After assessing a start-up’s idea and position in the market landscape, it is imperative to dissect the revenue model and perform traction analysis. As Angel List co-founder Naval Ravikant states, traction is “quantitative evidence of market demand.” Both the revenue model and traction analysis provide your investors a clear understanding of how you plan to create or grow current revenue streams. While you may not have solid evidence of these numbers, projections for these critical values can shape your impression to investors. Here at CAN, we have highlighted a few of the key elements of a robust analysis.
One must start with a simple truism of all forecasts: they are invariably wrong. Therefore, the risk of an investments is not that what we believe will happen will not (of that we can be sure), but rather the degree to which things differ from our expectation. The difference can be for the worse or the better. For example, Google went public in 2004, but was forced to scale back both the size and price of its IPO by close to 25% as investors pushed back on the company’s prospects. Finally pricing its IPO at $85 per share on August 19, 2004, Google went on to beat earnings expectations four of the next five years driving the stock to $490 per share on its fifth anniversary as a public company. Forecasters were, true to their nature, wrong, but reality differed from expectations in ways that were better than forecast. The job of a business leader or investor is to understand the risks in their business. They must seek to reduce the risk that events unfold short of expectations and maximize the chances of them coming up ahead.
The revenue model provides a quantitative understanding of past and expected revenue streams, which helps investors define the speed by which a company is growing. Key measurements include annual recurring revenue (ARR), monthly recurring revenue (MRR), and recent month-to-month growth to help create projections of future growth. For e-commerce operations, it may be more useful to use Gross Merchandise Volume (GMV) rather than revenue, which values the merchandise sold over a given period of time through customer-to-customer exchange sites. For SaaS companies, it will be necessary to clarify how you plan to make money from users. Examples include transaction fees, monthly vs. yearly subscriptions, listing fees, and more. You should explain any market conditions that affect your revenue model, such as seasonal goods.
You should also start to think about your customer traction. First, you need to see how many customers are knocking on your “e-door” and identify your customer distribution channel for your good or service. Indirect distribution channels tend to place wholesalers and/or retailers between the original business and consumer. Direct distribution channels, conversely, are a direct to consumer model. Deciding under which type of channel you plan to organize allows you to better configure user engagement. While working on this step, you should calculate the cost of customer acquisition (CAC), which is used in conjunction with customer lifetime value (CLV) to understand your investment in customer relationship management (CRM). CAC is the total cost of sales and marketing per the number of customers acquired. However, remember that you may invest in CAC marketing early on but should not expect to realistically see its results until months to years later.
For effective traction analysis, remember that “the customer” is not one homogenous block of people; rather, it is a group that is constantly in a state of flux. It is up to you to set up your company in such a way that you can acquire more customers and increase the value acquired from each one. Think of this step as keeping people in your store once they have come in and creating steps to turn one-time customers into loyalty card members. These ideas can thankfully be quantified. A customer’s lifetime value takes into account the average value of a sale, number of transactions, and the time period that you can retain this customer. Churn rate is the proportion of customers who leave a supplier during a given time. As your start-up moves from the alpha to beta stage, you can start to see the churn rate and its converse, logo retention. If retention is low, it may be an indication to revisit the product’s accessibility, on-site conversion metrics, customer service resources, downselling policies, or other issues that may be causing customers to leave. Finally, make sure to calculate both the net and gross dollar retention, which takes churn into account of the monthly revenue.
If done analytically, revenue modelling and traction analysis can provide some insight into the inner machinations of your start-up. Start with the basics, utilize any starting data you have acquired, and reach out to the CAN network for further questions.
Key Takeaways:
- Revenue model can help clarify your start-up’s potential for growth
- Revenue streams
- Fee-for-service
- Subscription plans (monthly, annual)
- Transaction fees
- Monthly recurring revenue (MRR)
- Annual recurring revenue (ARR)
- Month-to-month growth rate for the past few months
- Gross Merchandise Volume (GMV)- mainly for third party sellers
- Traction Analysis: How to get customers to find your door + how to keep customers in your store + how to make customers loyal to the brand
- Identify your distribution channel (direct vs. indirect)
- Calculate your cost of customer acquisition
- Identify your churn rate or customer retention rate
- Customer Retention Rate: percentage of customers retained over a period of time
- Churn Rate: proportion of customers who leave over a period of time
- Calculate your customer lifetime value based on your market segments
- Lifetime Value = (Average value of sale) x (Number of transactions) x (Retention Time Period)
- Net and Gross Dollar Retention
- Net Dollar Retention Rate = (Starting MRR + expansion – downsell – churn) / Starting MRR
- Gross Dollar Retention Rate = (Starting MRR – downsell – churn) / Starting MRR
This page was written by Neelima Gaddipati and Jeffrey Camp. Ms. Gaddipati is a member of the Cane Angel Network investment team and is pursuing her joint MD/MBA at UM graduating in 2021. Mr. Camp is the Managing Director of the Cane Angel Network.
