value and growth models

05.899/499

Value and Growth Models for Lean Startups

Jim Morris

Spring Semester 2014

05.899 & 499 Mobile Service Innovation Spring 2014 2

Why Quantify?

• If you start a business you will have to measure performance: cash on hand, cash flow, revenue, costs, profit, growth rate, even stock price.

• There are many other measures that can be used to predict financial ones, e.g. number of users.

• Your value and growth hypotheses are theories. To tell if they are good theories, you need to measure the things they predict.

• The theories start with rough numbers that experience will refine.


Your Secret Weapon• Unlike old, “bricks and mortar,” businesses

internet businesses can easily measure many more things about users.

• Each user can be followed, recording every interaction and its outcome, predicting her future interactions—without even asking her!

• Your quantified value and growth hypotheses will tell you what measures to build in as you implement the service.


A Simple Service

Providing a service to a uniform population for a fee.


A Simple Value Hypothesis

A Site with App MemberService/$

• The member joins and pays a monthly fee until she resigns.


Quantifying the Simple Value Hypothesis

• Double-click the table to get the Excel® spreadsheet.


Development and computing costs are insignificant.• The development costs occur only

once, so are not part of the value diagram, which reflects just ongoing costs.

• The ongoing computing infrastructure costs—servers, networking—are small relative to things like marketing expenses and office staff. They can be free until you have a lot of users; and, even then, the per-user cost will decrease every year.


A Simple Growth Hypothesis: Three States of Engagement

Visitor

Member

Advocate

Advertising

Convinced

Value

Atrophy

Forgets

Resigns

Word of Mouth


Quantifying the Simple Growth Model


Combining Value & Growth

We can add columns derived from the value hypothesis to compute the weekly loss and accumulating debt for the first year. This provides an estimate of the needed investment for the year, $60,000.


Start-up Plan for a Simple Service

• One-time development costs: $100,000.

• The Growth Hypothesis predicts two years to grow the membership base to the $7,000 required by the Value Hypothesis.

• Assuming I get half-way there in one year I need one years’ total costs, about $80,000.

• Total: $180,000.

• Extra credit: Combine Value and Growth spreadsheets to show changing profit picture.


A Commission-based Service

Generating sales for a business and collecting commissions

• Relay It • VICI


Commission-based Value Hypothesis

Our Service Member

Something/$

Merchant

New Sales/$

(Encourage Purchase)

X


Quantifying Commission-based Value Hypothesis

• A salesperson signs up merchants.• Each merchant has 125 patrons who join.• Each member makes 1 purchase per week.• Additional advertising is needed.


Commission-based Growth Hypothesis

The Growth Hypothesis varies based on the nature of the service—simple, social, or two-sided.


Commission-based Start-up Funding

Assuming the Simple Growth Hypothesis, it will take about year to build up to the 2,500 member goal in the Value Hypothesis. Therefore we need a year’s worth of operating costs: 12*$7,500 plus a 10% contingency: $100,000.


Advertising-funded Services

Using Google AdSense, you can put ads on your pages, whether or not they are related to your service. Then you care about how many people visit your site.

Some projects that might do this are• HUE• Icnutri• TrekXplore


Value Diagrams for Advertising-funded Services

MemberMerchan

t

Product/$

Service Advertising/

$

X/Ad V

iews


Quantifying the Advertising-funded Service Value Hypothesis

When anyone comes to our page they see banner ads, each of which pays us CPM/1000.


The value members receive needn’ t be part of the value hypothesis computation.

• They are receiving some sort of value for their time, and that affects the number of page views, but we just guess that number for now.

• The number of page views are dependent on the growth hypothesis, which is more important in this case.


A Simple Growth Model That Gets 20,000 Members in a Year

Notice that most of the growth occurs at the end of the year, since it depends on accumulating word-of-mouth.


Start-up Costs for Advertising-based Services

• It takes most of the year to get to profitability, so you need to cover costs for the entire year: 365*$336 or about $123,000.

• Businesses that depend solely on selling ads require large start-up costs.


Social Network Services

The value hypothesis may vary (simple, commission, advertising), but the growth hypothesis is special.

• UrbanBite• Cup of Sugar (Community Sharing)• TrekXplore


Social Network (Facebook, LinkedIn, etc.) Growth Model

Visitor

Member

Advocate

Advertising

Convinced

Value

Atrophy

Forgets

Resigns

Word of Mouth

NetworkEffect


Quantifying Growth Hypothesis for Social Network Service


Two-sided Services

• Spotter• Point• TrekXplore• UrbanBite?

Each side has its own value hypothesis, and the growth hypotheses are different but inter-dependent.


Taxi Dispatcher, e.g. Lyft

Possible Operation Rider requests specific ride with phone. Dispatcher negotiates with idle Taxies (via phone app?) and sends taxi. Rider gets ride, pays dispatcher. Dispatcher pays taxi, less commission.

This competes with existing dispatchers because They don’t use modern technology well

• GPS• Computer planning• Real-time auctions

Our system gives them better access to customers. They charge taxis a fixed monthly fee. Handling payments might improve safety. Drivers can adopt it without giving up existing dispatchers. Some taxi drivers are abandoning existing dispatchers and using social cell-

phone networks already. We can measure user satisfaction on every transaction!


Value Diagrams

Taxi RiderRide

Dispatcher

$Customer/$

Taxi RiderRide/$

Dispatcher

$

Old New

Rather than charge a driver a fixed monthly fee, charging him a commission each ride, arranged and paid for by the rider’s phone.


Creating a Value Hypothesis Spreadsheet

1. Decide on the period to measure, e.g. 0ne day, and a market, e.g. Pittsburgh.

2. Create a spreadsheet describing with all the factors that effect value flows and costs

Number of each type of stakeholder Transactions per day Price per transaction

3. Estimate measures about the market.

4. Select initial choices for the numbers you can control.

5. Create formulas to compute outcomes leading to profit for the service.


Spreadsheet for Two-sided Value Hypothesis


Spreadsheet Structure

Ride Price

# New Rides

% Taxis Signed Up

Commission %

Daily Fee

Guesses

Choices

Taxi Revenue Increase*

All Taxis

Signed-up Taxis*

*+

Taxi Cost Increase

-Taxi Profit Increase

Dispatcher Revenue*


Growth Model for a Two-sided Market

Visitor

Driver

Advocate

Advertising

Convinced

Value

Atrophy

Forgets

Resigns

Word of Mouth

Visitor

Rider

Advocate

Advertising

Convinced

Value

Atrophy

Forgets

Resigns

Word of Mouth

Drivers

Riders


Two-sided Growth Model


A Flip from Rider to Driver Surplus


Sensitivity Analysis (Optional)

• Changing the numbers in your spreadsheets gives you a feeling for what parameters matter the most.

• There is an Excel trick, Data Table, that allows you to explore the question of what matters more more systematically.

• To decide what research to do first, compute the sensitivity times the range of uncertainty and look at the parameter(s) with the highest score.


Pre-cooked Spreadsheet w/Sensitivity Analysis


Two Factor Sensitivity Analysis:How to Divide Advertising between Drivers and Riders