to operate the enterprise in contrast to the lifetime value of the customer.
This week I read an interesting piece on the cbinsights.com blog, which covers the VC industry:
In this guest post, Sapphire Ventures’ Rajeev Dham and Nino Marakovic dive into what the customer lifetime value to customer acquisition cost ratio actually means for a company’s ability to be profitable and successful.
My first thought is that it is hard to believe that startup companies might not inherently know that there are evidence driven ratios between cost and sell.. It’s scary too. In direct response marketing for a product – a sale to cost ratio of at least 4:1 or 5:1 (there are rare exceptions of course) are minimal baseline ratios that are used to determine if a product has a chance at success.
To be overly simplistic, you invent something that costs $5 to make and ship to a customer. The sale price of that item needs to be more than $20 in order to create consumer awareness and sales for the product (Advertising and Promotion). That’s just for starters. Can you motivate the customer to become a multi-buyer? That is either multiple purchases at the same time or multiple instances of product purchase etc.? If you are only able to sell your product for twice or three times the cost to produce and ship you most likely do not have a sustainable business model and you should go back to the drawing board or find something else to do.
Service businesses are different since the length of the customer’s tenure (LTV again) is more critical to the enterprise’s overall success. The idea may be cool but that does not mean it will make a great business.
With TV shows like ABC’s Shark Tank many more people have been exposed to the idea of entrepreneurship and what it takes to be successful – at least according to Shark Tank. What many of the participants trip over is their revenue model. That and their (too often unrealistic) view of their own company’s enterprise value (hint: enterprise value is only as good as what someone would actually pay)!
There is only one Facebook. Even Twitter continues to work on its revenue model. The idea of “If you build it, they will come” is a cop-out when it comes to developing a realistic revenue model that merely indicates a chance for success.