Start-ups today often overlook the importance of utilizing the right cash flow model. Most founders are comfortable believing that in order to succeed in this cut-throat industry, one need to focus more on constantly developing, innovating their products. But if one looks to how the biggest names in the industry achieved success, this is not necessarily the case.
Success with software, apps or web services necessitates not only for you to create great products and services that solve a need (B2C) or problem (B2B) but also for you to utilize the right cash flow model for your company, start-ups and big names alike. While the product or service creates value and the business model captures value; it’s the cash flow model that keeps startups, or any business for that matter, alive.
Cash flow is where the essential properties of a business model are determined
As a startup founder, it is imperative that you can read a balance sheet and understand the basics of profit, cash flow statement, income statement, depreciation, etc. In other words the ABC of finance.
Try the following quiz to see if you’re up to the task:
By understanding the impact of cash flow on your business, you can plan out every aspect that could affect how your business earns income. The right cash flow model should be able to help you to determine who will pay for your services, how often, how much, and when they are going to do so, all in the littlest details. The right cash flow model should also help you keep away from that dreadful situation, bankruptcy, which may happen if you don’t manage your cash flow. The only reason why companies die is because of cash flow not because of low profits or even negative margins.
CASH FLOW is more important than your mother
Software companies and startups have to select the right business model that will be profitable to them. The business model has a huge impact on the success of the business. The commonly known business models are; “PAY NOW”, “PAY NEVER”, PAY FIRST” “PAY SOON” and “PAY LATER” model. All these models differ in cash flow trajectories. Many SaaS (Software as a Service) companies use the popular “PAY LATER” business model mainly due to its skyrocketing growth strategy. It has become apparent that success can be detrimental to the cash flow in this model.
The PAY NOW model
Below is a cash flow model that focuses on providing on-premise software solutions to clients to make them self-reliant, while at the same time generating one of the most favorable cash flow in the market, the “PAY NOW” Model.
Utilized by majority of the big software companies (such as Microsoft, Oracle, SAP, etc.), the PAY NOW model, also known as bootstrap-the-client model, is based on the “Solution Selling” approach. This model is perfect for B2B or enterprise software companies that depend as much on the product as well on their services to create revenue. This model utilizes a long sales cycle with a relatively slow growth, which means revenue may not come for until several months.
However, the PAY NOW model also generates more short term cash as growth accelerates. This model also requires a perpetual sales force machine, one that require a smooth salesman, someone who knows how to generate a demand even if he is not that well-versed to the technical aspects of your software enterprise, as well as a support engineer, who will handle all the technical, integration questions that will be raised by clients. With the PAY NOW model, key performance indicators show a maximum gross profit margin of 95%, making it one of the most in-demand models in the industry today.
The PAY LATER model
Many SaaS (Software as a Service) companies use the “PAY LATER” business model mainly due to its skyrocketing growth strategy. However, this model has its cons and pros. It has become apparent that success can be detrimental to the cash flow in this model.
In “PAY LATER” model, as used by many SaaS companies, the products, solutions, and services are delivered to customers and consumed by customers over the internet. The model is consumption and subscription based, and it can recur. There are two important factors that determine this business model. These are the customer acquisition costs and the customer lifetime value. The customer acquisition is the metric that matters most in the “PAY LATER” business model. The model is basically a reverse bootstrap as the client is allowed to pay for the service over time, similar to renting a car instead of buying it.
The software company and any web service company are to familiarize themselves with how the model works before choosing it. It has become a trend that many software companies are resorting to the “PAY LATER” model. However, success with this model leads to a negative cash flow as you long as the company keeps growing. The famous and much seeked after “hockey stick” only kicks-in when growth slows down. Thus, the business needs to be careful when selecting this model for their growth. The model is considered the worst cash flow generator as compared to other business models that are aforementioned herein.
However, choosing the right business model is all about considering the Pros and the Cons associated with it. If the Pros outweigh the Cons then the business might take the risk. “PAY LATER” model, too, has some advantages and disadvantages. These are mentioned below:
The advantages of “PAY LATER” model in SaaS companies
• The speed of innovation, and the feedback loop is very powerful
• The growth rate is expected to increase in this market since there has been a remarkable growth by 17.9% in the year 2011 and 2012.
• The purchase decision is made by the budget owner.
• Hockey stick growth model is perfect for Silicon Valley style financing.
The disadvantages of “PAY LATER” model in SaaS companies
• The client bootstraps the vendor from the cash flow point of view
• The model needs the software company to run a 24 hours x 7 days service
• The vendor is responsible for the efficient running of the hardware and the software, and all the risks are upon the shoulders of the vendor
• There is limited vendor-lock-in
These are a few disadvantages and advantages of the “PAY LATER” model for SaaS companies. The companies can choose whether the model is right for them based on the Pros and the Cons. Churn in this model is the profit killer. Once halved, the customer lifetime may be doubled as well as the net profit of the company in question. Choosing the right model can help the business to thrive in a long run.
The PAY NEVER model
The “PAY NEVER” is one of the cash flow models that born-on-the-web companies can choose to make it big time.
In the PAY NEVER model, the product is free, and the users are the traded goods. It is also known as the bootstrap-the-vc-model. A lot of web-based companies use this business model.
When choosing the right business model, you must consider the nature of your product and the business. If you think that the product or service will become viral and will be used by a zillion of users in a winner-take-all market then PAY NEVER is the one for you.
There are two types of the PAY NEVER model. The first one is user based. Examples of companies that use this model are Twitter and Facebook. Then there’s a usage based or consumption. Companies that use this model are Google and Techcrunch.
There are two market shares of the PAY NEVER model. They first one is the Winner Take All market or the Twitter Model. Then there is the Power-Laws model or the Google model. The second company has half the market share of the first company and the third ranked will be a third of the first. Monetisation of the Pay Never business model is through advertisement or data and needs millions of users.
The PAY NEVER business model can (and must) lead to fast growth. It is often used by multi-billion companies. They use VCs and IPO as their main source of funding. Their goal is to acquire smaller companies and not be acquired.
Businesses with the PAY NEVER utilise growth hacking and promote their products through low-to-no-cost, alternative marketing tools such as viral marketing and social media. They also use APIs to grow, such as Instagram, Spotify, and Zynga. They try to go viral in order to grow. Once the product gets critical mass, they would use their customers as leverage and talk to major brands. Their main goal is to acquire users and maintain them.
The PAY NEVER is a good business model if the business has access to the deep-pocket funds to allow them to offer the product for free. It is often a race against time; therefore, the Startup must consider whether they can afford this path without a clear path to profitability.
The PAY SOON and PAY FIRST cash flow models are coming online soon!
It is important for startups to note that there is no one-size-fit-all solution when it comes to cash flows models — often a combination of different models is the best approach. Careful assessment of company goals, growth and access to capital, as well as the competition and the state of the market, should be taken into consideration in deciding for the right cash flow model to use, a tool which can either make or break your entire business operations.
Key takeaway for software en web service Startups:
Cost of Sales is the name of the game