Chapter 1 — How to build a financial model for Product-Led Growth (PLG)
Here’s a question for you: Let’s say you are a growth marketer at a startup, and you have been asked to build a plan for Product-Led Growth (PLG) for your company’s product.
What should be the target number of sign-ups per day, and how much budget do you need to generate that many sign-ups?
As growth marketers, we often get hung up with metrics like daily sign-ups, Daily Active Users (DAUs), and Monthly Active Users (MAUs). But, the reality is if you only measure and pay attention to one metric, you fall victim to the classic misstep of missing the forest for the trees.
The bigger picture of how much revenue you are affecting (if you are in B2B space) or bringing in and the efficiency of each dollar you bring in is often lost in the pursuit of singular metrics like daily sign-ups and the cost of sign-ups. What’s worse is you usually don’t know how much you should spend on your growth efforts and how much to allocate the capital across different channels and campaigns.
I have had the privilege of working in startups, where over time, I have seen a pattern of how best to build a foundational plan that considers a consolidated set of KPIs and a basis to run experimentation and fast iterations. With this methodology, I’ve learned that there is a systematic way to determine the number of sign-ups, budget, and capital allocation and then use that as a starting point to build a growth plan.
In this article, I want to share my process for building a PLG financial model as a way to align all the stakeholders and establish a way to come up with a budget and a capital allocation mode.
Step 1: Define your revenue target
The first step is to define your revenue target. Let’s say, for example, that you want to generate $1M in revenue over the next 12 months.
Step 2: Determine your Average Selling Price (ASP)
Next, you need to determine your Average Selling Price (ASP). For this example, let’s assume an ASP of $400 per month or $4,800 per customer.
Step 3: Calculate your total number of paid Customers
Using your revenue target and ASP, you can calculate the total number of customers you need to acquire to hit your revenue target. For example, to generate $1M in revenue at an ASP of $4,800 per customer, you need approximately 209 customers. Here, I am assuming that one user sign-up is the same as one customer. This may be different for companies with the model of multiple users adding up to become one customer account.
Step 4: Estimate your sign-up conversion rate
Now that you know how many customers you need to acquire, you can estimate your sign-up conversion rate. For this example, let’s assume a 5% conversion rate from sign-up to paid customer. This varies wildly for different companies, and we will look at some best practices to improve this in a future chapter.
Step 5: Calculate your total number of sign-ups
Based on an assumption of a 5% conversion rate from sign-up to paid customers, we can now calculate that we would need approximately 4,160 sign-ups over 12 months to get 209 paid customers.
Step 6: Break down your sign-up target by month
To make your customer acquisition target more manageable, you can break it down by month. For example, you could aim for 346 sign-ups per month to hit your target of 4,160 sign-ups over 12 months. You can also assume a monthly growth so that the sign-ups are initially smaller and then grows over each month. In our example, we have taken and built a 10% growth month over month.
Step 7: Determine your acquisition channels and campaigns
Once you have your monthly sign-up target, you can determine the acquisition channels and campaigns you will use to achieve that target. This could include paid search, social media ads, email marketing, content marketing, referral programs, partnerships, events, PR, and other campaigns specific to your industry and product. However, once we bring in the channels, we realize that each channel has a different conversion rate, so in our model, with the assumptions listed below, we need about 760 sign-ups in a month.
Step 8: Allocate your acquisition budget
With your acquisition channels and campaigns identified, you can allocate your acquisition budget accordingly. For this example, let’s assume you have a budget of $650K for the first year, and you want the average sign-up cost to be, at most, $200.
Here’s a sample table that you can use to track your PLG financial model:
You can also look at the table and copy the doc from Coda below
If you are more comfortable with Google sheet then you can copy it from here:
https://docs.google.com/spreadsheets/d/1taWYbcRpNTgIc5yohE6btnVTId-9JoTSHqKDQO6Sciw/edit?usp=sharing
This table includes columns for the channel, unique visitors needed, conversion rate, monthly sign-ups, conversion to paid percentage, number of paid customers, cost per sign-up, and monthly cost. It’s based on the assumption of a 5% conversion rate from sign-up to the paid customer and an ASP of $4,800 per customer, with a target of 208 paid customers over 12 months.
Now, let’s take this same table and spread it out over 12 months. This becomes the base for measurement and tracking KPIs for every month.
With this framework, you can have a cogent conversation with your stakeholders about your budget and show that you plan to bring in $1M with an approximate budget of $650K. That is about spending $0.65 to bring in $1. You can tweak the table above to meet your company goals and continue to iterate on the channels as the experiments continue to show you over a period of time which channels are working better than others.
In the next chapter, let’s look at how to create a data and martech architecture to measure and build dashboards for this framework.
Conclusion
In conclusion, building a solid financial model for your PLG strategy is essential for achieving your revenue targets and maximizing your return on investment. By following the steps outlined in this article and using the sample table provided, you can create a detailed plan for acquiring new customers, track your progress over time, and make data-driven decisions to optimize your acquisition channels and campaigns. In addition, with a well-defined PLG financial model, you can set yourself up for success and confidently scale your business.
You can look at the table of content for the book below. I will continue to link the chapters as I finish writing them.
