13 Business Models To Get To $10 Million In Revenues

by Steven Carpenter
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13 Business Models To Get To $10 Million In Revenues
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Steven Carpenter
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2010
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After last month’s TechCrunch Disrupt, and to provide a business companion to the popular “Lean Startup” customer development methodology, this TC Teardown focuses not on how one specific company makes money but rather seeks to provide a breakdown of the main general ways consumer Internet startups try to make money. Consider it a guide to Internet business models. If you are currently thinking about or are in the process of developing your own consumer startup idea, these key business models will help give you a working knowledge of what it takes to get to $10 million in revenues (assuming you have a good product that the market wants).

(Before you post in the comments about how unique your startup is, this list is not meant to capture every consumer business permutation. There are always going to be exceptions. And the breakaway companies like Zynga, Groupon, Facebook, Twitter, and Foursquare, to name just a few, inevitably introduce nuances to pre-existing models.)

You can think about consumer Internet companies in three major categories. The following three categories of consumer Internet startups and the representative underlying thirteen business models should give you a more than basic understanding of the main drivers of 95 percent of the consumer Internet startups you hear and read about on TechCrunch. The best consumer investors are intimately familiar with these metrics, so make sure you know which business you are in and how you can get to $10 million before meeting with them.

The two main points I am trying to convey are 1) the activities needed to monetize each kind of consumer Internet startup are different and 2) the activities are not difficult to understand.

Currently there is not a good resource to demystify the various consumer Internet business models. In my effort to reduce these to basics elements, I know I have likely overlooked something obvious. Please feel free to comment or email me at tcteardown at gmail to let me know what I may have overlooked or to introduce your truly unique take on one of the models so that I can update this post and it can be useful to others. You can also view, download, and use each of the below financial models here.

The 3 Main Ways Consumer Internet Companies Make Money

As a consumer Internet company, you are trying to attract enough potential customers by providing one (or more) of three kinds of products: 1) media, 2) premium services, or 3) access to a physical good. These are not mutually exclusive—a startup can generate revenue from more than one of these sources. For example, many media companies make money off of both advertising and premium services, like LinkedIn.

1. Media:

If you are a media company, you are providing free content and collecting purchasing intent so that you can either sell ads, send leads to products or services your audience might be interested in, and/or upsell to a subscription or digital goods. This category is comprised of a large percentage of consumer Internet startups because startup costs are typically the lowest. As has been said many times before, these kinds of companies are cheap to start but expensive to achieve scale. Representative media startups are those creating applications in search, gaming, social networks, new media, video and audio, and lead generation companies.

2. Paid Service:

If you provide a paid service, you are trying to attract as many potential consumers to you as cost effectively as possible, get them to pay you for a service, and then work to keep them as paying subscribers for as long as possible. Most startups in this arena follow the “Freemium” strategy, where some content or basic service is provided for free in the hopes of converting a small portion of the free base to paying subscribers. “Freemium” is by no means the only way to acquire customers, but it can usually be the most cost effective means, especially if the service is built upon cheaply produced media or third-party infrastructure providers such as Amazon’s S3, and the variable costs to serve a new customer are minimal.

Payments and financial services companies are included here because they provide some services for free or for a fee and also charge businesses a small percentage of each transaction. Representative startups are companies that create premium subscription services, new banks or investment firms, and payment companies. These kinds of companies frequently require more capital than media startups to start, but may need not as much to scale, since they can leverage the cash paid in from consumers.

3. Physical Commerce:

If you sell a product that is fulfilled via a warehouse, can be sent via UPS, or is a coupon that can be used to purchase goods and services in the real world, you are running a commerce company. These startups generate revenue for each transaction and need to be disciplined around the efficiency of their warehousing operations, returns and customer service, and the amount spent on sales and marketing.

13 Consumer Internet Business Models

Below you can see a chart depicting the 13 consumer Internet business models (with examples), the 3 or 4 key monetization drivers for each, and the scale a company needs to achieve to get to an annual revenue run-rate of $10 million. Of course there are lots of activities companies in these categories need to do well, but these are the most important drivers to building a sustainable business.

The 13 kinds of consumer startups are (in no particular order):

  1. Search
  2. Gaming
  3. Social Network
  4. New Media
  5. Marketplace
  6. Video
  7. Commerce
  8. Retail
  9. Subscription
  10. Music
  11. Lead Generation
  12. Hardware
  13. Payments

Below is a brief overview of the first four company types with corresponding mini business models so you can see how the key drivers work. The remaining business models will appear later in Part II.

Type 1: Search

As a search company, you are trying to get as broad an exposure as possible to consumers looking for products and services. The more queries you are able to generate, the more likely a user is to click on one of your paid links. The key metrics for this kind of company are:

  • Monthly Uniques
  • Queries Per Month
  • Percentage of users that click a paid link
  • Revenue Per Click

These metrics are inter-dependent so the number of uniques per month you need, for instance, will largely be dependent on the average revenue per click you can command. For a company where 5 percent of searchers click on paid links and command $0.35 per click on average, the company needs to have 2.5 million monetizable clicks per month to get to $10 million in revenue. Hunch is a good example of a startup that combines elements of traditional search with a new-kind of service, in this case a personalization engine, to provide more accurate product recommendations, and therefore, hopefully will achieve higher conversion rates and better revenue per click.

Type 2: Gaming

As I wrote in detail in the Teardown on Zynga, the casual social gaming startup, online gaming companies create entertainment via casual games, fantasy role-playing games, virtual worlds, and mobile games. The idea is to create core intellectual property around a concept, provide a portfolio of games for free, and then upsell a percentage of users to pay for virtual goods. The main drivers of the business are:

  • Monthly/Daily Average Users
  • Conversion Rate to paying user (typically 1% – 2%)
  • Average Monthly Spend

As this is a volume business, gaming companies need to achieve at least 5 million monthly average users to have a chance to hit $10 million in revenues. In this last way, social gaming companies, likeZynga and Nexon, combine elements of traditional media with commerce by replacing fulfillment of a physical good with a digital one.

Type 3: Social Network

Startups that create media around shared experiences or common interests typically make money from ads and sponsorships, and less frequently, premium services. As a new media company, a social network like MyYearbook (junior high school students) or Dogster (pet lovers), cares about how many unique visitors a month they are attracting, how many ad impressions they are able to display, how much of their inventory they can sell, and the average rate an advertiser will pay. In general, the more focused the social network is on a particular vertical, the higher the CPM rates tend to be. A startup needs to get to several million users and high repeat usage to offset a typically low CPM media buy.

  • Unique Visitors
  • Ad Impressions
  • Sellthrough Rate (ie, what % of your inventory is sold)
  • CPM

Type 4: “New Media” Platform

The hardest to define of all the startup types, and also the hardest to predict their ultimate success, are new media platform companies which create content around new technology-enabled experiences. Many of these companies are commonly thought of as social networks. But Facebook, Twitter, and Foursquare are all examples of startups that require consumers to change current behavior and consume media in a new way. For Facebook it is providing a new way of keeping up-to-date with our social network; for Twitter it is providing a way to interact directly with newsmakers and current events; for Foursquare it is providing a way to stay up-to-date with our friends and family’s whereabouts.

  • Unique Users
  • Actions (eg, Tweets, Check-Ins)
  • Perrcentage Monetizable
  • CPM
  • CPA

Key metrics here are the number of people you can attract to your service (both creating content and consuming it), the number you can convince to change their behavior to create new content (status update, tweet, check-in), and the percent you can monetize in this new format. The great thing about these companies is that if you can convince people to use these new tools and consume the content, you will likely have a fast-growing business that easily surpasses $10 million on very little capital. The challenge is that these companies are typically hit-driven, winner-take-all businesses that require significant capital to scale. And you will likely need to convince media planners and advertisers that creating a new ad format is worth their ad budget.

 

 

Type 5: Marketplace

As I wrote in detail in the Teardown on hand-made goods marketplace Etsy, online marketplace companies create efficiencies between buyers and sellers that are difficult to achieve in the real world. The leading online marketplace is eBay, which happens to run the default sale process as an auction, but fixed price sales have emerged as competitive due to their simplicity and ease of use. Marketplace companies make money by getting as many people as possible to put their goods up for sale and charging a nominal fee for those listings. The more products available for sale the more buyers are attracted to the platform, and the higher the likelihood that a sale will be consummated, generating a commission for the company. Due to the network effects of marketplaces and small fees, these businesses are notoriously difficult to achieve critical mass and take a long time to build. But once they do, these companies tend to have a long, profitable existence. Newer listing companies, like AirBnB, which focus on higher price points ($100+), may achieve scalability faster than traditional product marketplaces.  In my financial analysis below, I estimate that a typical marketplace would require 2 million listings a month generating gross sales of $12.5 million a month in order to achieve $10 million worth of annual fee and commission revenues for the marketplace itself.

Key Drivers:

  • Listings
  • Listing Fee
  • Sales
  • Commission

Type 6: Video

While the cost of video production has come way down, creating high-quality video content still requires a moderate investment and high level of skill. Innovation in the video space has seen the use of freelance video producers who charge $200-$300 to produce and edit a 5-minute, professional-looking video on a variety of subjects. Once you have a handle on production, video companies need exposure to as broad an audience as possible, so distribution is key. Video ad rates are typically amongst the highest in online media ($15-$20 CPM) but a viewer will only see one ad per viewing. Therefore, the number of ad impressions is critical because the broader your audience, the higher you will rise in importance with the online media buyers. Most media buyers will not even consider your videos as a buy until you can guarantee their clients exposure to tens of millions of viewers.  An Internet video company would need 120 million video views per month at an $8 CPM in order to reach $10 million in annual revenues.

Key Drivers:

  • Unique Viewers
  • Ad Impressions
  • Sellthrough Rate
  • CPM

Type 7: Commerce

Selling physical goods online is one of the more proven consumer business models. With Google’s ascension over the past decade, e-tailers are getting smarter and smarter about driving cost-effective traffic to their offerings via free search engine optimized pages as well as paid keywords. Social media via Facebook and Twitter has become another main activity to aggregate purchasing intent; Groupon, for example, drives more than 50% of its traffic from Facebook and Twitter. Creating unique community experiences, like Threadless and ModCloth, is another innovative way to increase customer loyalty and repeat purchases, while keeping the marketing spend low.

Once you drive potential consumers to your offering, you need to convert those people into paying customers. Because of these free and low-cost direct marketing channels, it has never been easier and more cost-effective to launch an ecommerce business. That said, fulfillment, customer service, and managing a warehouse is incredibly complicated, so attaining profitability for these companies can take years.

Key Drivers:

  • Uniques
  • Conversion Rate
  • Average Spend
  • Gross Margin
  • Acquisition Cost

Type 8: Rental

Similar to commerce companies, rental startups like Chegg, Zipcar, and RentTheRunway, sell access to a digital or physical good. The biggest difference with these companies is that they are selling short-term access rather than ownership, so how frequently they turn over their inventory along with the average rental rate and frequency of rental are the main drivers of the business. Cost effective access to inventory and how many times an asset needs to be turned over to breakeven are keys here.

Key Drivers:

  • Uniques
  • Conversion Rate
  • Average Rental Rate
  • Repeat Purchases
  • Customer Acquisition Cost

Type 9: Subscription

Subscription companies sell access to a premium service recurring on a monthly, quarterly, or annual basis. Subscription businesses are typically either content (music, video), information-based (financial, news), access-based (LinkedIn), or data services (Box.net). Regardless of what kind of premium service you are providing, the single most important metric is customer lifetime value (LTV). LTV incorporates your churn rate (what percentage of your customer base stops paying you each month) and dictates how much you can spend on customer acquisition. Once subscription-based businesses mature, they are incredibly predictable and profitable—see Netflix—because the company knows how to aggressively and cost-effectively acquire a customer based on expected margin. These kinds of businesses should never spend more than 40% of expected LTV on marketing to ensure profitability. Like marketplaces, subscription businesses often take several years to get to scale but if they hit 50,000 subscribers, they are typically around for the long haul.

  • Uniques
  • Conversion Rate
  • Customer Acquisition
  • Churn Rate
  • Life Time Value

Type 10: Music

As I wrote in the Teardown on Pandora, consumer audio/radio startups are difficult to monetize because they are typically amongst the lowest-valued forms of advertising. It makes sense because audio ads are not actionable, and display ads often get ignored (music apps tend to stay open in a browser tab in the background). The other challenge to audio companies is access to cost-effective content—music rights are difficult to secure and typically cost-prohibitive. Pandora has shown that a sustainable business can be created, but it also takes huge scale (10 million+ users) to reach that critical point.  If you can attract 10 million unique listeners a month and show them 40 ads each at a $2 CPM, plus you can convert 1 percent of those into paying users of some kind and squeeze out an extra $2.50 from each of those, then you can get to $10 million in annual revenues.

Key Drivers:

  • Uniques
  • Ad Impressions
  • CPM
  • Conversion Rate
  • Upsell Value

Type 11: Lead Generation

I have found that lead generation businesses are amongst the most widely followed, least understood of the 13 consumer models. The reason I say that is not that entrepreneurs don’t know what the model is, they do, but that the scale required to generate a sustainable lead gen business is not appreciated. Lead gen businesses need to do four very difficult things well:  1) drive a ton of traffic; 2) get people to click on offers; 3) convert a significant portion of those clicks to complete the offer; and 4) have enough high-value offers that the company generates enough revenue. Successful companies here either focus on a vertical, like financial services, that pays high bounties ($50+) or they have figured out how to encourage significant volumes of repeat purchases. The challenge with financial services lead gen companies is that customers don’t tend to turn over their credit card company or open a new brokerage account several times a year. A startup like Hunch, if it chooses to monetize via leads, has a shot at increasing repeat purchase volume due to itspersonalization engine and forecasting demand.

Key Drivers:

  • Unique Visitors
  • Offers Viewed
  • Conversion Rate
  • Affiliate Cost Per Action

Type 12: Hardware

Perhaps the most traditional business model of the group, hardware companies manufacture a physical good and then distribute the product through online and offline channels. Hardware companies make money based on retail price less cost of goods sold, minus marketing costs. Hardware startups, such as Kno, and Tivo and mobile phones before that, are bundling hardware with ongoing services. There are three factors that lead me to believe that we will see an explosion of innovative hardware companies over the next few years: 1) manufacturing costs in China continue to come way down as is their ability to cater to customized, small runs; 2) software is becoming easier to update remotely; and 3) the ability to bundle unique services on the devices. This is a space to watch.

Key Drivers:

  • Units Sold
  • Gross Margin
  • Marketing

Type 13: Payments

Payments are a volume-based business. These companies are charging pennies for each transaction that flows through their systems, so the biggest drivers of these kinds of businesses are the number of customers that have access to your payment method and the size of the average transaction. The characteristics that make up a good payments or financial services company are the number of high-quality distribution deals you can enter with a customer base that has demonstrated it will pay for goods and services.  You need one million customers a month making payments of at least $25 to get to $10 million in annual fee revenue, assuming a 3.5 percent fee.

Key Drivers:

  • Unique Users
  • Average Payment
  • Transaction Fee

 

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