Value and growth models

05.899/499
Value and Growth
Models for Lean
Startups
Jim Morris
Spring Semester 2014

05.899 & 499 Mobile Service Innovation Spring 2014 2
Why Quantify?
• If you start a business you will have to measure
performance: cash on hand, cash flow, revenue, costs,
profit, growth rate, even stock price.
• There are many other measures that can be used to predict
financial ones, e.g. number of users.
• Your value and growth hypotheses are theories. To tell if
they are good theories, you need to measure the things
they predict.
• The theories start with rough numbers that experience will
refine.

Your Secret Weapon
• Unlike old, “bricks and mortar,” businesses
internet businesses can easily measure many more
things about users.
• Each user can be followed, recording every
interaction and its outcome, predicting her future
interactions—without even asking her!
• Your quantified value and growth hypotheses will
tell you what measures to build in as you
implement the service.

A Simple Service
Providing a service to a uniform
population for a fee.

A Simple Value Hypothesis
A Site with App Member
Service/$
• The member joins and pays a
monthly fee until she resigns.

Quantifying the Simple Value
Hypothesis
• Double-click the table to get the Excel®
spreadsheet.
Time period is a month
Description Source Value
Revenue Members Goal 7,000
Fee Choice $1.00
Revenue Members*Fee $7,000
Costs CPM* http://www.labnol.org/internet/average-cpm-rates/11315/$10
Number of Ads Choice 100,000
Advertising Ads*CPM/1000 $1,000
Computing Service Guess, Heroku $500
My Salary Choice $5,000
Costs Advertising+Computing $6,500
Profit Revenue-Cost $500
* Cost per 1,000 ad appearances. See http://www.labnol.org/internet/average-cpm-rates/11315/

Development and computing
costs are insignificant.
• The development costs occur only once, so
are not part of the value diagram, which
reflects just ongoing costs.
• The ongoing computing infrastructure
costs—servers, networking—are small
relative to things like marketing expenses
and office staff. They can be free until you
have a lot of users; and, even then, the per-
user cost will decrease every year.

A Simple Growth Hypothesis:
Three States of Engagement
Visitor
Member
Advocate
Advertising
Convinced
Value
Atrophy
Forgets
Resigns
Word of Mouth

Quantifying the Simple Growth
Model
1,000 Number of people visit because of ad (1% of impressions)
5% Probablity vistior joins
4% Probabilty member becomes advocate
2 Number an advocate interests
0.10% Probablity member resigns
Week Visitors Members Advocates
1 1,000 0 0
2 1,000 50 0
3 1,000 100 2
4 1,004 150 5
5 1,011 200 10
6 1,020 250 16
7 1,031 301 22
8 1,043 352 28
9 1,057 404 35
10 1,071 457 43
11 1,085 510 50
12 1,101 563 58
13 1,116 618 66
14 1,132 673 74
15 1,149 729 83
16 1,165 786 91
17 1,182 843 100
18 1,200 901 109
19 1,217 960 117
52 Week Model
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52
Members
Members

Combining Value & Growth
1,000 Number of people visit because of ad (1% of impressions) $0.23 Fee 4.3 Weeks/Month
5% Probablity vistior joins 10 CPM
4% Probabilty member becomes advocate 22,998 # Ads
2 Number an advocate interests $230 Ad Cost
0.10% Probablity member resigns $115 Computing
$1,150 Salary
Week Visitors Members Advocates Revenue Costs Profit Debt
1 1,000 0 0 $0 $1,495 -$1,495 -$1,495
2 1,000 50 0 $11 $1,495 -$1,483 -$2,978
3 1,000 100 2 $23 $1,495 -$1,472 -$4,450
4 1,004 150 5 $34 $1,495 -$1,460 -$5,911
5 1,011 200 10 $46 $1,495 -$1,449 -$7,359
6 1,020 250 16 $58 $1,495 -$1,437 -$8,797
7 1,031 301 22 $69 $1,495 -$1,426 -$10,222
8 1,043 352 28 $81 $1,495 -$1,414 -$11,636
9 1,057 404 35 $93 $1,495 -$1,402 -$13,038
10 1,071 457 43 $105 $1,495 -$1,390 -$14,428
11 1,085 510 50 $117 $1,495 -$1,378 -$15,806
12 1,101 563 58 $130 $1,495 -$1,365 -$17,171
13 1,116 618 66 $142 $1,495 -$1,353 -$18,524
14 1,132 673 74 $155 $1,495 -$1,340 -$19,864
15 1,149 729 83 $168 $1,495 -$1,327 -$21,191
16 1,165 786 91 $181 $1,495 -$1,314 -$22,505
17 1,182 843 100 $194 $1,495 -$1,301 -$23,806
52 Week Model
-$70,000
-$60,000
-$50,000
-$40,000
-$30,000
-$20,000
-$10,000
$0
-$1,600
-$1,400
-$1,200
-$1,000
-$800
-$600
-$400
-$200
$0
1 4 7 101316192225283134374043464952
Profit
Debt
We can add columns derived from the value hypothesis to
compute the weekly loss and accumulating debt for the first year.
This provides an estimate of the needed investment for the year,
$60,000.

Start-up Plan for a Simple
Service
• One-time development costs: $100,000.
• The Growth Hypothesis predicts two years to grow the
membership base to the $7,000 required by the Value
Hypothesis.
• Assuming I get half-way there in one year I need one
years’ total costs, about $80,000.
• Total: $180,000.
• Extra credit: Combine Value and Growth spreadsheets to
show changing profit picture.

A Commission-based Service
Generating sales for a business and
collecting commissions
• Relay It
• VICI

Commission-based Value
Hypothesis
Our Service Member
Something/$
Merchant
New Sales/$
(Encourage
Purchase)
X

Quantifying Commission-based
Value Hypothesis
• A salesperson signs up merchants.
• Each merchant has 125 patrons who join.
• Each member makes 1 purchase per week.
• Additional advertising is needed.
Revenue Description Source Value
Merchants Goal 20
Members per Merchant Goal 125
Sales per member Guess 4
Commission Rate Choice 10%
Average Sale Price Guess $10
Commission Price*Commission $1.00
Revenue Members*Sales*Rate*Commission $10,000
Costs Signing up Merchants Guess $5,000
Advertising Guess $2,000
Computing Service Guess, Heroku $500
Costs Advertising+Computing $7,500
Profit Revenue-Cost $2,500
Monthly Numbers

Commission-based Growth
Hypothesis
The Growth Hypothesis varies based on the
nature of the service—simple, social, or two-
sided.

Commission-based Start-up
Funding
Assuming the Simple Growth Hypothesis, it
will take about year to build up to the 2,500
member goal in the Value Hypothesis.
Therefore we need a year’s worth of
operating costs: 12*$7,500 plus a 10%
contingency: $100,000.

Advertising-funded Services
Using Google AdSense, you can put ads on your
pages, whether or not they are related to your
service. Then you care about how many people visit
your site.
Some projects that might do this are
• HUE
• Icnutri
• TrekXplore

Value Diagrams for Advertising-
funded Services
Member Merchant
Product/$
Service

Quantifying the Advertising-
funded Service Value Hypothesis
When anyone comes to our page they see banner ads, each of which
pays us CPM/1000.
Time period is a day
Revenue Description Source Value
CPM http://www.labnol.org/internet/average-cpm-rates/11315/$10
My share of CPM Google Adsense Policy 68%
Ads per Page Choice 3
Page Views Goal 20,000
Total Revenue (CPM/1000)*Share*Ads*Views $408
Costs Marketing Choice $100
Computing Service Guess, Heroku 500/7 $71
Salary Choice 60000/365 $164
Total Costs Advertising+Computing+Salary $336
Profit Revenue-Costs $72

The value members receive needn’ t be part
of the value hypothesis computation.
• They are receiving some sort of value
for their time, and that affects the
number of page views, but we just
guess that number for now.
• The number of page views are
dependent on the growth hypothesis,
which is more important in this case.

10 Number of people visit because of marketing
5% Probablity vistior joins
80% Probability member views page
10% Probabilty member becomes advocate
0.25 Number an advocate interests each day
0.10% Probablity member resigns
Day Visitors Members Advocates
1 10 0 0
2 10 1 0
3 10 1 0
4 10 1 0
5 10 2 0
6 10 2 0
7 10 3 1
8 10 4 1
9 10 4 1
10 10 5 2
11 10 5 2
12 11 6 2
13 11 6 3
14 11 7 3
15 11 7 4
16 11 8 4
17 11 8 5
18 11 9 6
365 Day Model
0
5,000
10,000
15,000
20,000
25,000
1
16
31
46
61
76
91
106
121
136
151
166
181
196
211
226
241
256
271
286
301
316
331
346
361
Members
A Simple Growth Model That Gets
20,000 Members in a Year
Notice that most of the growth
occurs at the end of the year,
since it depends on
accumulating word-of-mouth.

Start-up Costs for Advertising-based
Services
• It takes most of the year to get to
profitability, so you need to cover
costs for the entire year: 365*$336 or
about $123,000.
• Businesses that depend solely on
selling ads require large start-up
costs.

Social Network Services
The value hypothesis may vary
(simple, commission, advertising),
but the growth hypothesis is special.
• UrbanBite
• Cup of Sugar (Community Sharing)
• TrekXplore

Social Network (Facebook,
LinkedIn, etc.) Growth Model
Visitor
Member
Advocate
Advertising
Convinced
Value
Atrophy
Forgets
Resigns
Word of Mouth
Network
Effect

Quantifying Growth Hypothesis
for Social Network Service

Two-sided Services
• Spotter
• Point
• TrekXplore
• UrbanBite?
Each side has its own value hypothesis,
and the growth hypotheses are different
but inter-dependent.

Taxi Dispatcher, e.g. Lyft
Possible Operation
 Rider requests specific ride with phone.
 Dispatcher negotiates with idle Taxies (via phone app?) and sends taxi.
 Rider gets ride, pays dispatcher.
 Dispatcher pays taxi, less commission.
This competes with existing dispatchers because
 They don’t use modern technology well
• GPS
• Computer planning
• Real-time auctions
 Our system gives them better access to customers.
 They charge taxis a fixed monthly fee.
 Handling payments might improve safety.
 Drivers can adopt it without giving up existing dispatchers.
 Some taxi drivers are abandoning existing dispatchers and using social cell-
phone networks already.
 We can measure user satisfaction on every transaction!

Value Diagrams
Taxi Rider
Ride
Dispatcher
Customer/$
Taxi Rider
Ride/$
Dispatcher
$
Old New
Rather than charge a driver a fixed monthly fee,
charging him a commission each ride, arranged
and paid for by the rider’s phone.

Creating a Value Hypothesis
Spreadsheet
1. Decide on the period to measure, e.g. 0ne day,
and a market, e.g. Pittsburgh.
2. Create a spreadsheet describing with all the
factors that effect value flows and costs
 Number of each type of stakeholder
 Transactions per day
 Price per transaction
3. Estimate measures about the market.
4. Select initial choices for the numbers you can
control.
5. Create formulas to compute outcomes leading to
profit for the service.

Spreadsheet for Two-sided Value
Hypothesis
Transaction Source Daily
% Taxis Signed Up Guess, after one month 5%
All Taxis Guess 500
Ride Price Guess $20
# New Rides Guess 5
Commission % Choice 5%
Daily fee Choice $1
Taxi Revenue Increase Price*Rides $100
Taxi Cost Increase
Commission*Ride Price +
Daily Fee
$6
Taxi Profit Increase Revenue-Cost $94
Dispatcher Revenue
Signed-up * All Taxis * Taxi
Cost Increase
$150
Human Expediter Guess $100
Dispatcher Profit
Dispatcher Revenue - Human
Expediter
$50
Dispatcher Profit per Day

Spreadsheet Structure
Ride
Price
# New Rides
% Taxis
Signed Up
Commission %
Daily Fee
Guesse
s
Choices
Taxi
Revenue
Increase
*
All Taxis
Signed-up
Taxis*
*
+
Taxi Cost
Increase
-
Taxi Profit
Increase
Dispatche
r
Revenue
*

Growth Model for a Two-sided
Market
Visitor
Driver
Advocat
e
Advertising
Convinced
Value
Atrophy
Forgets
Resigns
Word of Mouth
Visitor
Rider
Advocat
e
Advertising
Convinced
Value
Atrophy
Forgets
Resigns
Word of Mouth
Drivers
Riders

Two-sided Growth Model
10% Probablity satisfaction causes advocacy
20% Probablity dissatisfied member resigns
100 Number drivers who are interested by ad 1000 Number of riders interested by ad
20% Probablity driver joins 20% Probablity rider joins
100% Percent of week available 5.0% Pecent of week seeking ride
2 Number an advocate interests 2 Number an advocate interests
Week Visitors AvailableSatisfactionAdvocates Matches Visitors AvailableSatisfactionAdvocates Drivers Riders
1 100 0 0 0 1,000 0 0 0 0
2 100 20 50% 1 10 1,000 10 100% 20 20 200
3 102 40 50% 3 20 1,040 20 100% 55 40 400
4 106 60 50% 5 30 1,110 30 100% 102 60 608
5 110 82 51% 8 42 1,204 42 100% 160 82 830
6 116 104 52% 11 54 1,319 54 100% 227 104 1,071
7 123 127 53% 15 67 1,453 67 100% 304 127 1,335
8 130 151 54% 20 81 1,607 81 100% 390 151 1,625
9 139 177 55% 24 97 1,780 97 100% 487 177 1,947
10 149 205 56% 30 115 1,975 115 100% 596 205 2,303
11 160 235 57% 36 135 2,192 135 100% 717 235 2,698
12 172 267 59% 43 157 2,433 157 100% 851 267 3,136
13 185 301 60% 50 181 2,702 181 100% 1,001 301 3,623
14 200 338 62% 58 208 3,001 208 100% 1,167 338 4,163
15 217 378 63% 68 238 3,333 238 100% 1,351 378 4,763
16 235 421 64% 78 271 3,703 271 100% 1,557 421 5,430
17 256 469 66% 89 309 4,113 309 100% 1,784 469 6,171
18 278 520 67% 102 350 4,569 350 100% 2,038 520 6,993
19 304 575 69% 116 395 5,075 395 100% 2,319 575 7,907
20 332 636 70% 132 446 5,638 446 100% 2,631 636 8,922
21 363 702 72% 149 502 6,263 502 100% 2,979 702 10,050
22 398 775 73% 168 565 6,957 565 100% 3,364 775 11,302
23 436 855 74% 190 635 7,728 635 100% 3,792 855 12,694
24 479 942 76% 213 712 8,585 712 100% 4,268 942 14,239
25 527 1,038 77% 240 798 9,536 798 100% 4,797 1,038 15,956
Drivers Riders
Members
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52
Drivers
Riders

A Flip from Rider to Driver
Surplus
10% Probablity satisfaction causes advocacy
20% Probablity dissatisfied member resigns
20 Number drivers who are interested by ad 1000 Number of riders interested by ad
20% Probablity driver joins 10% Probablity rider joins
100% Percent of week available 5.0% Pecent of week seeking ride
2 Number an advocate interests 2 Number an advocate interests
Week Visitors AvailableSatisfactionDrivers Advocates Matches VisitorsAvailableSatisfaction Riders Advocates
1 20 0 0 0 0 1,000 0 0 0
2 20 4 100% 4 0 4 1,000 5 80% 100 8
3 21 8 100% 8 1 8 1,016 10 82% 196 22
4 22 12 100% 12 2 12 1,044 15 84% 290 41
5 24 17 100% 17 3 17 1,082 19 86% 385 64
6 26 21 100% 21 5 21 1,128 24 89% 483 91
7 29 27 100% 27 6 27 1,181 29 91% 585 121
8 32 33 100% 33 8 33 1,243 35 94% 693 156
9 36 39 100% 39 10 39 1,312 40 96% 808 195
10 39 46 100% 46 12 46 1,390 47 99% 934 238
11 44 54 99% 54 14 54 1,477 54 100% 1,070 286
12 49 63 97% 63 17 61 1,571 61 100% 1,218 336
13 54 72 95% 72 19 69 1,672 69 100% 1,375 390
14 59 82 94% 82 22 77 1,779 77 100% 1,542 446
15 65 93 93% 93 25 86 1,893 86 100% 1,720 507
16 71 104 91% 104 29 95 2,014 95 100% 1,909 571
17 77 117 90% 117 32 106 2,142 106 100% 2,111 639
18 84 130 89% 130 36 116 2,279 116 100% 2,325 712 1,399
19 91 144 89% 144 39 128 2,424 128 100% 2,553 789 0% 204
20 99 159 88% 159 44 140 2,579 140 100% 2,795 871 5% 585
21 107 175 87% 175 48 153 2,743 153 100% 3,053 959 10% 1,399
22 116 192 87% 192 53 166 2,918 166 100% 3,327 1,052 15% 3,203
23 125 210 86% 210 58 181 3,104 181 100% 3,619 1,151 20% 6,971
24 135 229 86% 229 63 196 3,302 196 100% 3,930 1,256 25% 14,441
25 146 250 85% 250 68 213 3,512 213 100% 4,260 1,368
Drivers Riders
Members
Satisfaction->Advocacy
0
200
400
600
800
1,000
1,200
1,400
1,600
1 5 9 13 17 21 25 29 33 37 41 45 49
Series1
0
5,000
10,000
15,000
20,000
1 2 3

Sensitivity Analysis
(Optional)
• Changing the numbers in your spreadsheets
gives you a feeling for what parameters
matter the most.
• There is an Excel trick, Data Table, that allows
you to explore the question of what matters
more more systematically.
• To decide what research to do first, compute
the sensitivity times the range of uncertainty
and look at the parameter(s) with the highest

Pre-cooked Spreadsheet
w/Sensitivity Analysis
Transaction Source Daily
Dispatcher
Profit
Difference Derivative
% Taxis Signed Up Guess, after one month 5% Price $50
All Taxis Guess 500 Min $5 -$44
Ride Price Guess $20 Max $35 $144 $188 $6
# New Rides Guess 5
Commission % Choice 5%
# New
Rides $50
Daily fee Choice $1 Min 1 -$50
Taxi Revenue Increase Price*Rides $100 Max 9 $150 $200 $25
Taxi Cost Increase
Commission*Ride Price +
Daily Fee
$6
Taxi Profit Increase Revenue-Cost $94
% Taxis
Signed
Up $50
Dispatcher Revenue
Signed-up * All Taxis * Taxi
Cost Increase
$150 Min 1% -$70
Human Expediter Guess $100 Max 25% $650 $720 $30
Dispatcher Profit
Dispatcher Revenue - Human
Expediter
$50
Dispatcher Profit per Day Sensitivity Analysis

Two Factor Sensitivity Analysis:
How to Divide Advertising between
Drivers and Riders

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