Revenue Models

Founders Institute – May 2014
Linh Le
Where are we…?
So you have a product that creates value…


(i.e. it solves a real customer problem)


…and now you‟re entitled to “capture” some of that value.


A revenue model: how you capture that value
Entrepreneurs…
create value first

then capture value
Thieves…
capture value first

without creating value
Agenda
1. Marketing 101 – Pricing
2. Multi-Sided Platforms – Pricing Considerations
3. Lessons Learned
Marketing 101: Pricing
• Price: a way to capture value (i.e. monetise)

… but can also create value in itself, for example:
– encourage trialability
– attract the “right” customers
– helps people to value your product



Marketing 101: Pricing
• Two methods to thinking the dollar price:


1. “Cost-Plus” pricing (easy, but dumb)

2. “Value-Pricing” approach (harder, but more accurate)




“Cost-Plus” Pricing
• Remains one of the most common pricing strategies
– Belief that pricing is „determined‟ by the marketplace‟ or it‟s „something
beyond your control‟

• Determine marginal cost / COGS

• Add an arbitrary „reasonable‟ % margin

• How do you know that this is the „right‟ price?
“Value-Pricing” Approach
• Example:
– You have a product that has a marginal cost of $10
– Your product provides cost-savings to your customers (e.g. improved
productivity, reduced headcount)
– The value of savings the savings to the customer is determined to be
$1,000
– Where should you price your product?

• Answer: Somewhere between $10 and $1,000
– How do you want to “share” the value created with the customer?


“Value-Pricing” Approach
WILLINGNESS TO PAY
Source: Harvard Business School
Objective Value & Perceived Value
• Objective Value = Cost of the Next-Best Alternative +
Value of Performance Differential


• Perceived Value = The value of the product as
perceived by customers
– e.g. through Market Research (surveys) – but take caution!

Price: In reality
• Ask the customer
• Cover your costs
• Look at competing/similar offerings as a benchmark
• Better to not compete on price – compete on benefits /
value created
• Experiment – e.g. via promotions
• Other things to think about:
• When to charge
• Frequency of charging
• How do you actually make your revenue model work (particularly
“commission”-based revenue models… in Australia)


Multi-Sided Platforms (MSPs)
• What is a multi-sided platform?

Businesses that connect two or more groups of customers,
such that the demand by one group increases demand by
the other group(s) and vice versa (network effects).

• Otherwise known as businesses with the “chicken-and-egg”
problem

• Examples: Facebook, eBay, eHarmony, Windows, Google
• as well as: bars/nightclubs, shopping centres
MSPs: Pricing Models
• In theory, many potential sources of revenue & profits
• In reality, most MSPs have found they have to offers services to
one side for free – or at a loss.







• If you have more than one side: who should pay, sho should be
subsidized?


Source: Harvard Business School
MSPs: Pricing Principles
1. Charge higher prices to the side that has lower price-elasticity of
demand (charge the more desperate side)
• E.g. eBay - merchants

2. Charge more to the side that derives more value from the presence
of the other side
• e.g. Men / women in a singles club, 99designs – customer

3. Charge more to the side that has more market power over the other
• e.g. Steam – game developers/publishers (users are more picky about
games, games are less substitutable)

4. Consider charging less or subsidising „marquee customers one
side
• e.g. Coles/Woolworths in a shopping centre; first customers on your
platform
Lessons Learned (or Re-Learned)
1. Find a co-founder (1, at most 2) with whom you have
“chemistry”.
2. Never do business with friends and family
• If you must: be very clear what you‟re going to take a „haircut‟ on – the
relationship or the business
3. Never split equity equally.
4. Co-founders with overlapping skill-sets = recipe for
disaster.
5. Always vest equity with co-founders and employees.
Lessons Learned (or Re-Learned)
6. If you‟re not selling the product or building the
product, WTF are you doing?
7. Don‟t cut (too many) corners on UI/UX – cut the
corners on the coding, if you have to.
8. Done is better than perfect.
9. Be clear on your exit strategy – if things go well…
and if things don‟t go so well
• How long are you willing to persist?
10. Finally… remember you‟re building a business in the
“context of life”.