How to Choose the Right Revenue Model for Your Business’ Profitability and Sustainability
Updated: Jun 1, 2022
Choosing the revenue model that best suits your company is not easy. With the impact of the internet on businesses, there are many frameworks to select from nowadays. You also have to consider other factors, such as your target audience and overhead costs.
Revenue models guide product creation, pricing, expenditures, and revenue growth. With the right revenue model, you can build a solid foundation for your business to scale and succeed.
Put Your Customers at the Center
Some entrepreneurs may find themselves focusing on sales or day-to-day administrative work. While these are essential tasks of any business, your focus should be on your customer. Knowing who buys your products will help you create the correct revenue model.
Your customers should be the driving force behind your revenue model. Client-facing components of a revenue model can include:
Using these components, you can present a storyline to your customers about the value of your product. That value proposition, in turn, will directly influence your customers’ perception and loyalty. Consider how you package your products and the innovation behind the solution so that you can attract and retain the right customers.
As Tara Spalding shared:
“If you don’t have a customer, you don’t have a business. If you do not know how to do your packaging to attract the right customers, then you’re going to attract the wrong customers.”
Choose the Right Revenue Model
There are various business models that you can choose from. Each model has its measurements, indicators, and required effort and financial resources. It's vital to choose a model that will best suit your specific business so you can focus on tracking a single measurement — including the product, packaging, and consumers.
Some of the data you’ll have to keep track of with your revenue model are:
Products — These are the physical goods you’re selling.
Buyers — They can be customers, a business, or an entity.
Financial transactions — This is the exchange of payments and products. A transaction-based business for physical goods could be:
direct to consumer (DTC)
distributed to buyers by someone with a tighter relationship with them
provided in a marketplace where supply matches demand
Your financial model will be affected by the different assets in your revenue model. You can always add another model later on if you want, but keep in mind that combining two or more business models may be unnecessarily complex; at the very least, it will require different dashboards.
Implementing the Six Elements of a Revenue Model
Customers are the first thing you should consider when choosing a revenue model. But, other essential elements will determine the suitability of a specific model for your business, including:
Marketing span — Are there low acquisition costs?
Predictable result — What aspects do you want to track, and what are the results?
Structure income — How are you going to make money?
Trackable expenditures — What are your expenses? How often do you track them?
Profitability — How are you going to achieve profitability?
Scalable model — How can you make your processes more efficient?
Most businesses leave scalability and customer acquisition costs out of their business models. Using these six elements as a checklist will assist you in determining the right revenue model for you.
Observe Historical Data
If you want to predict the future of your business, you need to look back on past data. Historical data tells you what works and what doesn't work for your revenue model. With this data, you can leverage what works – and improve what doesn't. Historical data can include:
What is your conversion rate?
What marketing channels work for you?
What is your average sales lead time?
Focused group discussion (FGD)
Once you've determined this historical data, you can assess your current processes, determine what to improve upon, and better equip your business for "what if" scenarios.
Create a Pro Forma
Creating a pro forma predicts future results based on historical data, your current situation, and current market conditions. Some cases in which you might need a pro forma include choosing debt financing or capital expenditures.
If you build future results into your pro forma financial statements, you can think ahead and strategize how you’ll achieve profitability. A pro forma will help you answer these questions:
What is your profitability going to look like?
What is your passbook going to look like?
How much do you need to invest to achieve your revenue and customer acquisition goals?
How and when should you hire employees?
What is the runway to turn a lead into cash?
How can you negotiate, or elongate, payment and compensation plans?
Christina is often asked why a pro forma is so vital for businesses. Her answer:
“If you don’t have a vision on how your business is going to move forward, how can you convince anyone to invest in your business?”
Consider the Three Key Financial Components
The three critical financial components to keep in mind when choosing a revenue model are:
Customers — How will you acquire customers and charge the right price?
Cost of goods sold — What are the direct costs of providing your services or creating a product (such as materials, manufacturing, distribution, labour)?
Cost of doing business — What are the expenses of running your business (e.g. sales, marketing)?
The cost of goods sold is vital to determining your gross profit. If you don't know your gross profit, you might not be able to cover your costs of doing business.
Determine the cost of goods sold, the cost of doing business, and your assets; profitability and growth can decline if you don't differentiate these three expenses. Considering these three costs can help you increase your revenue and balance out expenses.
Build Your Runways and Breakeven Points
Your runway consists of the number of months remaining until your business runs out of cash. While building your runway, consider the following:
How much unused cash do you have right now?
What is the average time it takes to collect cash from customers?
What is your deferred revenue?
On the other hand, your breakeven point is the time when your revenue will equal your costs. Usually, you'll reach this point around two years into your business. If you're not quite there, you need to determine why, and how long away your breakeven point will be.
After hitting your breakeven point, you'll see your profitability and cash increase. Christina states:
“Until we understand when the breakeven point is going to happen, sometimes it’s hard to determine what is the profitability. When do I have enough cash to start investing on the next growth stage?”
Track Your KPIs
Implementing the right revenue model for your business will help you determine which KPIs you need to track. The first KPI you’ll want to monitor is the top-line KPI or sales. You also want to consider the following KPIs:
Cost of acquiring one customer
Billable hours per project
Monthly recurring revenue
Average accounts receivable collection
Revenue growth is not a standalone metric; other KPIs support it. There are KPIs that will be specific to your chosen revenue model. Christina says:
“You’re choosing the right revenue model, then you have to choose the right KPI. Because at the end of the day, all of these KPIs are needed to build the right financial models.”
Using Your Revenue Model to Create Profitability and Sustainability
To create a strong foundation for business growth, you need to choose the right revenue model that will serve your business. Knowing the different factors contributing to the revenue model will help you determine which one will usher your business into profitability and success.
Learn more about Tara Spalding and her company, BoomStartup. Visit their website to learn more about Tara's work and what they do.
If you want to learn more about revenue models and how to choose the right one for your business, a CFO can help you figure out what model will suit you best. Understand how the right revenue model will benefit your business with the help of a finance team. Chat with Profit Reimagined™ to help you cover your foundations and deepen your understanding of these concepts.