[YC Startup School] Startup Business Models and Pricing
[YC Startup School] Startup Business Models and Pricing

[YC Startup School] Startup Business Models and Pricing

Date
Feb 15, 2023
Tags
Start-up
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My notes on Startup Business Models and Pricing with YC Group Partner Aaron Epstein

Previous Blog Post:
[YC Startup School] Notes on “Should you start a startup?”
[YC Startup School] Notes on “Should you start a startup?”
[YC Startup School] Key takeaways from “How to get and evaluate ideas”
[YC Startup School] Key takeaways from “How to get and evaluate ideas”
[YC Startup School] How to talk to Users
[YC Startup School] How to talk to Users
Next Blog Post:
[YC Startup School] How to get your first customers
[YC Startup School] How to get your first customers

9 business models of (nearly) every billion-dollar company

SaaS (Software as a Service)

Cloud-based subscription software
notion image
PRIMARY METRICS:
  • Monthly Recurring Revenue (MRR) or Annual Recurring Revenue (ARR)
  • Growth Rate: Measured weekly or monthly
  • Net Revenue Retention: % of recurring revenue retained from a prior period
  • CAC: Costs to acquire a new customer
TAKEAWAYS:
  • All the benefits of recurring revenue
  • Can have non-recurring revenue, but don’t include in ARR/MRR
  • Usually sold to businesses, ideally on annual contracts
  • Growth can be driven by direct sales, self-serve acquisition channels, or both

Transactional

Facilitate transactions and take a cut
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PRIMARY METRICS:
  • Gross Transaction Value (GTV): Total payment volume transacted
  • Net Revenue: Fees charged for transactions (often a %)
  • User Retention: % of month 1 customers that make a purchase in month 2, etc
  • CAC
TAKEAWAYS:
  • Usually fintech and payments businesses
  • One-time transactions rather than recurring
  • Often high volume with a low fee (1-3% is common)
  • Best transactional businesses have extremely consistent revenue from high repeat usage

Marketplaces

Facilitate transactions between buyers and sellers
notion image
PRIMARY METRICS:
  • Gross Merchandise Value (GMV): Total sales volume transacted
  • Net Revenue: Fees charged for transactions (often a % take rate)
  • Growth Rate
  • User Retention: % of month 1 customers that make a purchase in month 2, etc
TAKEAWAYS:
  • Hard to get off the ground, chicken & egg problem
  • Need to scale supply and demand in sync
  • Network effects at scale drive exponential growth
  • When they work, often become dominant winner-take-all winners

Subscription

Product or service sold on a recurring basis, usually to consumers
notion image
PRIMARY METRICS:
  • Monthly Recurring Revenue (MRR) or Annual Recurring Revenue (ARR)
  • Growth Rate: Measured weekly or monthly
  • User Retention: % of month 1 customers that make a purchase in month 2, etc
  • CAC
TAKEAWAYS:
  • Recurring revenue is the most valuable revenue
  • Usually sold to consumers, often paying monthly
  • Usually lower price points, from a higher volume of customers
  • Growth driven by scalable, self-serve acquisition channels

Enterprise

Sell large fixed-term contracts to big companies (5k+ employees)
notion image
PRIMARY METRICS:
  • Bookings: Total signed contract value (recurring + non-recurring)
  • Revenue: Recognized when delivering on the contract
  • Annual Contract Value (ACV): Total contract value / # of years
  • Pipeline: Top of funnel → Demo → Close
TAKEAWAYS:
  • Very few customers, much larger deals ($100k+/year)
  • Growth driven by direct sales
  • Often begin with paid pilots or LOIs
  • Usually long sales cycles, with many gatekeepers
  • The buyer is not always the end user
  • Lumpy growth: measuring m/m growth rate doesn't make as much sense

Usage Based

Pay-as-you-go based on consumption in a given period
notion image
PRIMARY METRICS:
  • Monthly Revenue (not recurring!)
  • Growth Rate
  • Revenue Retention: % of revenue from last month’s customers in this month
  • Gross Margin: Revenue - Cost of Goods Sold (COGS)
TAKEAWAYS:
  • Don’t confuse usage-based revenue with recurring revenue
  • Charge per API request, # of records, data usage, etc
  • Grow as your customers grow
  • Product and pricing scale to support tiny startups to large enterprises

E-commerce

Sell products online
notion image
PRIMARY METRICS:
  • Monthly Revenue: Total sales
  • Growth Rate: Measured weekly or monthly
  • Gross Margin/Unit Economics: Revenue - Cost of Goods Sold (COGS)
  • CAC
TAKEAWAYS:
  • Includes D2C brands and Shopify stores
  • Not marketplaces, so keep 100% of each sale
  • Higher COGS = lower margins
  • Products often commoditized
  • Need to be excellent at user acquisition and operations/unit economics

Advertising

Sell ads to monetize free users
notion image
PRIMARY METRICS:
  • Daily Active Users (DAU): Unique users active in a 24 hour period
  • Monthly Active Users (MAU): Unique users active in a 28 day period
  • User Retention: % of active users on D1/7/30/etc
  • CPM (Cost Per Thousand) or CPC (Cost Per Click)
TAKEAWAYS:
  • Typically consumer social products with huge scale
  • Customer is the advertiser, not the end user
  • Users are the product being sold
  • Need billions of impressions each month
  • Registered Users is a vanity metric

Hardtech/Bio/Moonshots

Hard businesses with lots of technical risk and long time horizons
notion image
PRIMARY METRICS:
  • Milestones: Progress towards the long-term vision
  • Signed contracts
  • Letters of Intent (LOIs): Non-binding contracts indicating interest to purchase
TAKEAWAYS:
  • Often take years to get to a live product because of technical and/or regulatory risk
  • Impressive technical milestones or experimental data can de-risk the tech
  • Revenue is often years away, so signed LOIs are usually the best way to show customer interest

Business model lessons from top 100 YC companies

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Interesting points

SaaS business → 31% of the top 100 YC companies (recurring revenue make for great businesses)
Transactional → 22% of the top 100 YC companies but create 29% of the overall value
Marketplaces → 14% of the top 100 YC companies but create 30% of the overall value
5 of the top 10 YC Companies are Marketplaces. But tough to get off the ground because you have to supply for both sides of the marketplace: supply and the demand
Only 3% of the top 100 YC companies are advertising because they need organic virality (Twitch, Reddit)
Don’t sell ads unless you will be a top 10 site on the internet.
 

What’s not in the top 100

→ Services or consulting businesses
Problems:
  1. Non-recurring revenue
  1. Scaling with people
  1. Low margins
→ Affiliate businesses
Problems:
  1. Too far away from the transaction
→ Hardware businesses
Problems:
  1. Requires lot of capital
  1. Low margins
→ Businesses built on other platforms
Problems:
  1. Platform risk if the business gets shut down
 

Recurring revenue consistently creates winners

  • High predictability
  • Higher customer Life Time Values (LTVs)
  • Lower Customer Acquisition Costs (CACs)
 

Biggest winners built with moats

  • Network effects
  • Lock-in or high switching costs
  • Technical innovations: Cruise with self-driving cars
  • Higher margins or better unit economics
  • Organic distribution through virality or word-of-mouth
 

Characteristics of the best businesses

  1. Generate recurring revenue
  1. High retention rate
  1. Build defensible moats
  1. Close to the transaction
  1. Scale with software, not people
  1. Proven and business models that are familiar to customers
 

Startup pricing insights

What pricing can teach you:

  1. Who wants your product
  1. How much they want it
  1. How much value your product provides
  1. Which channels you can use to acquire customers
 

You should charge for your product or service!

→ Can learn about whether your users are willing to pay or not
→ Find the right “order of magnitude”
→ Pricing isn’t permanent, will change over time so don’t overthink it
 

Price on perceived value, not costs

How to find your value?

→ Talk to your users: “What is the problem that you are hoping our product could solve?”
  1. make more money
  1. reduce costs
  1. move faster
  1. avoid risk
→ Keep raising prices until you get pushback. Ideal price is when customers complain but they still pay
→ Don’t undercharge that your competitor. Don’t have price as the only differentiator.

Pricing implies value

 

When it is okay to give a lower price

→ for your first user
→ for a valuable logo (recognizable logos for social proof)
→ if you get lock-in
→ if you can renew at a higher price
 

Keep your pricing page simple!

Example: GitLab
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References: