Financial modeling for start-ups Part II: Understanding the revenue model

In our previous post we saw how Aparna, an entrepreneur keen on starting her online garment store, starts to understand the metrics of an e-commerce business. Aparna is all excited to learn about new things and now wants to learn about the revenue model of her online store. Reena explains her-“E-commerce is a broad term and there can be various online businesses that can be classified under it. Each of these businesses have unique ways of making money. For your online designer outfit store, you can make money in three ways (1) Product sales (2) Advertisements (3) Affiliate Marketing.

Reena goes on to explain each of these models in details to Aparna.

Product Sales model

This is the revenue generated directly from the sales of the outfits. More than 60% of the revenue will be generated by this core model. It will take some time for Aparna before she starts realizing the revenue. The raw material procurement time, product development time, website setup time etc. Aparna will have to resort to paid advertisements and SEO techniques to draw visitors to her website. The formula for revenue generation is simple:

One of the very important elements here is the pricing of the products. Points to consider while determining the pricing of the products

  1. Will she be developing a new pricing model?
  2. Will the price be aligned with existing benchmarks?
  3. Will the price be competitive?
  4. Will the products being sold be exclusive and premium? Will this allow the brand to price its products at a premium?
  5. Will the price cover the cost and allow a reasonable profit?

What are the various assumptions that need to be considered while making a projection?

Affiliate Marketing

Another source of revenue that Aparna can consider is through Affiliate marketing. This is a revenue model where she will be paid a commission whenever a customer referred by this website to another site purchases something from there. Typically the referral commission rates are between 5% and 30% of each purchase she refers (depending on the type of product). Generally, the low-priced products have high commission rates while the high-priced products have low commission rates.

Points to consider while opting for Affiliate marketing-

Situation:  If Aparna makes referral sales of Rs 1000 products with 30% commission, she earns Rs 300 per sale. Similarly, if she makes referral sales of Rs 5000 products with 5% commission, she earns Rs 250 per sale. If Aparna sells 20 products priced at Rs 1000 then she would earn commission Rs 300*20=Rs 6000. And if she sells 20 products of Rs 5000, then she would earn Rs 250*20=Rs 5000.

Question: Will Aparna sell more of low-priced products or high-priced products?

Situation:  Since Aparna sells designer bridal and festive outfits, the visitors to her website are usually females with a taste for premium handcrafted garments. However, Aparna has received offers for affiliate marketing of men’s accessory website and a sportswear company.

Question: Should Aparna opt for affiliate marketing of these websites or look for something completing her products or her customer’s sense of taste such as a website selling jewellery or a women’s accessory?

What are the various assumptions that need to be considered while making a projection?

Advertisement revenue

When we browse through Facebook, many a times we see sponsored content. Online advertising is an immensely popular revenue model for online businesses. In this method, companies or organizations would purchase advertising space on Aparna’s site, provide a designed ad or written message, who will pay Aparna for allowing them to promoting their products. These sponsored Ads may be served by the site owners own ad server or through third party networks like Google AdWords.

The two common types of online advertising revenue model includes revenue-per-click. Revenue per click allocates value to each of the click.

Let us assume the cost of click is Rs 200 and the number of times an advertisement is clicked in a month is 100, this way Aparna can earn Rs 200*100= Rs 20,000 from advertisement revenue.

The advertiser considers the following while placing the advertisement on a particular website:

  • Targeting the audience
  • Quality of the advertisement and the size of space booked
  • Relevance to the audience
  • Time of the year