Lesson #108: How to Determine Your Revenue Model

One of the first questions a potential investor is going to ask you is "how do you plan to make money".  It is critical you have a well-thought-through plan here for the long term, even if revenues will be minimal in the short term.  As you will read herein, revenue models can vary based on: (i) your industry; (ii) your product or service within that industry; and (iii) what your direct competitors are doing.   Today's lessons will address these three areas, as well as (iv) assessing whether your revenue plan passes the sanity check for your business and prospective investors.
Every industry has a certain revenue model history and expectation from customers.  For example, the retail industry sets a retail price on their products, that includes enough gross profit margin to cover the cost of the product itself and the other proportional costs of running the business.  The publishing industry drives revenues from subscription fees for their content, or from advertisers wanting to get in front of their large base of readers.  Technology companies sell their products either under installed license contracts (big upfront payment), or as a hosted software-as-a-service (small monthly payments).  So, research what is normal in your industry, as it will be easiest to sell through to prospective customers. 

That said, there is no rule you cannot think out of the box, if you have a new way to approach the business that customers will appreciate.  Think about iTunes and how they revolutionized the purchase of music.  Before the internet and companies like iTunes, you would need to go to a retail music store like Tower Records and buy an entire CD for $14.99 (if they had it in stock).  With iTunes, not only were you guaranteed they had it in stock, but you could simply buy the one track you wanted for $0.99, from the convenience of your home.  It revolutionized the music buying experience for consumers.  But, at the same time, the model really hurt the music labels, that were seeing a fraction of revenues from music sales than they were seeing in the past, forcing them to change their models to drive more revenues from live concert tours than ever before.

Secondly, within any one industry, there can be many variable revenue models to consider.  Let's look at the travel industry, as an example.  A tour operator adds a 35% gross margin to the net cost of their tours.  A travel agent takes a 15% commission for selling a tour operator's tour.  A travel website sells advertising on its website at a $10CPM.  A travel magazine sells an annual subscription for $19.99.  A travel related mobile app is downloaded for $0.99.  A travel reservation system could be licensed to tour operators for $25,000 per year.  I think you get the point, they can be many variations here.  So, pick the one that makes best sense for your business.

Thirdly, the most important piece of the puzzle is figuring out how your competitors drive revenues, and using them as a benchmark.  This includes not setting your prices in excess of your competitors, for similar services (please re-read Lesson #20 on Setting Your Product and Pricing Strategy for more details here).  It also includes not swimming upstream, by trying to sell through a new model, which may be better in the long run, but too hard to get your arms around in the short run, compared to your competitors models. 

As an example, let's say you are trying to sell a coupon book for $500, that will lead to $2,500 in savings from the coupons therein over the course of a year.  Someone that is interested in coupons, most likely isn't going to afford the $500 asking price to start, regardless of the underlying coupon value.  And, even if they can afford the $500, a consumer may be skeptical they will actually use enough coupons therein to cover their upfront cost.  In this case, maybe it is better to market $100 books for $500 worth of savings, much more digestible.  Or, give the books away to consumers for free, and take a revenue share from the merchandisers as consumers redeem their coupons over time, or upfront from advertisers within the book??  You do not want to create any friction between consumers and them easily and willingly buying your products or services.

The last step in setting your revenue model is making sure it passes the sanity check: (i) is it logical within your industry; (ii) is its marketable to consumers and better than your competitors; (iii) is your revenue per transaction high enough to cover your costs and drive a profit (covering costs of the product, fulfillment and marketing); (iv) have you tested your marketing initiatives first, to ensure you are clear on where your cost of acquisition per customer will end up, and set your revenue plan from there; (v) can you turn your startup losses into profits with a 12-24 month period, and limit such losses at a digestable/fundable level for investors; and (vi) can a 10x return reasonably be acheived by your investors in a 3-5 year period.  All of these pieces of the puzzle are tightly interwoven when trying to determine your revenue model.

There is no one right way to build a business and revenue plan.  But, hopefully, this lesson will point you in the right direction towards building a winning model.

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Lesson #107: Social Media Analytics & ROI

It feels like the Wild West out there in the social media marketing world.  Advertisers are identifying the need to get in front of large social media audiences, like Facebook and Twitter, spending around $5BN a year in advertising on those two sites alone.  And, there are tons of startups out there trying to pitch social media marketing, management and analytics tools.  Which is good, because CMOs are starting to get more pressure from their CEOs and CFOs to clearly show an ROI from their social marketing spend, which has been lacking during the infancy of this channel.  The problem is, with the glut of fragmented solutions in the marketplace, many of which are still learning the business themselves, it can be a daunting task to identify the right technologies to use to optimize your social marketing efforts.

To help me better learn this space, and to get an opinion about the best social media analytics tools in the market today, I engaged the help of my colleague, Joshua Sigler, a Senior Product Specialist at Sprout Social, a Chicago-based leader in social media analytics for SMB's, financially backed by Lightbank (the Groupon founders' venture capital fund).  Joshua did his best to keep his assessment non-biased, and truly educate me on the wide range of solutions available in the market.

To start, I want to summarize what I feel are the various pieces to the social marketing technology puzzle, to ensure whatever strategies and tools you employ, include all of the various components you may need.  This includes technologies to assist with: (i) social content management (e.g., publishing schedules, distribution to all platforms, communications with fans/followers); (ii) content analytics (e.g., retweet/click activity, fan/follower growth, trends over time); (iii) customer sentiment (e.g., are customers happy or angry with your brand/product); (iv) building a social CRM (e.g., identifying brand influencers most passionate and engaged with your product); (v) social commerce (e.g., allowing purchase directly from your Facebook brand page); (vi) campaign management (e.g., buying media on Facebook or Twitter, building creatives, tracking impressions/clicks), and (vii) ROI analytics (e.g., calculating brand awareness, consumer sentiment, e-commerce conversions from your social marketing spend on the inhouse team managing your efforts or the media dollars spent to accelerate growth). 

In addition, it is important you research: (a) how many internal group partitions or team members can access the system; (b) how many separate social media accounts can be managed from your central dashboard; and (c) how these social tools can be used for task management by non-marketing departments (e.g., sales, customer service), to make sure they meet the needs of your specific business.

Right now, many of these technologies are fragmented from many different providers only tackling one piece of the puzzle, and hence, do not tackle the full suite of client needs discussed above.  I expect to see a lot of industry consolidation in this space, as marketers are going to want all pieces of the puzzle aggregated into one easy-to-use social platform.  There are a handful of companies that already provide numerous pieces of the puzzle, and I am going to focus on them below.  But, I haven't found anybody that is doing everything yet, especially in a price point affordable to most startups.

The companies that are most progressed in this space, include companies with affordable solutions focused on SMB's (e.g., HootSuite, TweetDeck, SproutSocial) and companies with very expensive solutions focused on larger enterprise-scale clients (e.g., Radian6, Sysmos, Meltwater, ExactTarget).  I have not personally played with each of the tools, and relied on Joshua to help me assess the plusses and minuses of these various technologies.  So, make sure you kick the tires for yourself, to formulate your own opinions of what will work best for your needs.

In terms of the SMB facing technologies, I would summarize it as follows. TweetDeck (now owned by Twitter) is primarily a platform used to consume and post tweets. It's heavily focused on Twitter and it doesn't incorporate analytics or team functionality like some of the other tools. HootSuite has begun adding business oriented features in the past year, but is generally considered a consumer product, with the vast majority of their 3MM customers using the free version of their software.  SproutSocial offers the largest mix of features for businesses, and even though it only offers a paid version of its platform, it is very affordable for SMBs with functionality on par with many of the enterprise facing solutions, which can be materially more expensive.  As an example, Radian6 has an annual cost starting at $10,000 per year, whereas SproutSocial has full-featured plans starting at around $500 annually.

In terms of the enterprise facing technologies, Radian6 was the first mover in this space, building a large business on 1st generation social monitoring and analytics and was recently acquired by Salesforce.com. The early enterprise tools like Radian6 have a reputation of being confusing to use and lacking audience engagement features.  I did not dig too deeply on Sysmos, Meltwater or Exact Target, since I focused on the affordable solutions for my startup readers, and simply offered up Radian6 as one alternative, if you require more features and functionality.

I am definitely not a pro on these technologies.  So, if you feel that I am missing any important ones, please be sure to add them in the comments field below.  But, it is clear to me, SproutSocial has built a really terrific product for the price point, and is even getting the attention of bigger enterprise clients.  So, be sure to reach out to Joshua at 312-878-3787, if you have any questions from here.

Social media should be a component of any smart marketing plan, and it is critical you efficiently manage and track your efforts with tools like the ones discussed herein.

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Lessons in Marketing: Super Bowl 2012

I am sure most of us watched Super Bowl XLVI last night.  Some of us for the game, others for the ads and others for the halftime show.  I just wanted to make sure none of you lost the valuable marketing lessons that we can apply to our businesses.  Below are a few observations and tidbits from the game itself, the halftime show and some of the ads that were featured.

As for the game itself, the NFL has successfully created an annually anticipated event that attracted over 111 millions viewers in the U.S. last night (46% of all TV households), and hundreds of millions more globally (the #1 watched show of alltime).  Notice I did not say the NFL featured a football game, as the Super Bowl has become much more than a football game. It has become a platform for football, for corporate advertisers, for the halftime musicians, for an excuse for friends to get together, for grocery stores to sell food and beer, for apparel companies to sell merchandise, etc.  There is no other single event that commands this scale of audience and engages Americans into action, moreso than the Super Bowl.  So, the lesson for your business:  remember you are selling more than a product or service, you are selling an experience.  And, you have to continually improve that experience over time, to command more and more loyalty and excitement around your brand, as the Super Bowl has built up over the last 46 years.

As for the halftime show, I am curious how many music downloads Madonna had last night, during her 15 minute show?  Probably as many as consumers who downloaded her music in the last month overall.  Not even American Idol, the #1 music focused show, can stimulate as many downloads for its acts, in such a short period of time.  So, figure out what platform is going to ignite your business and how you are going to tap into it, to help your business take off overnight. 

Staying on the halftime discussion, we have to talk about Madonna herself.  Madonna is a marketing genius, that has figured out how to reinvent herself and stay relevant, since she first hit the scene in 1982.  First of all, she is 53 years old, still looks great and is dancing on stage with artists half her age.  Secondly, she knows what is going to keep her relevant, staying visible in front on hot distribution vehicles (e.g., the Super Bowl, episodes of Glee). Thirdly, she surrounds herself with hot young talent, as she did last night with Nicki Minaj, LMFAO and Cee Lo Green, to tap into their young fan bases by association.  And, the same holds true for your businesses.  You constantly need to be reinventing your business and looking for partnerships that can help you scale your growth over time.

That said, Madonna was not perfect last night, by any means.  First of all, it was obvious the acts were lip synching their performances, which lessoned the authenticity of the product.  And, Madonna mostly sang songs that were produced decades ago, positioning her as an "old act".  Instead of using the majority of her time on promoting her newest album, showing she is still relevant as a "new artist".  As a comparison, I thought Jennifer Lopez did a much better job resparking her career when she performed her newest song, On The Floor (a duet with Pitbull, a hot current artist), during the finale of American Idol.  So, the business lesson:  when you have the opportunity to materially move your sales needle, don't blow it with an inferior product or the wrong pitch.

And, finally, as for the Super Bowl ads, I am not going to disect the plusses and minuses of every single one.  There are plenty of sites that can do that, including this recap of the 2012 Super Bowl Ads at Hulu.  What I am going to do is highlight key things that I would deem important as a marketer, in terms of taking advantage of getting in front of such a large audience.  To me, that is summarized as:  (i) did it help me build my brand awareness; (ii) did it help me spark a viral buzz; (iii) is the messaging in tune with my core product; or (iv) did it help me sell more product, understanding it is tough to do all of these things in one ad.  Below, are a few "hits and misses", based on this criteria.

A few hits:

• I thought Hulu won the night in terms of having an ad that was fun and memorable, but was also directly tied to their core business, featuring key clips from TV and movie watching history, directly relevant to their TV and movie watching business.
• Audi did a nice job emphasizing one of their car features (e.g., headlights as bright as daylight), with them unintentionally killing all the vampires at the night party when it arrived.
• Acura featuring Jerry Seinfeld as the #2 person on the waitlist for their hot new car, and the extent that he is willing to go to get to #1 on the waitlist.
• The ecstatic high school graduate who thought his parents just bought him a Chevy Camaro, prominently featured throughout the entire commercial.
• A Hyundai car literally getting your "pulse going", by resuscitating a man back to life with his seatbelt, by quickly starting and stopping the car in repetition.
• Budweiser showing clips over the history of time, with people partying with their beer over the decades.
• Pepsi's ad was clearly a hit for Melanie Amaro, the winner of X Factor's singing contest, and I think it was also a hit for Pepsi too, as she topples the king (Elton John) and gets Pepsi for all. 

A few misses:

• I loved the positive message of the Chrysler ad with Clint Eastwood talking about Detroit and the auto industry fighting back.  But, would Chrysler have been better served by featuring a few of its cars??  Honestly, I was waiting for a "brought to you by the Obama campaign" closing graphic, for successfully bailing out the auto industry.
• I loved the return of Ferris Bueller in the Honda ad, which sparked a viral sensation (which in some regards acheived its goal), but I bet it had people wanting to see a Ferris Bueller movie sequel more than it had them wanting to buy a Honda.
• Volkswagon is doing a better job marketing for Star Wars, than they are for their own cars.

Just remember with these ads, funny is great (especially to create virality online), but funny is even better if you can directly tie it back into your core product, which should be heavily featured in the ad.  Don't waste your 30 seconds in the spotlight on stuff irrelevant to your core product and marketing goals, especially when you are spending $3MM on that 30 second spot.

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Lesson #106: Succession Planning

Most startup executives just assume the founding management will be there forever, things will always go perfectly to plan and there really isn't a reason to think about succession planning, especially for a young business.  A faulty assumption, in my opinion.  At all times, regardless of the size of the business, you need to think about who will take the reins for each role within the company, in case any current manager disappears for whatever reason (e.g., fatal accident, quits, termination).  And, more importantly, making sure any transition will be as seamless as possible, both in good times (with departing manager cooperation and involvement) and in bad times (without such support).

To successfully think about your succession planning, I think it comes down to the following categories: (i) hire subordinates that can fill your own shoes some day; (ii) share key information and train your potential successors on things they will need to know to be successful in your job; (iii) make sure all key procedures in the business are well documented, for followers to use as a "blueprint", if needed; and (iv) foster this "succession planning" philosophy into all employees within the organization, from top to bottom.  I will talk about each of these topics below.

I always recommend hiring the best talent possible, regardless whether or not they are smarter than yourself (as some people are intimidated by the potential of looking stupid, and steer clear of such situations).   Not only will the business perform better with A+ talent while you are still involved with the business, but having A+ talent "in the wings" is exactly what you want to fill your shoes in your absence.  So, to me, succession planning definitely starts with hiring the right people, with a long term vision in mind.

Now that you have the best "successor potential" talent in your organization, you need to mentor them along and train them on key areas of the business.  Not only train them on the skillsets they will need for their own job, but you need to keep them well versed on your own role and key things they will need to know to potentially step into your own job someday.  The employee will be excited about learning new skills that improve their knowledge base, having your trust and the long term potential for promotion.  And, the company will be much better off having a "backup QB", ready to come in off the bench, if the "starting QB" goes down.

In addition to having great talent in the wings, you need to make sure key information and procedures are well documented.  There should never be a single point of failure in a business, where all relevant information is lost with the departure of any one person.  So, think about what information and process is most important to each role in your company, and have employees train their "backups" with such information (e.g., key passwords, key procedures, key relationships, key contacts, key reports, key systems).  And, keep a copy of all documented "backup" information and procedures with your head of HR in a centrally accessable place (as a double backup, if ever needed).

And, don't forget, we are not only talking about replacing a CEO or other C-Level manager here.  We are talking about fostering this philosophy all the way through the entire organization, for all jobs from top to bottom.  So, it is up to the senior execs to not only use these practices, but to communicate how important it is for their subordinates, to do the same.

My rule of thumb is:  what happens if that person gets hit by a bus and doesn't come back to work.  Make sure the company has the back up talent with "blueprint" in hand, to continue operating at full steam ahead.  And, it is much easy to gather and document this "blueprint" during the "good times", when you least need it.

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Lessons in Leadership: Joe Paterno

With the passing of Joe Paterno this weekend, after a tumultuous last two months since the breaking of the Jerry Sandusky child sex-abuse scandal at Penn State, I thought we could pull out a few interesting leadership lessons that we can apply to our businesses.

First of all, a little more about Joe Paterno, the iconic football coach at Penn State from 1966 through his firing in November 2011, after the scandal broke.  During this time, he became the winningest football coach in the history of college football, with an incredible 409-136-3 winning record.  He lead his teams to 37 bowl games and won 24 of them (or 65%).  He has been walking the football sidelines since before I was born in 1969, and is mentioned in the same breath as other all-time great coaches, like Knute Rockne, Bear Bryant, Woody Hayes and Bo Schembechler.  Joe Paterno was the face of Penn State and all of college football for generations, sitting atop the pedestal of his field as a Hall of Fame coach.  Joe took great pride in his reputation and his position as a father-figure to his players.

But, in one fell swoop in November 2011, that all changed.  Paterno's walls came tumbling down and his reputation became forever stained with the breaking of the Jerry Sandusky scandal.  Sandusky was his assistant coach at Penn State for 30 years (1969-1999), and the defensive coordinator of the program in 1999, the year he stepped down (supposedly for not being able to become the head coach, with no retirement in sight for Paterno).  We should have known something was wrong in 1999, when Sandusky simply evaporated from the world of college football, with no head coaching position elsewhere, for one of the best defensive coordinators in football, at the time.

According to investigations underway, Sandusky had been sexually abusing under-aged boys while at Penn State, right around the time of Sandusky ending his coaching career at Penn State in the late 1990's.  And to make matters worse, Sandusky's actions continued to happen well after that time, even within the walls of the Penn State football facilities.  As witnessed by assistant coach Mike McQueary walking in on Sandusky raping a 10 year old boy in the Penn State locker room showers in 2002.  This incident was reported to Paterno the next day, who supposedly took it to the senior athletic administrators to deal with.  Nothing ever happened to Sandusky, who continued to walk the streets of Penn State, right through the scandal breaking in November 2011.

So, the immediate questions, as it related to the key players in this series of events, are: (i) what really happened in 1999 that lead to Sandusky retiring (it is too coincidental that the first sex abuse claim was from that exact time frame), and what did Paterno and the university know about it; and (ii) what more could McQueary, Paterno and senior Penn State officials have done to deal with the 2002 incident and Sandusky, both at that time and thereafter. 

We'll never know the answer to the first question, until the investigation is completed (and now, key witness Paterno, is gone forever, making that a difficult task).  But, as for the second question, it is clear to me: (i) although McQueary witnessed the event in process and should have immediately taken the boy out of there, he did take the information to his boss Paterno and the university official who manages the campus police to deal with the next day (which I imagine was a very difficult thing to do, for a young graduate assistant trying to make a long term coaching career for himself in "Paterno Land"); (ii) Paterno put his 30 year personal relationship with Sandusky and the reputation of Penn State football, in front of the interests of the victims of Sandusky (without thinking about long term consequences to himself if this news ever came out down the road); and (iii) the Penn State police chief, athletic director and other university officials did everything they could to keep any negative light coming to the university (for an amazing 12 year period between 1999 through 2011, until the hachet finally fell).

So, the key business lessons here: (i) never try to hide bad news or criminal activity, regardless whether or not you are best friends with the offender, or are worried about losing your job or the negative impact on reputation (the truth will always come out, and you will be perceived as a stronger leader tackling difficult situations head on); (ii) once a bad employee is identified, they must be swiftly dealt with, not only by terminating employment and pressing charges, but in access to the company or its facilities (I am shocked Sandusky had keys to the Penn State locker room and was walking campus even after he stepped down); and (iii) if you do 100 great things as a leader, but mess-up on one big one (especially if you are perceived as covering something up), it can ultimately change your legacy from champion to chump in a nano-second.  Don't let yourself fall into that trap.

Unfortunately, I can see how this happened to Paterno and Penn State.  It is tough sending your best friend of 30 years to prison, and trying to deal with this in your own private way (e.g., firing from job, mandated sexual counseling), so the negative news doesn't impact college football recruiting or the millions of dollars flowing into the Penn State football program and university.  But, at what price?  The lost justice of Sandusky's victims, who were little boys that would forever be scarred for life? 

History will only tell if Paterno gets remembered as a champ or a chump.  But, it took 45 years of hard work to build up Paterno's stellar record at Penn State, and only 45 seconds to knock it down.  This story is very sad, at so many different levels (for Paterno's legacy, for Paterno's last thoughts before dying, for Paterno's family dragged into this, for the assistant coaches who got fired who may have known nothing, for the shocked PSU alumni, for the former Penn State players that looked up to Paterno as a father figure, for the current Penn State players and recruits forced into turmoil and potential NCAA charges for nothing they did, and most importantly, for the Sandusky victims involved). 

Nobody took his reputation more seriously than Joe Paterno.  That is why he coached for as long as he did, in becoming the #1 winningest coach of all time.  But, Todd Blackledge, a PSU alum and ESPN broadcaster, got it right this morning, when he said: "but despite the symptoms of lung cancer, Joe Paterno died most of all from a broken heart."

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Lesson #105: Run a Sensitivity Analysis on Your Projections

Back in Lesson #78, we learned How to Build a Budget.  But, one important point that we did not discuss was the necessity of running a sensitivity analysis on your projections.  A sensitivity analysis is changing some of the key inputs driving your model, for both upside and downside case scenarios, to learn the impact such changes have on revenues and your resulting cash flow needs.  These key inputs could include things like: (i) your average price point; (ii) your gross margin; (iii) your cost of acquisition for marketing (and the resulting number of leads); and (iv) your sales conversion rate, just to name a few.

As an example, if your base case suggests you can build a $1MM business with a $100 price point and 10% conversion rate, your revenues would drop to $800K with a $80 price point, and would drop even further to $600K with a 7.5% conversion rate from there.  What felt like relatively minor changes to your price point and conversion rate in isolation, combined for a 40% reduction in revenues.  And, more importantly, if that $1MM business was break even before, with $1MM of expenses, it has now become a cash user, with a loss of $400K.  Since you most likely will not have excess cash sitting around to fund any losses, you should have a plan to raise outside capital if it may be needed.  And, as we know, fund raising can take months, so you need to be constantly thinking far enough ahead to ask for capital before you need it, and not when you need it (which is too late).

I think the key driver entrepreneurs mis-forecast the most is cost of acquisition for marketing.  Most entrepreneurs don't have a solid grasp on how expensive marketing activities are, especially for consumer facing businesses.  Building an internet business today is materially more expensive than building an internet business a decade ago.  As an example, iExplore could drive a profitable pay-per-click campaign with Google at $0.20 per click and acheive a first page ranking at that level back in 2001.  But, today, travel is one of the most competitive categories in Google, with many more competitors and big-budgeted brands like Expedia, Travelocity, Priceline, Orbitz, Trip Advisor, American, United, Hyatt and Marriott all fighting for the top positions for key travel words.  That has driven first page search result prices through the roof, to over $1.00 per click on most words, making it near impossible to drive an immediate profit.  Hence, allowing only well-funded startups or big brand marketers the luxury of getting easily found. 

So, pay extra close attention to your marketing forecasts and benchmark your business off of the cost of acquisition datapoints being realized by other companies in your space today, using the same marketing tactics that you plan to use.  That said, don't forget about the marketing benefits big companies get from trusted brand names built over time and years of optimizing their marketing tactics.  If Amazon.com's conversion rate is 10%, do not forecast your business at 10%, even if you are directly competitive with them and using the same tactics.  Amazon has been in business for 15 years and has a very well-known customer experience and respected brand name.  It would be much better to forecast your business at the average e-commerce conversion rate of 3%, or better yet, at a material discount therefrom given the inefficiencies you will experience in the early testing days of your marketing initiatives.

Sensitivity analyses can also be run for upside scenarios, if things go better than plan.  But, honestly, for 99% of startups, most things go worse than plan, not better.  So, don't waste time on upside cases.  If an upside case happens, congratulations, you'll figure out what to do with the excess cash at that time.

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