Every business, irrespective of its scale, stage and size, has only one long-term goal: to generate profits. In the short term, startups may burn a lot on marketing or focus heavily on product development, but its long-term sustainability is possible only if it makes profits. 

Profit is essential for the existence of any business. It’s needed to repay investors, provide dividends, and power the next phase of business. Most importantly, it’s the strongest indicator of value created in the market. 

However, it’s also one the hardest challenges a startup faces in its entire journey. Customers aren’t quick to pay, and clients need to see real value, which requires a lot of experiments, research, funds, etc. To identify what ticks their customers, the startup team spends a lot of time experimenting with different models and tracking its impact on customers.

Based on the product, sector, scale, and many other factors, startups experiment with different models and observe which works best for them. In this article, we’ll cover the most important business models and metrics to track the essential aspects of the model.

1. The Enterprise Business

One of the important business models is the enterprise model, in which a company sells software or services to large enterprises. The main focus of an entrepreneur when working with enterprises should be on contracts, from which one may derive the necessary metrics. In general, an enterprise company should track the metrics related to profits such as the number of bookings, total customers, revenue, etc.

1. The Total Value of Bookings: It refers to the total value of the business agreements signed by the company. 
2. Total Customers: It refers to the number of clients that have made a booking or the total number of unique contracted customers by the business.
3. Revenue: It refers to the earnings generated by the company. Revenue should be recognized when the service is actually provided over the life of the agreement.

Sometimes, startups misinterpret revenues while calculating related metrics. For instance, let’s consider a startup that has signed a contract which needs to be serviced in the next year. Despite the fact that the contract period hasn’t started, sometimes startups include it in the revenue. This is an inaccurate indicator of revenues, since it isn’t being matched with expenses, and the contract might get canceled midway. Instead, startups can create new metrics to track such numbers. It will give more clarity on the actual earnings of the business.

2. The SaaS (Software as a Service) Business

An organization that sells subscription-based software licenses for cloud-hosted solutions uses a SaaS business model. The SaaS business model allows subscribers and other customers to use the SaaS software with an annual or monthly subscription rather than a one-time fee. This type of model allows startups to generate monthly recurring revenue while focusing on new features, new products, better service, and other benefits that offer lifetime value to both new customers and existing users. Examples of SaaS companies are Salesforce, Mailchimp, Slack, Shopify etc. 

Additionally, SaaS companies should track a few key metrics to make sure they are growing and attracting investors. The most important metrics are:

1. Monthly Recurring Revenue (MRR): It is recurring revenue normalized into a monthly amount. It estimates the amount paid by users that will pay for subscriptions on a monthly basis.
2. Annual Recurring Revenue (ARR): It represents the money that comes in every year for the life of a subscription. Compared to MRR, it shows the pace of revenue, rather than just the absolute number, and provides an annual snapshot of the company’s subscriber base.
3. Gross Monthly Recurring Revenue Churn rate: It is the percentage of revenue lost due to cancellation or downgrades. This metric is important especially when the company is at an early stage and only has a few customers. Losing even one or two will have a real impact on revenues.
4. Paid Cost to Acquire Customers (Paid CAC): It is the total acquisition cost/customers acquired via paid channels. Initially, startups focus on acquiring users organically, but in the later stages, startups might turn towards paid channels to acquire users.

When calculating the revenue the founders of SaaS startups should keep in mind that a recurring revenue business does not require customers to commit to an annual payment. The timeframe of a contract can vary based on the business in context. Startups can evaluate the general consumer’s requirements and set their own recurring payments accordingly. This factor should be taken into account while making estimates or projections for key revenue metrics. 

3. The Subscription Business

Subscription business models are based on the idea of selling a product or service to receive monthly or yearly recurring subscription revenue. They focus on customer retention over customer acquisition. In essence, subscription business models focus on the way revenue is made so that a single customer pays multiple payments for prolonged access to a good or service instead of a large upfront one-time price. Netflix is an example of B2C that follows the subscription business model. There is not much difference between the metrics of a SaaS model.

1. Monthly Recurring Revenue (MRR): It refers to the revenue generated by recurring services in a month. The revenue does not include one-time or non-recurring revenue.
2. Compound Monthly Growth Rate (CMGR): It refers to the average of month-over-month growth over a range of  6-18 months. In general, in a subscription-based company, the subscription revenue is small, so the company can consider this metric to track its performance.
3. MRR Churn: It is the monthly erosion of monthly recurring revenue. It’s important for startups to identify the reason and address it at the earliest.
4. Paid CAC: It refers to the total cost of acquiring customers through paid channels. 

4. Usage-Based Business

The usage-based business model is a consumption-based model in which customers are charged only when they use a product or service. Typically, the customer is billed at the end of the billing cycle. Some simple examples are, paying power bills based on the amount of electricity used, paying AT&T for data usage, etc. This model is being frequently used by SaaS companies now. It could become a leading pricing model of choice for SaaS businesses, overtaking the subscription-based model.

Twilio and Stripe are excellent examples of software companies that implemented a usage-based pricing model rather than a subscription-based model and saw great results. Usage-based business models also have similar metrics as subscription based models.

5. The Transactional Business

A transaction-based model is a classic way a business can earn money. The revenue is generated by directly selling an item or a service to a customer. The customer can be another company (B2B) or a consumer (B2C). The price of the product or service constitutes the production costs and margin. By increasing the margin, the business is able to generate more income from sales. In this case, Paypal and Stripe are examples, since they charge the user every time they use their services. The most important metrics here are:

1. Gross Transaction Volume (GTV): Refers to total sales or payment money volume transacted in a given period. However, the volume of payments that goes through the company platform isn’t revenue. The real revenue is Net Revenue, which is explained below.
2. Net Revenue: It refers to the money that one takes out of the transactions flowing through platform. In other terms, the money that goes into the company’s bank account for each transaction.
3. User Retention on a Monthly Basis: User retention rate measures the percentage of users that are staying with the startup’s service from month to month. In general, since the startup’s services enable the customers to generate money, there should be no reason for them to cease utilising their platform. 

It is extremely common for businesses to confuse Gross Transaction Value (GTV) with Net Revenue and count only cash entering the account without considering how many transactions are being made. Startups should remember this while measuring their own business performance.

6. The Marketplace Business

An organization that facilitates the exchange of goods or services between two consumers is working with the Marketplace Business model. A marketplace business model is the marketing, sales, and operational framework used for running a business. Some examples of marketplace companies are Airbnb, eBay, and Booking.com. The purpose of a marketplace is to facilitate the exchange of goods and services between sellers and buyers. Key Metrics that the company needs to track are:

1. Gross Merchandise Value (GMV): It is the total amount of sales a company makes over a specified period of time, typically measured quarterly or yearly. In the case of renting or selling a good, the marketplace company will receive a portion of the price set by the user.
2. Net Revenue: It is the portion of the GMV that a marketplace company gets in their bank account.
3. Net Revenue Compound Monthly Growth Rate (Net Revenue CMGR): It refers to the implied compounded monthly net revenue growth rate between two disparate months.

Laying the right foundation for any business often requires more work than one may realize. Paid user acquisition and organic user acquisition are mixed in a marketplace business model. Without separating these two metrics, it’s hard to determine whether the businesses’ growth will be sustainable.

7. The E-commerce Business

The E-commerce business model allows businesses and consumers to make purchases or sell things online. It is an online store that sells physical goods. In general, they manufacture and inventory the goods they sell. Amazon is a good example of an E-commerce Business model. It is possible for an e-commerce company to make its own products, but it is also possible to source them. There are some products on Amazon’s platform that do that as well. Keep in mind that users will return to utilise the startup’s brand and services time and time again.

Key Metrics to track here include:

1. Monthly Revenue: To compute gross monthly revenue, add up the startup’s total sales revenue for the month. Since there are no recurring purchases, the company needs to track the monthly revenue.
2. Revenue Compounded Monthly Growth Rate (Revenue CMGR): It measures the return on an investment over a certain period of time, and the revenue that comes from it. Since it’s a consumer product, track volume, and because averages aren’t everything, track compounded.
3. Gross Margin: It is calculated as gross profit in a given month divided by total revenue in the same month.

8. The Advertising Business

The advertising business model is a revenue generation strategy driven by advertising. In this industry, free services are provided in exchange for advertising. Twitter, Reddit, and Snapchat are some examples of businesses that use such a business model. These platforms are the most crucial component of the firm, especially if it is still in its early stages and is used by a large number of consumers. Key Metrics of an advertising business model are discussed here:

1. Daily Active Users (DAU): It is the measurement of the number of users who are active on an app or website each day.
2. Monthly Active Users (MAU): The number of unique users over the course of one month.

A major issue in the advertising business model is the lack of a reasonable definition of “active.” Being honest with business is essential. It is the founder’s responsibility to define what an active user is in relation to the product they are developing. Some founders even forget to take that into consideration at some point and they end up regretting it.

9. The Hardware Business

Hardware business models refers to businesses that offer actual physical goods to their customers. Some prominent examples of such businesses are: Fitbit, GoPro, Xiaomi, etc. Most of its KPIs are similar to e-commerce businesses.

Key Metrics to track for a hardware company:

1. Gross Monthly Revenue: To figure out gross monthly revenue, add up the total sales revenue for the month.
2. Revenue Compound Monthly Growth Rate (Revenue CMGR): It refers to the compounded monthly revenue growth rate between two disparate months. 
3. Gross Margin: This metric is relevant when the company is making money on each transaction. It answers how much money the startup is earning per sale. It’s considerably critical in the hardware business since it’s not recurring – which means the startup needs to generate money on each transaction.
4. Paid CAC: In simple terms, it refers to the average spending by a company to acquire a customer. This metric is also useful to calculate ROI (Return of Investment) per customer.

Conclusion

This article introduces various business models on which a startup can experiment with while running their business. Innovating in the business model can provide significant growth rate to the business. Hence, startups should ensure that they never lose sight of their customer’s needs and innovate their business model as per the needs of the market. This will improve the startup’s chances of survival and increase its scope of existence in the future. 

Note: Multiple references along with our personal insight was used to create this article. However, the primary inspiration behind this article was the Y Combinator’s session by Anu Hariharan on Business Models.

Useful KPIs for SaaS-Based Startups