So let's talk about revenue projections.
Um, the height this is the most complicated I'm going to get to in terms of mathematics.
So I think you should define revenues equals price times volume.
The issue is figuring out what prices and figuring out what volume is.
That's what a revenue projection is going to be like.
So let's start with neither price nor volume, but in order to measure volume, we're going to have to figure out what it is that we're measuring.
This is obvious in some circumstances, but it's not totally obvious in other circumstances.
Some businesses are very simple in the sense that every customer looks roughly the same.
Some customers, some businesses. Every customer looks very different.
And we're going to start having to define something like an average customer.
We can be more sophisticated, but just defining what an average customer is is a good starting point.
So how would we do this? I just threw up a few examples.
Where we have to think, how are we going to count our customers?
Well, in a museum, it's pretty easy. People often don't come back to a museum.
So at least in a simple world. So we're just going to count the number of visitors in our museum on a particular day, week or year.
Well, we're going to go to a restaurant and a museum. Everybody pays the same.
So maybe we're going to account for the fact that at some discounted prices and some and regular ticket prices.
Now, if we're going to a restaurant, we're also going to count.
Well, how many customers do we eat? Come. It's a bit more complicated because some customers eat three courses, either eat one course.
So and they've all pay different prices.
So we're going to have to work harder and saying the typical customer in my restaurant is going to pay £15 or £25 or £5 or whatever it is.
So we have to think a little more about it. Now, this is great, but let's go to a different world, an online newspaper.
Oh, well, that's very different,
because I can't just count the number of people coming into my restaurant because it's a completely different business model.
So you probably have to think about the number of annual subscriptions, plus the fact that half of the people want to have the content for free.
And so our unit in which we're going to count our revenue is very different.
Online video game. It sounds like the same like online newspaper.
No, it's not, because in our online video game, there are all these additional revenues that players get from buying additional features and,
you know, special hats and costumes and swords and so on.
So we're going to again, struggle with just defining it.
What is the unit that we're selling? Because we're selling more than one product.
A nuclear power station now gets really interested.
How are we going to do that?
Well, first is we're going to have an incredibly long horizon, obviously, but we're going to have to sell what's the unit that we're selling.
And then you have incredibly varying prices in the energy market.
So, you know, you're obviously selling kilowatt hours or something like that, but at very different prices.
Fashion consultant. Now, here's an interesting one.
What is how are we going to build a revenue model with prices and quantities for a fashion consultant?
Because a fashion consultant might just have three or four clients.
And so we really have to think of the unit as a contract.
But some contracts are going to be relatively short engagements.
Some of them are going to be long term engagements where I'm going to work a lot with one particular client.
So we're going to challenge it's going to challenge us to think really hard about our business,
to even think, how do I think about different customers,
military subcontractors, kind of actually similar, except that in that case, in the case of military subcontractor, you typically have one client.
So there's really no meaningful often it's just one contract and you're trying to figure out what's that contract worth.
The point I'm trying to make is you look at these industries, there's huge differences in how we defined a unit of analysis.
Now, once we defined a unit of analysis, we can use relatively similar techniques across all industries.
We're going to start by estimating prices. This is basically the question What can I charge to my typical customer?
This could be the person coming through the museum, through the restaurant. It could be the online subscription price.
How do I do that? Well, the different methods for coming up with an assumption of what we think is a price that our typical customer is going to pay.
By the way, if you want to get more sophisticated, you recognise the fact that different customers have different willingness to pay.
And you can you don't have to do the average customer. You can do a set of different customer profiles.
But I'm trying to keep it simple for now.
One customer, I can basically have a very customer centric view that says what value add my bringing to this customer?
What is his or her willingness to pay? This could be in if you're selling to businesses in order to assess their willingness to pay,
you might do a slightly more complicated calculation where you're going to prove them.
This is how much money I'm saving you, and therefore you should be willing to pay me half of your savings.
We call that our return on investment logic, where if you buy this, you guys as a corporation, you're going to get a return on investment.
That's typically not how you would think in a business that's selling directly to consumers.
But you still worry about the basic question What is their willingness to pay?
And you definitely want to segment your customers because their willingness to pay is going to differ between the early adopters and a mass market,
say. There are different logics, though, and I'm just giving you a way of thinking about them.
And you're going to mix these ways in coming up with your best estimate.
Another very different one is sort of a competitor based logic.
Think of a spectrum of cost in all prices.
I could have said here. Think of a spectrum of the prices people are willing to pay as a function of quality.
Think of hotels. Well, so what you're going to do is you can say, well, people obviously want a place to stay overnight.
So there's a willingness to pay.
But the price I'm going to be able to charge are largely determined by the sort of price quality trade-off that's in the industry.
So I'm going to have a real cheap motel. Well, there's no way I'm going to charge more than the Four Seasons.
So my pricing is constrained by the sort of price quality spectrum that I'm finding in the industry, and that's a competitor based logic.
And you want to think about the market dynamics.
So for example, in technology markets, you often a hardware markets say you have market dynamics that says prices are falling over time,
sometimes very rapidly, and you really want to think about where you are and in those price dynamics and then.
Sort of the opposite picture is typically when you're coming into an industry.
And by the way, I don't really recommend that as a strategy.
You've got to be careful with it. But many people come in at a low price.
I don't have any customers. I'm competing against everybody else.
Let me come in at a low price, sometimes a terrible strategy because you're undervaluing yourself.
You're sending the wrong signal to the market. In other cases, it's a reasonable strategy.
But the point is you're basically figuring out the prices you're going to charge as a function of what the competition is.
And then you say, Well, my introductory price is going to be at a 20, 30% discount to something like that.
These are all competitive logics, and there is a sort of third logic that is worth being aware of,
and that's sort of the constraints that are imposed by the values and value chain.
So here I just sort of produced a simple value chain where we're thinking about whom are we selling to?
Are we selling our product to a distributor? In which case, well, maybe this is, say,
a $9 price or now we're actually selling our product straight to the retailer because we're going to do the distribution.
We're talking about a different price range,
and that's completely different price range you get from being the retailer yourself and selling directly to consumers and even there.
Don't be fooled by the suggested retail price because only a small fraction of customers actually paid a suggested retail price.
So in building our pricing expectations, we have to be aware of these industry dynamics and get familiar with them.
These are a bunch of tools that we can use to generate the prices that we're going to use.
By far the most times you're going to spend on trying to figure out estimate are estimating your quantities.
How many units am I actually going to sell? And I'm going to give you four different techniques.
And each of these techniques are reasonably practical.
And in some businesses, some of them work better than others.
In an ideal world, you're going to combine them all, but that doesn't always work.
So the first before we do that, I think it's really useful to have this tiny little S-curve in mind.
The S-curve, I think, is incredibly helpful for thinking about start ups,
and it's incredibly helpful to think about new versus established industries.
What is it? It's basically a curve that says over time the revenues of a, let's say, firm.
You can do the same thing at the industry level, but, you know,
at the firm level are going to increase, but they tend to increase in an S-curve like shape.
Now, this is not a universal truth, but people have studied industries and firms have found that there's a lot of truth to that.
And there's some good reasons that basically in the beginning.
In the beginning, things are very slow and there's obviously a high uncertainty,
which means a lot of companies just tanked down here and they don't go anywhere.
But if the ones that continue, you then sort of see a rapid growth phase and then you see a slowing down growth phase in a mature market.
So this is a start-up, this is a growth company and this is an established company.
How are you going to do your financial projections is going to depend a lot on
which of these three types of companies you are a start-up growth or mature.
And the same is true whether you are in a new market, a growing market or a mature market.
Your financial projections are going to look different. And we're going to see this S-curve coming back in a moment because it's really a useful tool.
So top down, how we're going to do top down revenue projections.
Well. The idea. I'm going to give you an example in a moment, but I'll just give you quickly a sort of a description of the method.
Is you basically going to look. Not at your own business, but at the market.
And you're going to try to say this is something you have to do in your business plan anyway.
Every investor that you're going to present to is going to say, how big is the market?
And so you want to have an intelligent answer for that anyway.
Well, that intelligent answer can then also be used for informing your financial projections.
And in an existing market, if you can use secondary market data and say the market for fashion ties is x millions of pounds.
I because I looked it up online, it's generally available information.
That's the business I'm in. And if you're in an emerging market, you can't really do that.
That's where you're using the S-curve in order to sort of think about it and give a theoretical
reasoning of why you think this thing that nobody's buying today will be a big hit in a few years.
And now, classic mistakes. Everybody in China will buy my product.
That's simply never true. And the other thing.
Please, please, please never make that sentence. I only want 1% of the computer industry.
It's meaningless. If you say that I only want this tiny little fraction of this market.
Well, 1% of the computer industry is ginormous.
So it's not small. Just because it's 1% doesn't mean it's small.
But it also means that if you're only one 1% of the market, it means you don't understand your market.
You have not segmented and categorised your market properly because if you had,
then you should be dominating or playing more significant role in your niche.
That's a classic mistake. Now, let me actually give you an example.
This is actually comes out of a Harvard case study where we have a company that's
trying to give retail care treatment to patients in a sort of clinic fashion.
And they want to do this. And it's a very interesting business idea as the real business behind this.
It's now some years ago, and they want to introduce this concept into China and they want to introduce this concept into Taiwan.
And I just want to show you how people figure out the market sizes and on the basis of this example.
The beauty of this is Taiwan is a mature market that's at the top of the S-curve.
China at this time is at the bottom of the S-curve, not established market.
So here is a couple of statistics that you can find.
Population is now out of date is probably growing, you know, by a million every year, several millions and millions every year.
But at the time, basically, China had 1.2 billion people compared to 21 million in Taiwan.
And now this is the incidence rate of kidney failure, which is the symptom that we're treating.
And we're basically going to assume that people in Taiwan and China have similar health.
We could debate that, but we actually have data on the incidence rate in Taiwan.
And so we're going to apply that to China. Classic trick.
We understand one market. We're going to import the assumptions from one market into the market that we're interested in, say, China.
So now we're going to get the number of people who have early stage renal disease, which is basically the symptom that we want to treat.
And we're going to say, well, here is really interesting. We're not in Taiwan.
Taiwan is a very a market, a very advanced health care system.
We can treat everybody more or less so 100% coverage.
That's never going to happen in China. So, you know, the way we're going to offer these clinics, our target market is not all of China.
It's not rural China. It's urban China. And this estimate was 30% of people live in urban China, depending on how you define it.
So now we've narrowed down already the number of people that we're going to be able to treat.
And then we're going to say, oh, my God, not everybody can afford this. Well, Taiwan has complete health coverage, so everybody gets it.
China, it's private health insurance. Only 30% of the people can actually afford it.
So now we're going to be down to much lower numbers.
We can charge hundred 56 for a typical treatment session in Taiwan.
We can charge a third of that in China. And then we figure out how often does our customer come in a year and we can estimate the market.
So now the annual revenue we're going to get per patient is calculated here.
And based on this, we're actually calculating a market size.
By the way, this is a great exercise to do because what you're doing is you're starting with
a very large market and you're trying to figure out what is my relevant market.
The mistake you should not do is to take the number that we have up here,
which was basically 750,000 people and say we're going to have a market of 750,000 people and treating them,
I'd say $53 because the relevant market really shrank down to something much smaller, 67,000.
What we're getting at the end of the day, though, is an estimate of the market size.
And I've given you a little bit of detail with an example of how to get there.
Now we're going to use the second method.
This is a top down method, and you can see why I'm calling it top down, because we're trying to understand the whole market, how much is out there.
I have not talked about how much of the market I'm going to grab.
So in these calculations, I'm not saying that I'm going to capture 268,000,
and I'm just saying there's a market of 268,000 and somebody is going to grab it.
Okay. Now, bottom up revenue projections is kind of the opposite logic top down for you, for those economists in the room is a demand driven logic.
Bottom up is a supply driven logic. So I'm basically going to think about what am I going to be able to deliver?
I'm going to define my unit. We've done that already.
I'm going to estimate the number of customers multiplied by the average price estimate customer growth over time.
And I'm basically focusing on what I think I am able to sell.
So let me give you an example. This is some tasty fast switching.
This is a business plan of one of my students from a few years ago who thought that it's a delicious South American dish,
fresh fish with some some lemon. And they wanted to turn this into a fast food concept, basically.
Great idea. It's a new restaurant concept. How would we figure out our revenues?
Well, we start by saying what's our revenue from a typical customer?
So I turn it into pounds here.
So let's say they're going to eat as a side dish in a drink and we're going to offer that at £10, you know, probably, probably too cheap.
But number of customers in our operations.
Well, you know, we we may say at lunch, we can serve 50 people afternoon very operational numbers that are going to give me some idea oh,
this is really something that we're going to do. The concept was to do it in your offices.
This is sort of more appropriate for that business plan.
So we're only open five days a week. That's going to have a huge impact on my revenue projection of whether I operate five or seven days a week.
But anyway, what you doing is you just counting of numbers.
And in this particular case, the estimate will come to just under £300,000 of revenue.
Now, is this the right number? I have no idea.
I just made some assumptions about people coming to my restaurant.
So. But I know I can't deliver a lot more because I just don't have the capacity of holding more than 50 people for lunch or the evening.
That's a bottom up logic. You want to be very careful here about how you ramp up revenue.
So a classic mistake with a bottom up approach is to assume that you're at full capacity from the start.
You're not going to be at full capacity from the start.
These calculations, for example, assume that my restaurant is operating on full scale right away.
If I was more careful then I would sort of build that up over time.
Okay, so now I've given you two methods. I've given you a top down and have given you a bottom up.
Um, so, um, we're going to try to combine them and the answer is basically the bottom up should be well below the top down.
If the bottom up say what you can do is you can calculate the market,
share the bottom up basically gives you what you think you're going to make the top down, gives you what there is in the market.
You divide one by the other, you get a market share. And so, you know, if you somewhere say below 10%, then you're probably not aggressive enough.
Maybe you should try to sell more of your product if you're getting more, you know, say between ten and a half,
50% or something, maybe they're realistic, but you have to sort of have an argument.
If you're getting above 50%, you have to say, am I really able to dominate this market?
Am I going to be the biggest player in this market?
If you're above 100%, you clearly have a problem because you projected that your revenues are more than what the market's actually able to bear.
Okay, I'll go quickly through the other ones. Um. Copycats.
Industry. What we can do in some businesses is we can compare ourselves to the industry and we can compare ourselves to our own past.
This is mostly for more established businesses, so I'll sort of go quickly through.
One important inside, you use the S-curve. If you're just going to use your own past or what everybody else in the industry is doing,
you're going to underestimate the early growth because you're basically doing a linear projection of
what's already happening and you're going to overestimate your growth in the rapid growth phase.
And it's only in established businesses that you're going to come up with a reasonable estimate.
Looking at your own past, the point here is established businesses.
You can use your past growth rate and that's probably not a bad predictor. Start ups typically doesn't work.