Startup School Reference Guide for Lecture #7 — Nine Business Models and the Metrics Investors Want with Anu Hariharan

The lecture in its entirety. Recommend watching and then referring back to this afterwards!

While working to create the Snapchat for voice — wavechat.me — and attending Startup School 2019, I was inspired to create these “Cliffs Notes” for all the valuable content that YC provides to their attendees.

If you like it, please give Wavechat a try! https://apps.apple.com/app/apple-store/id1459456926?pt=690141&ct=mdm&mt=8

(To figure out what metrics to use) the most common thing people do is ask “Which industry are you in? Are you health care? Biotech? Enterprise?”

But that’s not the best way to think of metrics… the best way to think of metrics is how do you plan to charge your users — what is the business model? And which of these business models do you fit in?

Table of Contents:

0. The nine business models, and the metrics to track for each

1. Common mistakes across ALL the business models

Enterprise

This is a company that sells software or services to a large enterprise.

Examples: Docker, Cloudera, FireEye

Large enterprises tend to work in contracts. Within these contracts there are three components, which comprise the metrics you want to track.

Key Metrics to track

1. Bookings. Total number of commitments you have from companies that will pay you for your service.
2. Total Customers. Total number of companies that you have received a booking from.
3. Revenue. When your company has fulfilled the commitment outlined in the contract to the company, and the money is in your company’s bank account.

Common Mistakes for Enterprise

• Confusing “Bookings” and “Revenue”. Don’t count the money as revenue until it’s been paid to you!
• Counting Letters of Intent or Verbal Agreements towards your “Bookings” metric. Don’t add these in to your “Bookings” metric until the contract is signed by both parties!

SaaS

This is a company that sells subscription-based licenses for a cloud-hosted software solution.

Examples: Segment, Ironclad, Sendbird

SaaS is really a subscription business. You charge monthly for a software that you provide.

Key Metrics to track

1. Monthly Recurring Revenue (MRR). Hopefully you have built something that people really like, and they’ll continue to use it and they pay you every month.
2. Annual Recurring Revenue (ARR). This is good to track in comparison with MRR, as it shows the pace of revenue, as compared with just the absolute revenue number.
3. Gross Monthly Recurring Revenue Churn (Gross MRR Churn). When you’re early stage and you only have a few customers, losing even one or two has a real impact on your revenues!
4. Paid Cost to Acquire Customers (Paid CAC). Hopefully you’re acquiring users organically, but eventually you will experiment with paying to acquire users once you reach a certain stage.

Common Mistakes for SaaS

• Don’t use Annual Recurring Revenue (ARR) and Annual Revenue Run Rate interchangeably. The key word here is RECURRING. If your customers are not committing to 12 months of payment, you don’t have a recurring revenue business. This leads to confusion — if you start calling it ARR, everyone thinks, “Oh it’s repeat business.” It’s not, because you have to go back and acquire them each month, which incurs a cost! (either time or money)
• Don’t include one-time payments in Recurring Revenue calculations. If it’s not 100% confirmed, IT’S NOT RECURRING.

Subscription

This is a company that sells a product or service — usually to a consumer — on a recurring basis.

Examples: The Athletic, Dollar Shave Club, Blue Apron

The main difference between SaaS and subscription is the cost per sale. In subscription based models, the cost is usually much lower on a per customer basis. Because of this, track monthly growth churn and unit churn, not dollar churn. Revenue is distributed more evenly across customers, so you get a better representation of the company by measuring users and not dollars.

Key Metrics to track

1. Monthly Recurring Revenue (MRR). Revenue for recurring services in a given month. This does NOT include one-time or non-recurring revenue, such as fees and professional services.
2. Monthly Recurring Revenue Compound Monthly Growth Rate (MRR CMGR). When you’re still small, because of the small sample size, your MRR will be spiky. This smoothes out those spikes (in a way that doesn’t hide downturns like simple averages.)
3. Gross User Churn. In comparison with SaaS, you want to track user churn instead of revenue churn.
4. Paid CAC. Same as above — you don’t want to pay for users for a long time.

Common Mistakes for Subscription

• Don’t measure CMGR as a simple average — use discrete monthly growth rates. What happens with averages? It makes your growth look good because you had some spikes.

Transactional

This is a company that enables a financial transaction on behalf of a customer and collects a fee (usually a percent of the underlying transaction)

Examples: Stripe, PayPal, Coinbase, Brex

If you’re a type of business that processes someone else’s payments volume, then you should put yourself in the transactional bucket.

Key Metrics to track

1. Gross Transaction Volume. If you have 30 customers that were going through your company processing $100 million in total transactions, that’s GTV. But the volume of payments that goes through your platform isn’t revenue, which leads us to…
2. Net Revenue. This is the money that you take out of the transactions flowing through your platform — that goes in to your bank account!
3. User Retention on a Monthly Basis. Because of the nature of transactional businesses, you will likely have a large volume of customers. Because you’re powering your customer’s ability to make money, there should be no reason they stop using your platform.
4. Paid CAC. See above.

Common Mistakes for Transactional

• Confusing Gross Transaction Volume with Net Revenue. Only count the cash that hits your bank account!
• User retention is a COHORT metric. A cohort is a set of users acquired within a specific time frame. Saying you’ve retained 30% of your users — that doesn’t tell the full story. If you’ve retained 40% of your users in the last 12 months, that’s much more telling.

Marketplace

This is a company that acts as an intermediary between two consumers, connecting them to buy or sell a good or service.

Examples: Airbnb, Ebay

Marketplaces connect sellers and buyers to exchange a good or service. This differs from Transactional companies in that the Transactional companies help people process the financial transactions themselves.

Key Metrics to track

1. Gross Merchandise Value (GMV). If a host on Airbnb lists a $100/night room for 2 nights, that’s $200 Airbnb can count towards their GMV.
2. Net Revenue. The percentage of the GMV that Airbnb gets in their bank account.
3. Net Revenue Compound Monthly Growth Rate (Net Revenue CMGR). Since Marketplaces are typically consumer based, volume of users matters. Again, as opposed to averages, this is a more honest way of understanding how much you are growing.
4. User Retention. As above, you pay attention to volume of users, as opposed to revenue retention.
5. Paid CAC. See above.

Common Mistakes for Marketplace

• Blending paid user acquisition with organic user acquisition. If you don’t separate out the two, you don’t have a good sense if your growth is sustainable — or if the ROI for paid user acquisition is even worth it!

E-Commerce

This is a company that sells physically goods online. Generally they manufacture and inventory those goods.

Examples: Warby Parker, Bonobos, Memebox

In E-Commerce, you may make the products OR source the products, but ultimately it’s your brand — and people are coming to the brand to purchase it.

Key Metrics to track

1. Monthly Revenue. There’s no recurring purchases, so simply track revenue per month.
2. Revenue Compounded Monthly Growth Rate (Revenue CMGR). Again, because it’s consumer, track volume, and because averages aren’t the whole picture, track compounded.
3. Gross Margin. (Calculated by gross profit in a given month / total revenue in the same month) How much money are you making for each thing you sell? And it’s even more important because it’s not recurring — you need to make sure you’re making money on each transaction.
4. Paid CAC. Same as above.

Common Mistakes for Marketplace

• Not accounting for ALL costs that factor into Gross Profit. If you bought something and the cost is $10, a lot of companies wouldn’t include things like shipping costs, customer processing costs, and payment processing costs. If you don’t include those costs, you’re pricing it wrong!

Advertising

This is a company that offers a free service, and derives revenue from selling advertisements placed inside the free service.

Examples: Snapchat, Twitter, Reddit

At such an early stage, you’re not anywhere close to monetizing if you are in the Advertising business. Because of this, it’s ALL ABOUT THE USERS. Because of this, there are only 3 metrics that matter…

Key Metrics to track

1. Daily Active Users (DAU). Number of unique active users in a 24 hour day, averaged over a period of time.
2. Monthly Active Users (MAU). Number of unique active users in a one month period.
3. % Logged In. MAU with a registered account/total unique visitors over the same 28 day period.

Common Mistakes for Advertising

• Not reasonably defining what “Active” means. Again, it’s about being honest with yourself and your company. YOU SHOULD DEFINE WHAT AN ACTIVE USER IS IN THE CONTEXT OF YOUR PRODUCT. If you fudge “Active” definitions at the beginning, you’ll build a product that isn’t sticky.

Hardware

This is a company that sells physical devices to consumers.

Examples: Fitbit, GoPro, Xiaomi

Very similar to E-Commerce. All the metrics are the same.

Key Metrics to track

1. Monthly Revenue. There’s no recurring purchases, so simply track revenue per month.
2. Revenue Compound Monthly Growth Rate (Revenue CMGR). Again, because it’s consumer, track volume, and because averages aren’t the whole picture, track compounded.
3. Gross Margin. How much money are you making for each thing you sell? And it’s even more important because it’s not recurring — you need to make sure you’re making money on each transaction.
4. Paid CAC. Same as above.

Common Mistakes for all types of business models

1. Using Cumulative Charts. There is no rationale in the world to have cumulative charts. There is not a single company at scale that uses cumulative charts.
2. Not labeling Y-axis. If you don’t know what the Y axis label is, and you can’t tell what the bars mean, it tells you nothing!
3. Changing Y-axis scale. Start the X and Y axis at the same value!
4. Not showing your problems. The most important thing is to really be honest, measure, and fix things. It’s okay for charts or metrics to go down sometimes. No YC startup had a chart straight up and to the right — the most successful companies didn’t either.
5. Showing only % gains. It’s very important that whatever you’re measuring, be clear about the absolute number and the percentage relative to the absolute number.

As always, lmk if you have any questions or feedback!

Part 1 of this series is here: https://medium.com/@davegoldblatt/startup-school-notes-orientation-fbe4201b977c

Part 2 of this series is here: https://medium.com/@davegoldblatt/startup-school-reference-guide-for-lecture-2-how-to-evaluate-startup-ideas-6c6e61479cbf

Part 3 of this series is here: https://medium.com/@davegoldblatt/startup-school-reference-guide-for-lecture-3-how-to-talk-to-users-with-eric-migicovsky-f4afd41b8e9d

Part 4 of this series is here: https://medium.com/@davegoldblatt/startup-school-reference-guide-for-lecture-3-how-to-plan-an-mvp-with-michael-seibel-578e672eae1

Part 5 of this series is here: https://medium.com/@davegoldblatt/startup-school-reference-guide-for-lecture-5-how-to-set-kpis-and-goals-with-adora-cheung-951dc074e9dd

Part 6 of this series is here: https://medium.com/@davegoldblatt/startup-school-reference-guide-for-lecture-6-analytics-for-startups-with-ilya-volodarsky-31d933870915