What Is Revenue Economics, and How Does it Help Companies Scale?
First-stage revenue growth CEOs often dread spending their first half-million on a proven revenue engine. It’s a huge investment, full of uncertainty, and takes time to prove its value.
So what do many founders decide to do instead? They turn to what they think is the less expensive option — hiring a do-it-all salesperson who inevitably fails because they are placed into an environment where they cannot succeed. This produces a revolving door of over-promising and under-performing salespeople that costs many companies money without setting them up for long-term growth.
This is not how you scale. It’s time to quit throwing away money on bad salespeople — or even great salespeople who don’t have the foundation to succeed — and instead invest in the revenue engine by understanding your revenue economics.
What Is Revenue Economics?
At House of Revenue, we use revenue economics to help clients understand the true cost of their growth or scale. A revenue economics model concisely breaks down your cost to scale by tracking expenses related to data, people, and process, thus allowing you to understand the investment necessary to reach your revenue goals.
Before breaking down each of those three components, it’s important to remember this often overlooked truth: growth and scale are two very different terms.
- Growth — Growth is steady year-over-year growth in revenue. For example, if you consistently grow 10% YoY, that simply means that your total revenue increases 10% every year. What that does not show is the total expenses required to reach that level of growth. Most often with growing companies, revenue grows at the same rate as expenses, making your profitability remain constant.
- Scale — Scale, on the other hand, is the ability to grow revenue independently of expenses. Scaling companies understand the importance of investing in automation, systems, and processes to boost efficiency, eliminate overhead expenses, and scale revenue disproportionately from expenses. Think about this as a hockey-stick type graph — while the initial costs might seem like a hefty investment, the end result is a steep increase in revenue while costs remain consistent.
The truth is that some companies are not ready to scale. They are comfortable growing consistently and do not have the people in place needed to handle scale. However, if you are ready to scale, keep reading to learn more about revenue economics and revenue modeling.
Data, People, and Process
In order to scale, every company must have indisputable data analysis and intelligent people to use that data to recognize trends and build processes for improvement. Let’s break each one down.
If you’ve followed our House of Revenue content, you’ve likely heard me say that opinions are valuable but data is priceless. I trust that you and the people in your organization are intelligent, but if their opinions are not backed by data, then their talents are being wasted. Data should inform your opinions and allow you to identify trends, threats, and opportunities to differentiate yourself in the market.
With indisputable data in place, your people are able to do their jobs better and more efficiently. When constructing a revenue economics model, it’s important to remember that people are unpredictable. They cost money, have higher fail rates than automation, and have a set output that they work to achieve. We’ll touch more on this later, but remember this when building your model.
The last part of the puzzle comes down to process. You and your people have the data, now it’s time to use it to improve workflows, update technology, and build a communicative revenue engine. All revenue-generating departments — marketing, sales, and customer success — must operate under one roof and be tied together with automation and technology from RevOps.
With these three components mapped out and in place, you can begin thinking about your revenue economics model.
Building Your Revenue Economics Model
As I mentioned earlier, revenue economics is all about understanding how much it will cost you to scale. This is so important to understand because it sets you up for success rather than failure. If you are cautious with your model and understand the investment in front of you before attempting to scale, you won’t be surprised when you are still trying to break even a few months down the road.
To begin, download our revenue economics modeling template and follow along. These are the most important metrics to have when building your model.
- Average Revenue Per Client. To understand your expected profit, you need to know how much revenue you can expect, on average. It’s vital to break this metric down even further into average revenue per customer by:
- Market segmentation
- Geographic area
- Product sold
When you know which markets, locations, verticals, and products yield the highest return, you can map your scale around those most profitable areas.
- Average Life Cycle of Client. To know exactly how much you can expect to make from those clients, multiply their average revenue by their average lifecycle. Churn rates can also help you predict average life cycles based on the four segments above.
The Reverse Funnel
Now that you know what you can expect to make from each client, it’s time to discover the costs associated with obtaining them. To do this, we like to construct a reverse funnel. Essentially, take your normal funnel — beginning with top-of-funnel lead generation and ending with a closed deal — and flip it upside down.
- In order to close one deal, how long did it take from a qualified discovery meeting to their signature?
- What was the conversion rate at each step of the sales process?
- What were the different attraction methods used by sales and marketing to get that lead, and how much did they cost?
A reverse funnel gives insight into your time-to-close and the sales, marketing, and customer success methods that are the most effective in winning more deals in less time. Again, this is where keeping up with your data is so valuable because it shows the best ways to streamline processes and make more money.
Departmental Costs — People & Technology
With an understanding of how much it costs to obtain a client, we move into two other aspects of cost — people and technology. Break down these costs by department:
- Sales — What is the base salary of everyone on your sales team? What is their variable compensation? What are the overhead costs? From here, map out their quota on a conservative number — remember, people are unpredictable and will not produce at 100% of their capacity.
- Marketing — Similarly, estimate base salaries, variable compensation, and overhead costs of your marketing team. Remember to consider additional costs for your marketing budget — website development, paid media, technologies, subcontractors, etc.
- Customer Success — Map out all of your clients and their product suite penetration, potential to increase in user count, and ability to implement new technology. Too many people think that revenue generation stops after the contract is signed, but this is where millions of dollars in revenue expansion are waiting.
Build Your Model
With all of this put together in increments of 12, 24, and 36 months, you have a clear understanding of what your revenue scale will cost over the course of three years. Scaling is an investment, and when you prepare for results three years down the road, you are setting yourself up for long-term success, not just YoY growth.
Even when your revenue economics model is in place, it will take constant monitoring and evaluation to succeed. For a deeper dive into this subject, listen to the full radio show here, or schedule a conversation with House of Revenue today.