This article is part of the 8-part series of evergreen topics that all startup founders are confronted with. It is based on what the mentors actually teach startups during the StepFWD pre-accelerator.
The business model depends on the focus of the startup and what it does, namely if it’s B2C (consumer-oriented), B2B (business-oriented), B2G (focus on government and public institutions), or B2E (targeting large enterprises).
Once you know clearly who you are targeting, the first step in thinking about your business model is to see what happens in the industry/domain you are operating in by looking at how other startups or companies are selling their products. Why reinvent the wheel when there are already proven models. Of course, creating an innovative business model that is great is something that you shouldn’t dismiss.
You can learn from existing players’ experience by looking at their websites, figuring out how they do their pricing, the way they promote their products, and how they make the money. Ideally, it would be golden if you can have access to some industry inside information as well. All this can help you understand what to apply in your startup. Because usually what goes on the market, it’s what actually works.
What’s also very relevant before starting to implement your strategy is to talk to potential customers to see their reaction to your chosen business model and pricing proposal. Talking with around 20 potential clients can be enough to discover some patterns, create a convenient recipe for you and them, and then analyze if this can work for a bigger chunk of your clients. Because this step turns your research into something much more realistic for your business.
When it comes to defining their revenue streams, startups usually have to choose from 2 monetization models:
- Transactional revenue – earned from the customer making a one-time payment for the product or a rendering of a service
- Recurring revenue – earned from the consistent, ongoing payments rendered to the company for either the delivery of the value proposition or after the sales team cares for the customer
From the venture capital investment perspective, a lot of investors are looking for a recurring revenue stream because this gives them predictability of how much money you can generate. So if you know what your customer acquisition cost is and how much money you make from them using your product, you can calculate the lifetime value of that client and, in the end, have a predictable revenue stream for your business.
The transactional business model, which usually applies to marketplaces, it’s more tricky because you need to predict how often the users will come on your platform to use it and make a transaction. It is usually after you have some steady growth that you can make this accurate prediction (be realistic: you won’t have the necessary data at the beginning).
Go for a recurrent revenue stream because it gives more stability. The transactional model it’s less predictable and depends on the recurrence of users making a new transaction.
Among others, when determining your pricing, you should consider the cost-based versus the value-based approaches. So you should bear in mind your cost for delivering the product (with all the costs of marketing and business development included), and then you have the value that is perceived by the customer. The pricing should be somewhere in between those two.
A practical way (recommended by Kevin Hale, partner at Y Combinator) of reaching this sweet spot is to:
- Start from what is the cost to produce & deliver your product
- Increase the price of your product every time by 5%
- Until you see that there is a little bit of churn from your paying customers
- Or they are starting to comment about your pricing
There is also the concept of qualitative clients. As a startup, you should be looking for clients who are consistently using your product, are willing to pay, and are happy about that. Bad clients are those that use the product randomly, so you get no predictability from them or those that overwhelm customer support without paying a dime.
It’s okay to ask for a higher / lower price at the beginning. But learn from the feedback that you have from your quality clients and then adapt.
The best way of testing your monetization and pricing strategy is to talk with your potential customers or people who have experience in the industry and have seen what works or not (although everything they say should be taken with a grain of salt, and you should filter through your business vision lenses).
Through a series of well-done customer interviews, you can get a lot of insights from their practical experience about dealing with the problem, what solutions they’ve tried to solve it, and how much they would be willing to pay.
In this process, you must be aware of the difference between your product features and customer benefits. Features are the things that you provide in your product. But the benefits are the value that the client gets from those features.
After you’ve got enough information, you could fine-tune your pricing by doing some AB testing. The goal here is to see how customers react to various prices and pick the one that generates a growing demand for your product.
You should speak with your clients in terms of benefits first (what is interesting for them), and then about the product features.
If you need advice on how to approach your pricing and monetization strategy, we’ve invited Mircea for 1-on-1 feedback sessions on May 5 to which you can apply here.
This article is part of the StepFWD your startup series. Do you need resources for your startup? Check them out: