Three Kinds of Revenue

Quick Summary: Revenue develops in stages; understand where you are and what you want.

Abstract:

Pursuing revenue is a universal activity for all companies.  However, understanding what revenue really means and its implications are often not considered and can lead to missed expectations or even disastrous results. Knowing the different types of revenue, their timing, and their implications is critical.

There is a saying in the real estate industry: the three most important things are location, location, and location.  Similarly, for startups, the three most important things are revenue, revenue, and revenue.  Although the location concept for real estate is the same, revenue for startups needs to be thought of as belonging to three different categories.  They are referenceable revenue, scalable revenue, and profitable revenue.

It is very important for startups to understand the differences between these three categories in terms of their timing, characteristics, and impacts on the business.  Quite often the distinctions are not made or they are pursued in an inappropriate order which can result in serious consequences.  Before discussing the differences, it is important to define the term “revenue” when used in this context.

The term “revenue” can take on many different meanings or interpretations.  Quite often individuals can be discussing revenue with each person assuming a different definition. In general, it is defined as the income generated from the sale of goods or services.  However, each term (“income”, “generated”, and “sale”) can mean different things to different people depending on their context.  Startups are almost always cash constrained, with virtually every decision impacting cash requirements.  Although following GAAP standards is ideal, it must be remembered that “cash is king” and is the only thing that pays the bills.  So, in this context, “revenue” is defined as the amount of cash received in-hand from a customer in exchange for the goods and services provided.  Long-term contracts are great, but future payments won’t pay the bills today.  With the new restrictions on bank loans, many companies find themselves in the position of being unable to secure loans to fund operations.  Many of these companies go out of business even though they have actual orders or contractual commitments from customers because they do not have the funds to fulfill those orders.

The three types of revenue are briefly summarized below.  Separate articles in this series provide more details and observations.

Referenceable Revenue:  What Others Do

Although you can assume you have designed a product or service that meets prospects’ requirements, you cannot be sure until customers have purchased and paid for your product.  Ideally, customers will have repeatedly purchased it or provided positive recommendations to others who have also purchased it.  It is not what you say or think that counts, it is what customers do – pay and be satisfied or delighted with their purchase.  When you have a number of referenceable customers, you have significantly de-risked your business and are more likely to appeal to investors.

Scalable Revenue: Repeatedly Sold by Others

Quite often the entrepreneur or CEO can make initial sales perhaps with custom commitments, “hand-built” products, or configured services.  These types of sales do not require any repeatable, volume processes and can be very misleading about the ultimate size of the business.  Being able to scale the sale, fulfillment, and support processes to support high volumes is critical to the long-term success of a business. Once funded, the inability to scale sales and operations is probably the single largest factor that causes new businesses to fail.

Profitable Revenue: More Than Margin

High gross margin (revenue minus product costs) is not enough.  “Below the gross margin line” costs must also be carefully considered.  The actual cost to place a product in a customer’s hands is often grossly underestimated as is the long-term cost to support customers.  Other overhead costs can also significantly overwhelm high individual product margins until higher volumes are achieved.  Understanding the total cost of fulfilling a customer order is critical in determining its profitability.

 

From the above brief discussions, the differences in the revenue categories should be obvious.  Each will require different tactics, strategies, and emphasis at different points in time.  Knowing what to do, when to do it, and understanding the metrics and goals of each category will provide an orderly long-term plan to help the company meet its objectives.

Article Number : 3.040202   

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