Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

How to Build a Bottom-Up Revenue Forecast for Software Products

171 views

Published on

Software product managers are typically required to develop revenue forecasts for their products. The revenue forecast is a key element of the financial model that’s used for profitability analysis and as a sanity check for the pricing model.
For new products, or when key elements of the product strategy or the market have changed, we cannot build a credible revenue forecast by extrapolating from the past. In these cases, the revenue forecast needs to be built “bottom-up”.
In the “bottom-up”-approach, the revenue forecast is based on planned sales and marketing activities, using assumptions such as success rates of sales people and average deal sizes, as well as conversion rate modeling for web-based sales.

Published in: Software
  • Be the first to comment

  • Be the first to like this

How to Build a Bottom-Up Revenue Forecast for Software Products

  1. 1. How to Build a Bottom-Up Revenue Forecast for Software Products Software Product Summit 2019 – The ISPMA Conference April 9-10, 2019 – Frankfurt, Germany With minor updates, May 2019 Barbara Hoisl – barbara@barbarahoisl.com
  2. 2. Description Software product managers are typically required to develop revenue forecasts for their products. The revenue forecast is a key element of the financial model that’s used for profitability analysis and as a sanity check for the pricing model. For new products, or when key elements of the product strategy or the market have changed, we cannot build a credible revenue forecast by extrapolating from the past. In these cases, the revenue forecast needs to be built “bottom-up”. In the “bottom-up”-approach, the revenue forecast is based on planned sales and marketing activities, using assumptions such as success rates of sales people and average deal sizes, as well as conversion rate modeling for web-based sales. Value for the audience • understand the difference between the two common approaches for building revenue forecasts: extrapolation from the past vs. bottom-up modeling • learn the basic approach for building a bottom-up revenue forecast, both for web-based sales and for selling through a sales force 2 Summary
  3. 3. On Revenue Forecasts vs. Revenue Models
  4. 4. Software Product Manager (SPM) as “mini-CEO” Revenue forecast is key input to business case Uses of the revenue forecast § Justify investments / ask for funding § Enable planning – also for other functions, e.g. sales, support § Often: meeting forecast is key performance objective for SPM Special case: new product for new market § A reliable forecast is not possible: too many unknowns § But we can build a revenue model to evaluate our business model § what are key revenue drivers? § understanding how customer base builds up 4 Revenue Model is Key SPM Responsibility
  5. 5. Revenue Model Extrapolate the past based on past performance and market forecasts Bottom-up model model how customer base builds up Extrapolate the past Common for existing products or incremental new products Works only if § historic performance data available: same product or analogous product § no major strategy changes § existing market with reliable forecasts Does not work § for new products creating new markets Bottom-up model – based on company’s own activities 5 Two Approaches for Building a Revenue Model
  6. 6. Invent a forecast to meet an arbitrary revenue goal § e.g. goal set by “higher powers“ § or SPM knows the minimum revenue required to get funding A purely mathematical task: interpolate a plausible-looking curve § between current revenue § and future revenue goal 6 In real life, there‘s a third approach … time $$ Example: New Product revenue goal x launch
  7. 7. 7 Example Extrapolate the Past – Simple Example Revenue Model for an Enterprise Software Product in an Established, “Steady-State” Market Situation – the market § market growth: ∼ 8 % per year, stable § expect no no market disruptions § industry analysts agree: growth rate will stay stable Situation – the SW product § market leader § Is gaining market share: growing about 2 percentage points above market, i.e. 10% per year § still has “room to grow” Company plans no changes § update and evolve product as it did in the past. § keep sales model, channel strategy … The task: Build 3-year revenue forecast The approach: Extrapolate the past § future annual growth rates: 8% projected market growth by analysts § plus 2 percentage points: product “outgrows” the market § total: 10% annual growth rate
  8. 8. 8 Example Only works for existing products in a stable environment Extrapolation of Revenues – Simple Example 2 years ago Last year Current year (est.) Next year 2 years from now 3 years from now Product revenue in million $ 100 110 121 year-over-year growth - 10 % 10 % 10 % 10 %10 % 133 146 161
  9. 9. Building Bottom-Up Revenue Models
  10. 10. Bottom-Up Revenue Model 10 Revenue Build-up of customer base Our own sales and marketing activities
  11. 11. Example: Direct sales to large customers § Typical deal size: 200.000 € § Length of sales cycle: 6 months § Number of deals closed per sales rep, per year: 4 § Result: 800.000 € of revenue per sales rep, per year Annual revenue = 800.000 € * number of sales reps Based on § pricing strategy § planned sales channels § planned investment in sales, marketing, customer acquisition efforts § experience values, e.g. channel effectiveness, ROI for customer acquisition spending Unlike the “extrapolation” approach, does NOT rely on § current user and revenue base § market size & growth rates § experience values for adoption of similar products 11 Bottom-Up Revenue Model – Direct Sales Force
  12. 12. Example: Web sales “paid customer acquisition” => very expensive! Cheaper: viral engine of growth & growth hacking 12 Example: Bottom-Up Model for Web-Based Sales Ash Maurya, March 2013, http://leanstack.com/your-business-model-is-a-system/ AARRR! – pirate metrics Stage Conversion rate Result Acquisition 20.000 € in online marketing 2 € per new visitor 10.000 new visitors Activation 10 % 1.000 sign-ups Retention 20 % 200 repeat visitors Revenue 10 % 20 paying customers
  13. 13. 13 Forecast based on planned sales and marketing activities Consider including § Multiple revenue streams § Multiple target customer segments § International markets Make assumptions explicit & validate them Conduct plausibility checks § E.g. compare to size of available market: Is my forecast too good to be true? Sales cycles not considered or too short Lack of transparency § E.g. key assumptions hidden in Excel formulas Key assumptions not validated, not plausible § Revenue per user, typical deal sizes § Conversion rates § Churn rates Inconsistencies with other parts of business plan / financial model § E.g. staffing / funding for sales & marketing Avoid these mistakes Instead, do this Bottom-Up Revenue Model: How-to
  14. 14. Bottom-up model: required for new products creating new markets § no reliable market forecasts § customer adoption / acceptance unclear § no fully analogous products May be required for existing products § in case of strategy changes e.g. pricing, sales strategy More effort to build than extrapolation model Benefits § assess impact of planned strategy changes § run WHAT-IF analysis (e.g. pricing changes) § plug in actual data from A/B tests, e.g. on conversion rates 14 Summary: Building a Bottom-Up Revenue Model Typical approach Model adoption by customers based on sales, marketing, channels … Revenue as function of new & existing customers based on revenue per user or average deal sizes
  15. 15. Q&A Your experiences with revenue models Extrapolate vs. bottom-up vs. invent? Tipps and tricks for bottom-up models? 15
  16. 16. References 16 Hans-Bernd Kittlaus, Samuel A. Fricker: Software Product Management – The ISPMA-Compliant Study Guide and Handbook; Springer 2017 ISPMA: Software Product Management: Product Strategy, Excellence Level Syllabus: Student Edition V1.1, ispma.org, October 2016 ISPMA: Software Product Management - Foundation Level Syllabus V1.3, ispma.org, October 2016
  17. 17. Barbara Hoisl Strategy Consultant – Software Business & IoT Innovation Consultant, trainer, speaker Digital business models Software-based product innovation Portfolio management More than 25 years of experience in SW industry 14 years with HP’s global SW products business Master in computer science ISPMA Fellow Partner at pd7.group – Excellence in Software Product Management Author of reference book on SW-based product innovation “Produkte digital-first denken” (in German, Dec 2018) 17 barbara@barbarahoisl.com @barbarahoisl www.barbarahoisl.com

×