In individual team meetings we built a draft of the team’s financial model in Excel.
These are very simple models, meant to explore the basic assumptions around the revenue model for the product.
The goal of the exercise is to test if the revenue sources are adequate to create a sustainable company. To do this we look at a few factors. First, is the Lifetime Customer Value adequately greater than the Customer Acquisition Cost (LCV/CAV)? Second, can the company grow its customer base by using just a portion of revenue to attract new customers? A sustainable company must be able to operate profitably.
To test this out, we built a month to month simulation with three sections.
Customers – how many customers at the beginning of the month, the normal attrition of those customers (churn), and the addition of new customers through word of mouth and marketing.
Revenue – different revenue streams from the customer base. For these teams, the models included subscription fees, in app purchases, ad revenue, and product purchases.
Expenses – focused on customer acquisition costs.
For these models, teams are allowed to spend 25% of their revenue on marketing or other customer acquisition strategies. We do not build out a full expense model for the company.
Assumptions and Drivers – The models begin with a customer base and some cash in the bank. Inputs to the models are generally “rates” such as:
- Customer lifetime (or churn rate)
- % of customers who pay (especially for freemium models)
- price paid
- cost of sales (as a %)
- CPM rates for advertising
- conversion rates
- etc.
These are the green items seen in the thumbnail image above. The rest of the numbers in the spreadsheet are created automatically by formulae.
At the end of each team meeting they were asked to continue refining their spreadsheet. They can add additional revenue streams, additional customer acquisition methods, etc., and they can adjust any of the numbers in green (the Drivers). All numbers entered have to be reasonable and justifiable. Reasonable – meaning within the realm of reality even if there isn’t hard data to support it (e.g. it might be reasonable that a user would pay $1.99 for your app, but not reasonable they would pay $49.95 for it). Justifiable – meaning there is data available to support your entry (e.g. you may be able to find a range of CPM rates for similar ads to yours).