Tag Archives: revenue forecast

7 Steps to Calibrating Your Startup Growth

640px-Mahr_Micromar_40A_0-25mm_MicrometerWhen you start a company you naturally have two immediate and equally pressing priorities.  Those priorities are to solve a problem for customers and to validate that you can make money solving that problem.

To validate that you can make money and to understand when you’ll make it, you need to build a pro forma income statement. A pro forma income statement shows how much revenue you expect to receive from the sale of your product and what expenses you expect to incur over your first few years of doing business.

Three basic approaches exist to predict startup revenues:

  • You can just guess. But beware!  Nobody will believe the numbers.
  • You can estimate that you will achieve some percentage penetration of the total available market. Sadly, nobody will believe these numbers either.
  • You can determine which processes you will use to achieve sales, estimate how efficient those processes will be, and then derive how much revenue you will achieve based on those assumptions.

This article explains how to do startup revenue estimation using the third approach. It involves the calibration of seven key variables.  You’ll start with the initial estimation of the seven key variables and then refine them as you learn actual values.

The Seven Key Variables:

  1. Customer Acquisition Cost (CAC): For those new customers that you attract as the result of your marketing activities, how much does it cost you per customer? This is one of the most difficult to estimate. You will start with just a guesstimate based on the (very) few published data from other companies in industries similar to yours and using sales techniques similar to yours.
  2. Sales Cycle (SC): How many months transpire between your expenditure of marketing dollars and the acquisition of new customers? This will also be just a guesstimate based on your past experience.
  3. Average Order Size (AOS): How much revenue do you expect to generate each time a customer makes a purchase? You should have a pretty good idea of what you want to achieve here based on your product, pricing, and business model.
  4. Periodicity (P): How often will each customer make a purchase? You should have a pretty good idea of what you want to achieve here based on your product, pricing, and business model.
  5. Retention Rate (RR): What percent of existing customers will remain customers at the end of each year?
  6. Viral Coefficient (VC): How many people will each existing customer attract and successfully convert into new customers? This is a one-time conversion; once a customer refers this many new customers, we assume they no longer refer more new customers. Very few companies achieve a VC as high as 1.0.
  7. Viral Cycle Length (VCL): How many days will transpire between customers becoming new customers and their referrals becoming new customers?

Before you launch your company, verify that the estimates you’ve made for the 7 key growth drivers could result in a successful company. That is, there must be significant revenues and profit, and solid returns for all shareholders to be considered successful. If not, realistically adjust the values until the company shows returns. But don’t just change the values to make the company look like it will be successful; the new values must be achievable!

Refine the Seven Key Variables:

After launch, every month, compare your actuals to your planned values for the 7 key growth drivers. Enter actual values for CAC, SC, AOS, P, RR, VC, and VCL into your plan. It might be helpful to graph each one. You will likely find that

  1. CAC and SC will start off quite large and will only converge to stable (and lower) values after you learn how to find your target market and how to optimize your messaging.
  2. You will not be able to ascertain actual values for RR, VC or VCL until after a year or so.

Verify that the actual values for these 7 key growth drivers still result in a successful company – i.e., significant revenues and profits, and solid returns for all shareholders. If so, you are on track! If not, you need to pivot.

How to Change Actual Values for the Seven Key Variables:

  • To decrease CAC and SC: Improve your understanding of the target market. Hone your advertisements to the specific pains of your target markets. Focus on benefits rather than features of your products. Offer better pricing or better promotions to increase close rates.
  • To increase AOS: Offer quantity discounts. Improve your product.
  • To increase P: Offer frequent buyer programs. Improve your product.
  • To increase RR: Improve your product’s stickiness.
  • To increase VC and decrease VCL: Offer referral programs, especially ones that incent both referrer and new customer. Make products so exciting that they create a buzz. Add features that increase your product’s value to customers.

Summary:

As you can see, these seven key variables are fundamental to understanding your startup’s revenue. They are not easy to estimate, but you can at least determine during the planning stage what values you must achieve to be a viable company.

ABOUT THE AUTHOR:

Alan DavisDr. Al Davis has published 100+ articles in journals, conferences and trade press, and lectured 2,000+ times in 28 countries. He is the author of 6 books, including the latest, Will Your New Start Up Make Money? He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting their business strategies to optimize financial return for themselves and their investors. Formerly, he was founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003.
Photograph of CoverIf you’d like to learn if your great business idea will make money, take a look at Will Your New Start Up Make Money? If you’d like to verify that your great business idea makes financial sense, sign up for www.offtoa.com.

Refining Sales Projection Assumptions While Pivoting

This is the third of three articles on how to create a sales forecast when writing a business plan for a start up company.

In the first article we discussed the activities the create revenue. In the second article, we surveyed assumption-based techniques to create estimates of units you expect to sell in your start up company. In this article, we will focus on the pivoting process, i.e., as you run your company and realize that some of your assumptions are incorrect, how will you pivot [RIE11] and adapt?

Once you launch your company, you will learn much about what works and what does not work to attract new customers, and you will learn more accurate values for many of the assumptions for which you originally entered just estimates during planning. Let’s talk about the likely refinement processes that you will undergo for each sales model. (I will omit the wild ass guesses; once you start your company, you will need to replace these with more sensible sales models).

1. “Sales by Market Penetration” Sales Model

The primary value of a top-down sales model is to establish an absolute ceiling for your total available market; it is of little value in establishing sales estimates. If you insist on maintaining this model, you will be adjusting the market size as you learn more about it, and replacing estimated market penetration numbers with actual market penetration numbers as you determine them. However, this seems almost pointless because presumably you are learning what processes you are following to capture those sales, and as you learn those processes, you should be capturing them in a bottom-up sales model.

2. “Sales by Marketing and Sales People Effort” Sales Model

If you used this approach during the initial planning of your company to model the number of units, you likely guessed at how effective salespeople would be. As soon as the first few months in business, however, you should have a better idea of the Ratio of Employees to Units Sold, i.e., you will know how many units of each product each employee can sell in a month. What you won’t know, at least not initially, is whether those employees are still in the “ramp up” period, and thus not at their full potential, or whether they have already cleared that hurdle. To increase the Ratio of Employees to Units Sold, work on

  • Training salespeople
  • Improving fulfillment materials and website
  • Better pricing and promotions
  • Improved lead generation (i.e., better leads result in easier sales)

Improving the product and better alignment of the product with customers’ pains is a longer-term method to increase the Ratio of Employees to Units Sold.

3. “Sales by Marketing and Sales Dollars Spent” Sales Model

If you used this approach during the initial planning of your company to model the number of units you will sell, you likely guessed at how effective your marketing and sales budget would be in attracting sales. As soon as the first few months in business, however, you should have a better idea of the Ratio of Dollars Spent to Units Sold, i.e., you will know how many units of each product can be sold as a function of each dollar spent. This ratio captures many factors including the effectiveness of reaching the target market, the effectiveness of the message, as well as the effectiveness of the conversion of leads into customers. Thus this sales model starts off being fairly easy to use to create an early projection of sales, but is rather difficult to refine as you learn more about the effectiveness of the various components of the sales engines. Most entrepreneurs who start with this sales model, switch to the more detailed “New Customers by Marketing and Sales Dollars Spent” sales model soon after starting their companies. Nonetheless, to increase the Ratio of Dollars Spent to Units Sold, work on

  • Improving fulfillment materials and website
  • Better pricing and promotions
  • Improved lead generation (i.e., better leads result in easier sales)

Improving the product and better alignment of the product with customers’ pains is a longer-term method to increase the Ratio of Dollars Spent to Units Sold.

4. and 5. “New Customers by Marketing and Sales People Effort” and “New Customers by Marketing and Sales Dollars Spent” Sales Models

These sales models enable you to estimate sales initially and provide you with a solid basis for continuous improvement as you run your company and learn from experience. Whether you run the company and observe what happens or explicitly formulate and run experiments from which you will derive data, these sales models allow you start with initial conjectures concerning the parameters that drive your revenues and then refine those parameters as you learn. Those parameters fall into three categories:

  • The cost of acquiring customers as the result of explicit marketing and sales actions. Initially, you estimated how many resources (either labor or dollars) would be required to create one paying customer. As in the case of the two previous sales models, this is a composite of the effectiveness of reaching the target market, the message, as well as the conversion of leads into customers. As you run the company and tweak the product, prices, promotions, messages, targets, sales techniques, SEO, you will refine the values you entered for CAC and Ratio of Employees to New Customers Acquired to reflect reality. As you do so, financial projections will migrate toward reality as well.
  • Virality. Initially, you assumed that a certain percent of your current customers would draw a certain number of new customers each n days. Once the company starts, you now have real data to replace the estimates. However, don’t just accept the new data as fact. Work on improving the product and establishing new viral promotion campaigns to increase the viral coefficient and decrease the viral cycle. A leading indicator of the viral coefficient is the net promoter score (NPS). Quoting from [BES10],

Consumers are asked, “On a scale of 0 to 10, how likely is it that you would recom­mend our company to a friend or colleague?” Consumers offering a rating of 9 or 10 are anointed “promoters”, implying they are likely to promote the company to others. Those who give a rating of 7-8 are “passives”— they probably won’t discuss the company with anyone. Those . . . with ratings of 0-6, are dubbed “detractors,” since they might speak ill of a company and hurt its prospects with other potential customers. A company calculates its overall [NPS] by subtracting its percentage of detractors from its percentage of promoters. So, if 65% of an e-commerce firm’s cus­tomers rank as promoters, and 15% as detractors, the firm’s overall NPS would be 50.

  • Organic Growth. Initially, you assumed customers would spend a certain amount of money per month. Now that the company has started, replace that assumption with the real value. Next, initiate efforts to increase the Average Order Size, e.g., upsell, institute programs that reward frequent purchases. Improve product quality to reduce attrition. Listen to customers to find out what they want. Then reflect these improvements in the assumptions.

6. and 7. “Raw Materials Available” and “Manufactured Product Available” Sales Models

In both of these approaches, physical limitations constrain your ability to produce revenue. The only way that reality will differ from your projections is (a) to relax the physical limitations, (b) to create workarounds for the physical limitations (e.g., outsourcing, or finding alternate sources of raw materials), or (c) for you to discover that the limitation is not really a limitation, in which case you should switch to an alternative sales model. If “a” or “b” occur, change the assumptions in your model.

[BES10] www.bvp.com/sites/default/files/bessemer_top_10_laws_ecommerce_oct2010.pdf.

[RIE11] Ries, E., The Lean Startup, New York: Crown Business, 2011.

This article is extracted from my book published by Scrub Oak Press titled Will Your New Start Up Make Money?. Buy it at http://www.amazon.com/Will-Your-Start-Make-Money-ebook/dp/B00JOOZQNE.

 

Modeling Sales When Planning a Start Up

This is the second of three articles on how to create a sales forecast when writing a business plan for a start up company.

In the previous article we discussed the activities the create revenue. In this article, we will survey some of the techniques you can use to create estimates of units you expect to sell in your start up company.

Many dozens of techniques exist to model your anticipated sales. Each is based on unique assumptions and each produces quite different projections. We can categorize sales modeling techniques into three rough groups: top-down, bottom-up, and wild-ass guesses.

Top-down techniques:

  • Look at the overall target market and allow you to predict sales by estimating market penetration.
  • Usually result in highly optimistic estimates.
  • No educated third party will believe your top-down estimates, nor should they. However, they are helpful in that they provide you with an absolute ceiling of reasonableness when you perform your bottom-up estimations.

Bottom-up techniques:

  • Ask you to determine how you are going to actually find leads (or how they are going to find you),
  • Ask you to define the efficiency of the “engine” that converts those leads into customers.
  • Ask you to model the viral and organic growth engines of the company.
  • Once your company launches, you will be modeling the effectiveness of your company’s revenue this way, so it is a good idea to plan the company from the start using such a model.

Doing both top-down and bottom-up is a good eye-opening experience. I recommend that you use at least one top-down and at least one bottom-up technique.

Wild ass guesses (WAG) are really not techniques per se. They are, well, just wild ass guesses. They:

  • Ask you to estimate how many units you will sell (or customers you will have) each month (or year).
  • Educated third parties are even less likely to believe WAGs than top-down technique based estimates. However, a WAG may be all you have when you create your first financial plan. I highly recommend that you replace the WAG with something more reasonable before you show your financial plan to anybody else!

The following sections describe various ways to model sales. Each section describes a technique, when you should consider using it, its advantages and disadvantages, and provides a list of relevant business assumptions that you must record in each case. The business assumptions can be used to drive your predicted revenue during the planning stage; they also become the hypotheses you will be validating while conducting experiments [RIE11].

  1. “Sales by Market Penetration” Sales Model (Top-Down)

For each product and each market, estimate the percentage of that market you think you can reasonably capture each month (or year). Note that the term market is not particularly specific. If you choose to define it using its broadest possible interpretation (e.g., the population of Gen-X-ers in the United States, or the number of small software companies in New York), then you should expect your predicted target penetrations to be quite small. On the other hand, if you define it to be very specific and limit it to a very narrow vertical (e.g., Gen-X-ers who are members of public golf courses in Colorado, or software project managers in Fortune 500 companies), then you should expect your predic­ted target penetrations to be much larger. Assumptions you want to record when using this sales modeling approach (for each product and each market) are:

  • Market size. Current number of customers in the market, or alternatively, the number of products that could be absorbed by custo­mers in the market. Whichever one you select as your definition of market size, you must remain consistent throughout the rest of the model.
  • Average order size: If market size was specified as numbers of cus­tomers, then “average order size,” is the average number of units you expect each customer to purchase per month (or year); if market size was specified as numbers of products that could be absorbed, you may ignore this assumption.
  • Annual rate of growth of market. At what rate do you expect the market to grow each year? If you expect the market to shrink by 10% per year, record this assumption as minus 10%.
  • Market penetration. What percent of the market do you expect to have as your customers by month (or year)? This will be an array of assump­tions, one for every product in every market during every month (or year)

2. “Sales by Marketing and Sales People Effort” Sales Model (Bottom-Up)

One way to think about how your business will attract customers is for the business to have employees who proactively seek leads, and convert them into customers. This approach is most applicable to companies using direct sales. You will model sales by stating which employee types are ones that drive sales, and how many sales of which pro­ducts can be generated by each employee. Such a company often becomes successful when it creates a repeat­able sales model, i.e., when it can predict it would increase its revenue by 25% by increasing its marketing and sales staff by 25%. However, this ignores the long-term financial implications, i.e., whether the profit derived from products sold is greater than the cost of having marketing and sales staff on the payroll. This will be corrected in later techniques. The assumptions you need to define (for each product and each market) for this sales model are:

  • Which marketing/sales people? Of the various personnel the company is employing, which specific one(s) drive sales?
  • Ratio of employees to units sold. If one salesperson can close, say, 5 customer deals per month and the average customer purchases 4 units, then this ratio should be recorded as 20 (i.e., 5 × 4). The interpre­tation is that the company must hire one salesperson for every 20 products it wishes to sell. Notice this ratio aggregates all levels of the aforementioned sales funnel.
  • Ramp up. On average, how months elapse between when an employee is hired and s/he is fully up to speed?

3.  “Sales by Marketing and Sales Dollars Spent” Sales Model (Bottom-Up)

Perhaps your sales are not tied to salespeople but to some other proactive marketing and sales effort like rent (which gives you visibility to passersby), direct mails, phone calls, sales calls, product demonstrations, trade shows, maga­zine advertisements, Google AdWords™, or whatever. Performing these activities creates leads. Following up on these leads results in a certain percentage of them being converted through the sales funnel into sales. You could model your sales by stating which expenses are the ones that drive sales, and how many sales of which products can be generated by each dollar spent. A company has a repeatable sales model when it can predict it will sell X units when it spends $Y in a specific type of marketing or sales effort. The assumptions you need to define (for each product and each market) are:

  • Which marketing and sales activity? Of the many marketing and sales expenses that the company is incurring, which specific one(s) drive sales?
  • Ratio of dollars spent to units sold. If spending $10,000 on the specific activity creates, say, 200 leads, and you expect to convert 20% of them into prospects, and 50% of those into paying customers, and the average customer purchases 4 units, then this ratio should be recorded as 125, i.e.,

$10,000 / (200 × 20% × 50% × 4).

            The interpretation is that the company must spend $125 in order to sell one product.

  • Sales cycle. On average, how months elapse between when marketing dollars are spent and resultant revenues are realized?

4.  “New Customers by Marketing and Sales People Effort” Sales Model (Bottom-Up)

The previous two techniques allow you to predict unit sales of products from marketing and sales efforts. This (and the following) technique allow you to predict the acquisition and retention of customers from marketing and sales efforts. The assumptions you need to define (for each market) are:

  • Which marketing/sales people? Of the various personnel being employed, which specific one(s) drive sales?
  • Ratio of employees to new customers acquired. If one salesperson can acquire 20 leads and convert them into 4 prospects each month, and 50% of them into paying customers, then this ratio should be recorded as 2. Note: an alternative to recording this as a ratio is to record it as a customer acquisition cost (CAC). The CAC would equal the employee’s monthly base salary divided by the number of customers s/he could create each month [BES10].
  • Ramp up. On average, how months elapse between when an employee is hired and s/he is fully up to speed?
  • Average order size. What is the average monthly recurring revenue attributed to each customer? This will be an array of average order sizes, one for each year of the model.
  • Annual retention rate. What percent of existing customers remain customers after 12 months?
  • Viral coefficient. How many new customers will each existing cus­to­mer attract?
  • Viral cycle. How many days elapse between each new generation of customer referrals, i.e., how long does it take (on average) for customers to “spread the word” and get their friends to become customers?

5. “New Customers by Marketing and Sales Dollars Spent” Sales Model (Bottom-Up)

Similar to the previous model, but this one allows you to predict how many new customers you acquire as a function of how many marketing and sales dollars you spend rather than employees you hire. A company has a repeatable sales model when it can predict it will acquire X new customers with an expected average order size of $Z when it spends $Y in a specific type of marketing or sales effort. $Y/X is called Customer Acquisition Cost (CAC) [BES10]. A company has a sustainable engine of growth when the profit derived from a customer’s lifetime (called CLV, customer lifetime value) exceeds CAC. The assumptions you need to define (for each market) are:

  • Which marketing and sales activity? Of the many marketing and sales expenses being incurred, which specific one(s) drive the creation of new customers?
  • Customer acquisition cost (CAC). If spending $10,000 on the specific activity creates, say, 200 leads, and you expect to convert 20% of them into prospects, and 50% of those into paying customers, then CAC should be recorded as $500, i.e.,

$10,000 / (200 × 20% × 50%).

  • Average order size. What is the average monthly recurring revenue attributed to each customer? This will be an array of average order sizes, one for each year.
  • Sales cycle. On average, how months elapse between when marketing dollars are spent and the resultant customers are acquired?
  • Annual retention rate. What percent of existing customers remain customers after 12 months?
  • Viral coefficient. How many new customers will each existing cus­to­mer attract?
  • Viral cycle. How many days elapse between each new generation of customer referrals, i.e., how long does it take (on average) for customers to “spread the word” and get their friends to become customers?

6. “Raw Materials Available” Sales Model (Bottom-Up)

If demand for your product is unquenchable and the only limitation on your ability to sell is availability of raw materials to produce product, then the above sales models will not work. In such cases, use this model. Assumptions you need to define (for each product and each market) are:

  • Which raw material is the key driver of sales? Of the various raw materials, which specific one is scarce?
  • Availability of this raw material by month.

7. “Manufactured Product Available” Sales Model (Bottom-Up)

If demand for your product is unquenchable, raw materials are abundant, and the only dam­per on sales is how fast your manufacturing process can produce product, then this is the sales model for you. Assumptions you need to define (for each product and each market) are:

  • Units available by month. How many units can you manufac­ture during this parti­cular month? This will be an array of unit counts, one for every product during every month.

8. “Sales by Year” Sales Model (Wild Ass Guess)

When you first start planning a company, you may have no idea how large your market is (and thus cannot perform a top down analysis) and have no idea how you are going to sell your product (and thus cannot perform a bottom up analysis). When this is the case, you have no choice but to simply make guesses of how many products you will sell or customers you will attract. However, in no case should you ever show revenue projections based on such wild ass guesses to anybody else; they are solely for your own consumption.

In this “Sales by Year” sales model, you predict how many units of each product you will sell in each market during each year. It is ideal when trying to obtain a very rough idea of whether or not your company makes business sense. Because it is so rough, it is not effective at any later stage, especially when trying to convince others to join your team or invest in your company.

  • Units sold. How many units do you expect to sell in this market during each year? Because this sales model is used only for gross calculations, the assumption will be made that sales are spread evenly across all months of the year. If a finer spread is necessary, use the earlier sales modeling approaches. This will be an array of unit counts, one for every product in every market during every year.

9. “Sales by Month” Sales Model (Wild Ass Guess)

In the “Sales by Month” sales model, you simply predict how many units of each product you will sell during each month. It might apply to two kinds of businesses: (1) businesses that are less proactive with respective to sales, so that customers are expected to come to the company as the result of walking by a store front and you have no plan to proactively seek customers, or (2) businesses that expect to be proactive but have not yet developed a repeatable sales model and thus cannot predict with any level of accuracy the ratio of employees or expenses to sales. The biggest disadvantage is that it requires entry of a great many numbers. Because you might use different sales techniques in different markets and you might introduce different products at different times to different markets, you should define the following assumptions separately for every product × market combination:

  • Units sold. How many units do you expect to sell during each month? This will be an array of numbers, one for every product in every market during every month.

10. “Sales by Annual Growth” Sales Model (Wild Ass Guess)

This approach allows you to fine tune monthly predictions for sales of a product during its first year of launch, and then give rougher estimates for subsequent years by just stating an annual percentage increase. It is only slightly more refined than the previous method; not particularly good when trying to convince others to join your team or invest in your company. To use this model, specify these assumptions for each product in each market:

  • Introduction year. In what year will you introduce this product to this market?
  • Units sold per month during first year. How many units do you expect to sell during each month of the first year of its introduction? This will be an array of unit counts, one for each product in each market during the first 12 months of the product’s introduction.
  • Annual increase for each subsequent year. The first annual increase will be used to calculate the product’s second year of revenue in that market. Its rate of increase will be based on sales that occurred during the last month of the 1st year, i.e., last month will be considered to be the running rate of sales for the 2nd year of ramp up.

11. “New Customers by Month” Sales Model (Wild Ass Guess)

Use this approach when customers become a source of recurring revenue once they have been acquired. For example, if you are selling (a) annual service agreements, (b) software access using a Software as a Service (SaaS) model, (c) membership-based products or services, (d) subscriptions, or even (e) utilities. This approach could even work for some (bricks-and-mortar or bits-and-clicks) retail stores with strong custo­mer loyalty programs because once customers are acquired, the company might be able to reliably forecast return visits and recur­ring purchases. For all such businesses, you should define these assumptions for each market:

  • New customers. How many new customers do you expect to obtain during each month? This will be an array of new customer data, one every market during every month.
  • Average order size. What is the average monthly recurring revenue attributed to each customer? This will be an array of average order sizes, one for each year.
  • Annual retention rate. What percent of customers will remain customers after 12 months?
  • Viral coefficient. How many new customers will each existing cus­to­mer attract?
  • Viral cycle. How many days elapse between each new generation of customer referrals, i.e., how long does it take (on average) for customers to “spread the word” and get friends to become customers?

[BES10] www.bvp.com/sites/default/files/bessemer_top_10_laws_ecommerce_oct2010.pdf.

[RIE11] Ries, E., The Lean Startup, New York: Crown Business, 2011.

This article is extracted from my book published by Scrub Oak Press titled Will Your New Start Up Make Money?. Buy it at http://www.amazon.com/Will-Your-Start-Make-Money-ebook/dp/B00JOOZQNE.

 

Factors Driving Sales in a Start Up

This is the first of three articles on how to plan the sales forecast aspects of a business plan for a start up company.

Let’s say you plan for your company to sell 5 different products. Fundamental to understanding whether your business has the possibility of achieving financial success is coming to an understanding on how many of each of those 5 products you will sell. This first article is a primer on the factors that drive unit sales; the second article will contain a survey of techniques you can use to create estimates of units you expect to sell; the third will describe the process you will follow after you start your company to refine these estimates.

Three factors drive customers to your business and thus create revenue:

1. You can spend money to create awareness within your target market about (a) your product offerings, (b) how they (and you) are different than competitors, (c) your prices, and (d) generally driving traffic to you (physically or virtually) where potential customers can learn more about you. McClure calls this “lead acquisition” in his AARRR model [MCC13]; others have called it “prospecting”.

Money can also be spent pushing potential customers through the sales funnel, a concept originally proposed by E. St. Elmo Lewis in the late 1890’s., e.g., converting 10,000 leads into 500 prospects into 100 revenue-producing customers. Bessemer Venture Partners [BES10] calls the ratio of leads to customers the “conversion rate”.

Typical expenditures are rent, conventional advertising, Google AdWords™, writing blogs, sending emails, buying mailing lists, creating a website, search engine optimization (SEO), and labor for sales and marketing personnel. In most cases, a linear relationship exists between the expense and the resulting revenue, although many techniques exist to improve the linear relationship and thus one’s performance.

2. Viral effect. You can create incentives for current customers to refer others to become customers. Although this activity also costs money, the relationship to results in unlikely to be linear. McClure calls this “referral” in his AARRR model [MCC13]. Ries [RIE11] calls this the “viral coefficient”. Typical programs include ones in which customer success depends on attracting new customers (e.g., Tupperware), explicit referral programs (e.g., where a customer receives an incentive for referring another customer), or simply providing a great customer experience, so happy customers tell their friends about you or post great reviews about you on the web.

3. Organic Growth. You can take actions to retain existing customers and increase their average order size. For (almost) all businesses, the easiest sale is a repeat sale from an existing customer because in most cases it requires no additional effort on your part. Some call this the stickiness of the business. Bessemer Venture Partners [BES10] call the inverse of stickiness “churn”; others call it “attrition”. Programs to increase organic growth include frequent buyer rewards programs (e.g., like those used by all airlines and hotel chains), upsales (i.e., convincing customers of lower priced products to purchase higher priced products), freemium pricing (deliberately offering free services as an incentive to encourage some customers to see how valuable the premium and paid services would be), increasing the average order size during any one visit, increasing the number of visits per time frame, or simply providing a great customer experience so that customers are reluctant to ever take their business elsewhere.

[BES10] www.bvp.com/sites/default/files/bessemer_top_10_laws_ecommerce_oct2010.pdf.

[MCC13] www.slideshare.net/dmc500hats/startup-metrics-for-pirates-long-version.

[RIE11] Ries, E., The Lean Startup, New York: Crown Business, 2011.

This article is extracted from my book published by Scrub Oak Press titled Will Your New Start Up Make Money?. Buy it at http://www.amazon.com/Will-Your-Start-Make-Money-ebook/dp/B00JOOZQNE.