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TC Teardown: 13 Ways To Get To $10 Million In Revenues (Part II)

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Editor’s note: This post is the second part of an analysis of different consumer Internet business models by guest author Steven Carpenter. It is suggested that you first read Part I.

Most consumer Internet startups fall into a baker’s dozen of possible business models. In the first part of this post, I tried to lay out the three main buckets those business models fall into (media, paid service, and physical commerce) and then began to sketch out the first four business models (search, gaming, social networks, and new media). In my analysis, I include a rough financial model showing the key drivers necessary for each different type of business model to generate $10 million in annual revenues.

In this post, I continue with the final nine business models (marketplace, video, commerce, retail, subscription, music, lead generation, hardware and payments). As I mentioned last time, this list is not meant to be exhaustive but it should cover most consumer Internet startups today. Please feel free to comment or email me at tcteardown at gmail to let me know what I may have overlooked or help me flesh out my analysis. You can also view, download, and use each of the below financial models here.

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 its personalization 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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