248. [Amar] The 9 Key Business Models All STARTUPS Should Know

0:00The whole point of business is to make money and startups are no different. You'd be obsessed with a problem and create an amazing product, but if you aren't bringing revenue, sooner or later you're going to have problems, whether that's to keep investors happy or to pay the bills that you need to keep the lights on. How startups make money can be very different to traditional businesses. I'm going to go over five key principles for you to understand before going over nine different business models that you can test to work out what's best for your startup. I'm going to draw from examples from the 400 podcast episodes I've done as well as all the companies I've invested in and the funds I'm invested in too.

0:37Let's get straight into the principles. Principle one is paying yourself. A big mistake I've made and so many other founders make is forgetting to pay yourself and to put it into your calculations. Don't count yourself as free labour. If your business model only works on the basis that the leader isn't getting any money then you're not valuing your time and this can lead to huge problems down the line if you ever want to replace yourself or hire a manager. You can start off by just paying yourself a bit but make sure it's something and if you're struggling to pay yourself then you've got to really think about whether or not this business is right for you and the tough reality is that it's not always easy to pay yourself from the beginning and this forces you to think very carefully about how much you need to fundraise or how you need to make money sooner so you can make sure that that money is hitting your bank.

1:22Principle two is about revenue versus profit and startups are weird because most traditional businesses it's all about making profit where startups can delay this for some time before they actually need to get profit every month. Funding from angel investors, family offices and venture capitalists can mean that you've got a burn rate which means that you're able to spend more than you actually earn but this only works for a certain amount of time right you've got to keep convincing investors to keep pouring in more money to keep your business going until you start making profit and can be self-sufficient and independent.

1:54It took Facebook five years to become profitable. It took Amazon nine years and Uber 15 years. And the reason why startups think in this way and why we have this style of company is the idea is by making losses at the beginning you can create market dominance in a particular area and when you're dominant in that area you can then print money. And obviously we've seen that with the examples I've just mentioned about Facebook, Uber and so on. The idea for revenue focus over profit focus is generally less appealing when the market conditions are tough as we see right now but with the advent of AI and all the tools being used for sometimes companies can really focus on being profitable without sacrificing revenue growth at the same time so as AI becomes more and more embedded in the everyday systems the challenge of revenue versus profit isn't the same as it once was the other thing to consider too is looking at whether or are unit economics.

2:50So unit economics is as you get bigger and bigger does the cost per user come down which then makes it profitable and for some companies this then makes sense and it makes sense to invest in those massive projects on the idea that the unit economics will come down and the market dominance will mean that you can charge more which is a perfect combination right? Cost down and revenue up. Principle three is about users versus revenue and for those of you who are confused by the idea of people who want to focus on revenue rather than actually making profit this one's going to confuse you even more so I'm going to make sure I explain it well for you.

3:24This is a risky strategy but it works in certain situations so if you've heard of something called network effects network effects is where the value to each individual user is greater when more people are on it or using that particular product so social media is a classic example right it's more people on the platform the more reason there is for you to go there and the logic here is that if you turn on monetization too early you can create friction in the process which means that user growth slows down whereas if you can have a huge amount of users even if they aren't even making you revenue let alone profit one day you can turn the tap and those people then start making you money so by not charging by not adding advertisements and flat that you can create a greater value proposition to get users to use your app or use your product and once they've done that later on down the line you've got the stickiness where you hope they stick about even once you turn on monetization.

4:18How about founder Neil Tanner told a story of how they got to 5 million users and really interestingly his investors encouraged him to go down the route of focusing on user growth as opposed to growing revenues which is sometimes counterintuitive to what you might think but the whole goal is if we can get as many people using the app as possible once you have that captive user base then there's gonna be ways to monetize that so it's looking at get the engaged users get users really happy first and then you can figure out how to make money however when you have the situation when network effects aren't critical to your use so the more people are using something it doesn't really affect the other users then you should charge as early as you can because the feedback that comes from a customer is paying is a hundred times the feedback from a customer isn't.

5:03And I'm guilty again here, right? Is that sometimes you focus on so much about how do you make people happy rather than how do you actually create a sustainable business and charge them. And you can find that you have loads of happy users, but none of them actually convert to customers because they're too used to get what you offer for free. And if you can't figure out a way to monetize down the line, then you just have an expensive hobby. So this principle of revenue versus users you have to be very conscious that it makes sense to have the network effects of having lots of users to then make the proposition more valuable rather than just doing it because you're afraid to charge.

5:40Principle four is all about experimentation so you don't need to get the business model right at the start like repeat that in your head you can experiment you can get things wrong you can try one thing and it maybe doesn't work out and you go for something else. A, B test. And what you forget, and we all forget, is that many of the products we use today, the price that they're charging right now and the packages they offer are very different to what they offered a year ago or even two years ago. And you've probably seen it yourself that many of the subscriptions are going up every year. So many entrepreneurs are guilty of undercharging at the beginning.

6:16And that's okay if that makes you more comfortable to get people in the door, but you can increase the prices and you shouldn't feel guilty about that. If you're offering the value that makes your users and customers happy, increasing the prices is the valid thing to do to keep your business healthy and to make sure that you're able to pay your bills and also get that rewards for your hard work. And our final principle here is about being accountable. As a startup founder, there is so much noise. There's so many awards. There's so many features and this and this and this, right? Your job is to make money.

6:47as a business your job is to make money by solving problems that people need to be solved and they see monetary value in doing that if you're just helping people it's a charity so you need to make sure you're understanding how is it become a business that's going to make money that has value to add to this world and how do you make sure you're really a business by tracking the key metrics keeping on top of the numbers making sure that your cash flow is makes sense make sure your cash flow is feasible because there's so many companies who run out of money and that's it they're gone they could have had the best product in the world but they didn't figure out how to monetize it effectively and make sure that they could cover their bills next week will be quieter is not a good startup strategy you have to understand there's going to be different things are going to happen you're going to need to adapt you're going to keep going but you need to understand what's your expected costs what's going to potentially coming out so you can adapt and if there should be a margin of error in that right too, right?

7:42So if you think, okay, I need to have this much in the bank account because this is cost coming out, you need to work out what happens if something else comes into play. Am I just going to go bust just because I managed my money wrong? That shouldn't be you, right? You don't want to be in that situation. You've got to know how you're going to generate revenue and how you're going to keep your costs low. When are you going to break even and how much runway do you have? Financial management isn't optional. I'm now going to go through nine business models that Y Combinator recommends that come through their programs.

8:10So you can also check out their content too and see what works for you. Business model one is SaaS, software as a service. And this is what most of our subscriptions are today. We're customers of say, Superhuman, Figma and Notion. And we pay monthly for these. Investors love SaaS because it's easy to forecast, it's repeatable income and you can tell the churn rates are often quite low because you're generally working with other businesses. So for example if we're using Figma we're not going to suddenly stop using it because we've got processes and workflows that are dependent on it. In theory the variable costs are low which means that when you scale you get massive profit margins.

8:49The challenge is that you need to keep the customers from churning and you need to keep them seeing value in your product so that you keep them subscribed. Key metrics are monthly recurring revenue MRR or annual recurring revenue ARR. So for those of you who don't know recurring revenue means that it's a subscription that just keeps coming every month or every year. Growth rate so how much is the MRR or ARR increasing depending on what your customers are paying. Net revenue retention which is from the previous period how many those customers are still paying the following month and then customer acquisition cost which is how much does it cost you to get each individual new customer.

9:32Business model two is transactions and this is another common model where especially for say fintechs and people like that where they enable payments and then they take a commission based on that. So well-known ones include Stripe and PayPal and one of the founders from my network Benjamin Fernandez who runs Nala that's a platform which enables people to transfer money easily to and from Africa and they'll take a commission there. Now these models can be tough because often the commission is quite small so you need a huge volume of payments in order to make it viable as a business. But the thing is once you are embedded in the system and sticky then once a company is using you they're likely to keep using you over and over again.

10:15So it might be hard to initially gain customers but each of those customers can have a really large lifetime value. Visa and MasterCard have monster revenues as mature businesses in this sector while also charging very low rates and this is only possible because they have such large volumes. Key metrics here are gross transaction value so this is looking at how much money goes through the platform rather than just your commission part of it. Net revenue so that's how much fees are you charged for the transactions so it'll be a percentage of the GTV gross transaction value. User retention so of the people who use your platform in the first month how many of those people continue to do so and then CAC or customer acquisition cost which you mentioned in the previous segment.

11:01Third we have marketplaces these are another form of transaction business but this is where there's two sides of a marketplace which are being matched together and two different user segments. So commonly well-known ones we have Airbnb which matches homeowners who want to rent out their properties with guests. We have Uber which matches drivers with people who want to lift and Deliveroo who matches restaurants with people who want some food. An example of a founder of our network is Sandrine Zhang Theron. So she runs Vinteria as a CEO and founder and what it does it matches people you're looking to buy antique furniture or unique pieces with those who want to sell it.

11:41What's interesting about marketplace businesses is it can be very difficult to get started because you need both buyers and sellers. So in Sandrine's example, if there's not enough people who are selling furniture on the platform, then very few buyers are going to go to the platform to try and find furniture. And likewise, if there's not that many people who are buying furniture on the platform, then furniture sellers are unlikely to put their furniture on there because what's the point? So this is the problem that starts at the beginning. But once you get over that hump, if you can then be the dominant player in their industry, and this is where we've seen Airbnb, Uber and companies like that to just dominate that particular niche then the rewards can be massive and these businesses often utilize those network effects because the more people are on the platform the more valuable the platform is and sometimes they will operate a loss for a significant amount of time uber for example with 15 years so they can get this market dominance and then they can start to increase their prices key metrics here are gross merchandise value gmv which is the total sales volume transacted.

12:41So remember that if people are buying Uber or they're buying Airbnb, not all of that money is going to those companies. Net revenue, which is the fees for transactions, much like we just saw with the transaction example. The growth rate, which again we've explained already. And then user retention too, which is fairly self-explanatory. Next we have subscription models, which aren't necessarily software and might be more sold to consumers. So think of it's like a product. So some examples are Netflix and Peloton for example and then one from my network is a company called Simmer by Simmy Dillon and what they have is a subscription model where every week people get food to deliver to their door that they can then consume.

13:21But because it's quite high ticket items that subscription revenue can really rack up quickly and they've been able to be one of the fastest growing companies in the UK. Often when you're selling to consumers the amounts of money per consumer are quite a bit lower compared to selling to businesses. But you can also benefit from network effects where if you can see if consumers can see other people having it too they're more likely to get it so for example Netflix if some people watching stuff on Netflix then you have to get Netflix in order to keep up with the Jones. Key metrics here are very similar to SaaS so we have monthly recurring revenue or annual recurring revenue the growth rate the user retention and the CAC so the customer acquisition cost.

13:58Next we have enterprise and usually there's a much bigger contracts than traditional SaaS and this is where you work with large companies. So it's not uncommon for an individual deal to be worth six figures, seven figures and in some cases even eight figures and beyond. And in theory that sounds amazing right? Eight figure deal? But the sales cycles can be incredibly long. So if you're taking a year or even 18 months or even longer to close the deal it can be really heartbreaking when it doesn't go through. And this makes it very lumpy because you might get this massive deal come through which is 10 million pounds a year but if it doesn't come through how do you forecast that and you have this weird binary aspect whereas with traditional SaaS which is maybe a lower ticket you can predict and forecast more easily.

14:44It can be really difficult for new companies to crack into these industries especially where the founders don't have exceptional access because of their previous career. One example from our network is Autogen AI where one of the co-founders is Raj Khera and these have massive giant enterprise contracts where the contract itself could be worth six figures and more and there is a huge amount of money on the basis of this because the amount of saving these companies is ginormous. Generally when you see the case of when you go to somebody's website and rather than having a pricing page it has request demo or to learn more that usually means it's probably more likely to be enterprise pricing.

15:20So the different stats you can use here, the key metrics, we have bookings which is total signed contract value, we have revenue which is the amount that's actually delivered. Average contract value which is the total contract value divided by the numbers of years and then pipeline of how many major deals are in the pipeline and then how many go from top of funnel to a demo to actually being closed. Next we have usage-based pricing. So this is where the more you use of a product the more you have to pay. So right now with AI we're seeing this a lot where it's token based. The more tokens you use the more you have the pay.

15:57You have cloud products as well which also have used this in the past to say AWS, Microsoft Azure and these kind of products where the more storage you're using the more you pay. The model works well with this massively different usage per customer and that way you can have people at all different levels but also really capture the value of when you're serving the massive enterprise clients. Here the main stats to follow are monthly revenue which isn't recurring, the growth rate the revenue retention so what percentage of people paid for credits last month and then also paying this month and then the gross margin so of the revenue you're getting so if it's obviously you're charging based on usage then what's the margin there so if you're selling x number of credits at y amount you hopefully are getting z profit or z revenue which is bigger than the amount you're charging next we have e-commerce so this is where you're product-based business which is generally one-offs.

16:55So one example for my portfolio is Ocashield. They sell blue light blocking lenses and other different accessories and then every time you buy something from them that's their revenue right and that's how they price things. Usually this is D2C where the owner of the brand is selling it on their own website. So whereas a marketplace you're selling other people's goods maybe in e-commerce it's where you are the end seller and you are the end producer. Stats to track here so you've got monthly revenue which is total sales, the growth rate and then the gross margin and unit economics so we just mentioned that previously with usage but say for example if they drew an example of blue light blocking lenses how much does it cost to produce and then what's the average revenue so what's the price that you're selling it for and then we look at the CAC as well so the customer acquisition cost.

17:41Next we have advertising and this is generally we have a free product so the users aren't paying the people actually getting the value from the product and you have advertisers who are willing to pay to get the attention of the user base you've created. This is generally games or social products where you can really scale massively through network effects and users are basically the product being sold. So look at YouTube for example, while YouTube also has YouTube Red now but at the beginning they just had that model of you use YouTube for free and you watch the ads and then they make the money from the ads.

18:17The problem with this model is they use so many users for it to actually be useful. And most people never quite reach this scale. And that's going to be a big challenge, especially with SEO changing, everything changing. How do you maintain that advantage to have such a large audience that it's worth an advertiser paying the big bucks to be on your platform? So key stats here, daily active users, DAU, which is unique active users in every day. monthly active users MAU user retention and then you have cost CPM and CPC so CPM is cost per thousand and CPC is cost per click that's basically how valuable is your audience and what advertisers willing to pay and finally we have the last business model we're going to look at today and we're merging two here in a way so we've got biotech and hard tech so what differentiates this from most other business models is an extremely long pipeline for the product to be created.

19:16So for a very long time there might be no revenue and what then happens is generally there's massive contracts that then have huge value in the longer term and usually these are giant corporations or they're with governments. So say for example biotech you might spend 10 years developing a drug and once it's developed then your end customers are going to be governments, they're going to be large multi-international organizations but then each of those contracts is worth huge amounts and the same is true in hard tech and deep tech where again the innovation can take a really long time but then eventually once it's being made use of then corporations or governments will foot a massive amount of revenue so Wave is an example of this.

19:58Amashar is a founder of our network and what Wave has done is raised over a billion to develop self-driving car technology and once it's fully proven out then the contract value for major car manufacturers buying it is going to be giant. So if you hear the metrics are a bit harder so it's gonna be milestones, what's the progress towards the long-term vision, what signed contracts do you have in advance and then LOIs or letters of intent which is non-binding contracts which show that somebody's interested and you've got to be very careful about LOIs because generally the conversion rate is quite low and most people to be honest of any kind of sensibility are going to ignore most LOIs until the contract is actually done.

20:40But one thing to remember is that as you experiment you can try different business models and you don't have to have just one business model. I earlier mentioned YouTube for example that's both a subscription model and an advertising model and Netflix for example is doing the same thing. You can have multiple business models that it's best to experiment at the beginning, find what's working, double down on that and then expand again later on down the line. I hope this video is useful for you. Check out my other videos on this channel if you want to learn more as a startup founder and see you soon.