Value Cycles, Revenue, and Metrics
4 steps to a great startup
As a startup starts to get traction, opportunities and options for exploration often explodes — this can lead to a team spreading themselves too thin. To be effective, we need to make decisions on what to focus on and what not to. This is often a challenge for growing startups.
How can we figure out what to do next? How can we evaluate the opportunities in front of us and also identify missed opportunities that we are not yet seeing? When and how should we figure out revenue?
In this post, we will be introducing and using the notion of value cycles to help us frame what startups do, and help provide a means to answering these questions. If you’ve seen similar frameworks, do share them.
Value Cycles
Note: The term value in used an intentionally abstract form to refer to anything that could be valued by another person/entity — this could be a physical object, or a blog post, or even just aggregated data on user behavior.
In every product that we build, there is an ecosystem with multiple producers and consumers of value. For example, in a Q&A site (e.g., StackOverflow), each user creates a piece of value when they post a question or an answer. The site distributes this post to a much larger audience, who consume this valued content. The amount of value received by a user browsing the question correlates with the quality of the content.
StackOverflow can be viewed as a value multiplier as it takes a single piece of content and multiplies its value by the numbers of readers that see it. On top of that, it could also enhance the value received by the end user who read the post by making the experience better. For example, it could surface the best answers to the top and allow users to more quickly get to the high valued content.
The core of many businesses can be viewed in this framework. Publishers take great content from writers and help them get it out to many consumers. Chip manufacturers take raw material and create components that are then used by other companies which put larger devices together, such as a laptop.
In most traditional businesses, a dollar amount is directly placed on the goods — figuring out revenue at the start was important. In recent times, the Internet era has brought about technology that enables low cost of entry, distribution, and scale. This has resulted in an explosion of startups that are starting with a focus on value before revenue.
In the value cycles framework, a startup can be viewed as an intervention in an ecosystem that aims to increase the amount of value consumed: it can do this by creating value, multiplying/distributing value, enhancing the consumption of value, or through other means that increase the value consumed.
Let us make this concrete with a few examples.
Airbnb utilizes the latent value in the empty rooms of many homeowners and connects that with travelers. They found a source of untapped value (empty rooms), and created a product to enable the creation and consumption of value for both the homeowner and the traveler.
On Github, developers derive value from having a place to host their code. Developers also create value by publishing open source code and interacting with others in the community. Github has created a product to empower an ecosystem of creation, distribution, and enhancement of value.
Using Google search, users get value by being able to find content that they are looking for. On the other hand, website owners get value through having traffic directed to them via Google.
Converting Value to Revenue
Monetization is a conversion of value to dollars. This conversion is often not straightforward and depends on the actual value consumed.
Using Google as an example, a user searching for “best car insurance” is probably looking to purchase car insurance — as a result, the value that they get is often large and thus easily converted into dollars (try this and observe the # ads you see). However, a user searching for “cute cat videos” will get a lot of entertainment value from the videos they find, but it’ll be much harder for Google to monetize on this search term.
On Github, the conversion from value to dollars is a bit more nuanced — some users derive much greater value from having private repositories. Putting this feature into the product enabled them to monetize the product at multiple tiers — it costs more if you want more private repositories.
A common theme that is important to point out here is that the technological differences between the how people use the product are small. For Google searches, the same technology applies in both searches; for Github, having more private repositories doesn’t significantly increase their technical costs.
The difference lies in the how convertible the value is to dollars.
It is often easy to think that people would pay for technology or features, when instead they are really paying for the value they are receiving.
In figuring out a business model, first understand the value that you are creating, and then discover the opportunities for converting them into dollars; keep in mind that this conversion sometimes becomes much easier with a new feature or condition (e.g., adding privacy to code repositories for Github).
Value Cycles and Growth Metrics
In the early days of a startup, figuring out the value cycles that drive the product is much more important than revenue. We often hear this phrased as growth.
However, growth is often misleading as it is often associated with vanity metrics like # user signups, # page views, etc.
What’s really important is growth in value: What value are your users getting from your product? How are they using it? Are they creating value while using it?
Understanding and measuring the value creation cycles is important for developing a product. This means finding good metrics that really matters — for Airbnb, this could be the # positive nights; for Github, it could be the # commits or forks; for Google, the # successful searches; for Facebook, the # connections formed. You might have more than one metric that matters as your value cycles becomes more complex.
That said, in the absence of a good metric, a generic good one to use will be user engagement rates by cohorts — if your users are coming back and increasingly so, that’s a good sign.
By working towards a metric that reflects the value you provide, growth strategies become clearer — it’s not just about acquisition or activation of users (which are local optimization tactics), but instead it’s working towards increasing the value users are getting.
If you’re getting more value to your users, they’ll come.
4 steps to a great startup
This leads to the following 4 steps to building a great startup:
- Understand the flow of value in your ecosystem. Create a value cycle diagram to understand what value different users are getting.
- Focus on delivering value. Do user need-finding to gain empathy and a deep understanding of problems. Use those to develop products that deliver value to your users. Look out for untapped latent value in your ecosystem to get more ideas for products.
- Look for opportunities to convert value to dollars. Understand the willingness to pay for different kinds of value. Figure out if additional conditions (e.g., privacy) need to be true to unlock conversion. Remember that people pay for value and not features or technology.
- Determine your metrics for tracking growth in value. Make sure that you are always providing value, and increasingly so.
Of course, there is a lot more that goes into a startup than just these 4 steps — one needs to be mindful about costs, building a team, and a ton of other factors. This framework was not intended to cover that; instead, it’s focused on figuring out product and business opportunities.
Thanks to Tom Do, Rosanna Chau for very helpful comments in reviewing this post.
