Video: Creating Revenue AssumptionsCopy

In this video, Professor Hachikian explains how to develop revenue assumptions that will, in turn, inform the revenue model. 

https://youtu.be/kZQVn5ATe74

TRANSCRIPT

We are going to talk first about revenue, and then we’re going to get into the cost side. The important thing about revenue is that when you are mapping out your revenue in your financial model in your spreadsheet, it’s going to depend a lot on how you build that spreadsheet. It is going to depend a lot on the business model. I think if you’ve never modelled a company or you’ve never spent time modelling financials, it can be a little overwhelming. I always suggest that simple is better. 

Start really by thinking about what your business model? I’ve got two examples here.

One is a subscription marketplace. Somebody is paying a subscription fee to be able to be part of an online place to meet other people. So, you might have vendors you’re going to be thinking about growth, and there’s some kind of subscription fee etc. etc. 

The other is a retail location. Really different set of assumptions. Here you’re talking about stores. How many stores do you have? How many customers go into those stores? What’s the average revenue of each customer? So, you can see that depending on the business model, you’re really going to be thinking about different numbers. so what I really want to get into though is what does this really look like how do you actually go into excel and start thinking about building out something that reflects exactly what is here.

I’m going to be using an example, this is a company called Pretty Quick that got bought by groupon several years ago. It was a company that was part of a new venture challenge that we ran out of the university of Chicago and Chicago booth, and then, they were kind enough to lend us their financials. We want to kind of get a peek behind the curtain. This is a company that basically is not an impact company at all but it, you know, it shouldn’t matter. What this company does is they basically find extra appointments, extra salon appointments, like to get your hair done or your nails done and they auction them off or sort of try to book them last minute at discounts. That is essentially a pretty simple business in that way.

Part of what we’re trying to do is think about how to model revenue. The first thing you need to think about is all the categories of assumptions that you need to be making. Again, this is a market place, subscription-based marketplace, and so, what’s happening here is that entrepreneur is building out her financial models. This financial model has really thought about. What are the different categories of things that I need to be paying attention?

So, these are all revenue. We’re still on the revenue side of the income statement; the “what’s coming in”. She’s got assumptions here about sales people, and the number of pitches that sales people will do. She’s got conversion rates and average bookings etc. etc. So, what you can see is this, this is the set of assumptions are incredibly important. Like, if you just start going in and putting in, you know, we’re going to make 50 this month and 100 this month; that doesn’t mean anything. What you need to do is use calculations with assumptions underlying them and actually this is the gold in a financial model; how the numbers all add up; that’s you know that’s just math.

 These assumptions become really important.

There are a couple of things I want to highlight here about assumptions. I think people get a little bit freaked out when they think about trying to build a set a model with a set of assumptions because they feel like where am I going to get that information? No one’s just going to tell me, but actually you know one of the things that’s really nice about the entrepreneurship community, I think even more so in the impact entrepreneurship community is that you can call similar companies, maybe not exactly your competitors, but companies that are doing something maybe something that’s also technology-based or maybe something that’s also retail-based and ask them if they can tell you me a little bit about, like, how you thought about this? Or what your assumptions were, and whether that work, you know, that was true or not?

So another great source of data are mentors; people who you are working with, who’ve been through the ringer and who’ve done this, you know, built companies and have a sense of what you might expect in terms of the cost. A great place to get information is from your network.

You can see that first box up here is talking about in line with analog, so, in this instance, the revenue target or revenue sort of assumption is based on the number, the percent fee of the services book. The way this works is somebody on the platform books of books of service books a salon service then pretty quick gets 10 of that total fee in; that’s their revenue. So, you know this is the rationale here. Look, you can see it reduces risk for customers to adopt; you only charge when they receive a booking and there’s a 10, which is lower than their competitors. But, in line with analog so you can see that she’s got, she’s thought through, you know, where did I get that 10 from? Like, why did I pick that 10 percent why not 50 why not 3 really looking at analogs looking at competitors and I think that’s where you need to really you know look for information in order to assign your assumptions.

The other thing kind of looking down here, looking at average price per booking, this is a, you know, when you think about you know so this is a company that’s booking salon services for getting your nails done but also getting really expensive treatment like hair coloring or something like that. So, what you have to do is to think about the average. So, what you want to do is you don’t want to try to make a ton of different assumptions about all these different pieces, like how many nail appointments and how many you know hair coloring appointments? If you don’t have to, what you want to do is look across.

Say, if you’re selling something you know what is the average price that you’re going to sell it at? And, here you can see that they used weighted average of services booked base and a quantitative survey of 214 customers. So they looked at what their customers desired and what kinds of services they might purchase on this type of a platform? They used the actual prices of those services to kind of create a net average price so that’s, I think, really important; to be thinking about the last piece.

I’ll point out here is this one increases over time I think another thing that people really get tripped up on especially around revenue is they think that all the revenue is going to look at one year and you say, well I’m going to have like ten dollars of revenue every month for 12 months you’re like well, that’s not usually how it works. You know, usually like a dollar revenue in the first month two in the next month three in the next month and it kind of goes up it may net out to over the course of a year 120 right that would be the 10 a month times 12 months but it would its probably actually going to go up over time? And so it becomes really important to think about what those growth rates really look like. And, you can see here she’s thought about increasing over time so during their beta she’s assuming that they have a few booking half a booking a day, but then it goes up to two in a month, six so halfway through the year, four per day and goes on from there.

So, really thinking about increases over time and what rate you’re going to use the other thing I often see is that people use stagnant rates meaning like they will grow revenue by five percent every month. But again, it doesn’t usually work that way. It is more likely that you’ll grow revenue by a half a percent in the early months, a percent in the middle months, and maybe three or four percent as you get bigger and bigger, and your mark especially you know linking will get into costs in a minute but thinking about you know the more marketing you do the more customers you’re going to get so thinking about linking your marketing activities to the growth in your revenue so that’s a good way to think kind of like a gut check thinking about growth of revenue