Walk me through how you create a revenue model for a company

There are two main ways to build a revenue model. You can easily get away with just the first paragraph for each strategy, but I included examples because if you can conceptualize this beyond the “book answer” you will stand out.

Bottoms Up

Get down to average revenue per customer (revenue / customer count) and then find out how much it costs to add a customer. Use forecasted sales expenses to determine how much new revenue will be driven. This is simplified but conceptually will get you through the question

Ex. Let’s say a company has $100mm in revenue and 100 customers and it costs ~$1mm to acquire a customer

This means they have roughly $1mm revenue per customer. Now, let’s say they lose ~10% of their customers per year, and have forecasted $15mm of sales expenses next year

So, for next year you would multiply 100 Customers * 10% to determine that 10 customers will leave next year. Then multiply this by the average revenue per customer of $1mm to determine that the company will lose $10mm of revenue. Now our base for next year is $90mm

We will now use the customer acquisition cost of $1mm and divide the $15mm of sales expenses for next year to determine that the company will add $15mm of revenue next year from 15 new customers

Revenue next year = $100mm (last year’s revenue) - $10mm (attrited revenue) + $15mm (new customers) = $105mm in revenue next year

Top-Down

Use market metrics like TAM and SAM to estimate overall market size, estimate current market share and then forecast how that will change in the future to get to revenue

Ex. In a $100mm market, we have 10% penetration currently but think it can get to 30% in 5 years. So, if we’re at $10mm of revenue now you would forecast to $30mm in 5 years

This one is pretty useless unless you’re working with extremely high growth, differentiated solutions that have a self-serve aspect that makes sales & marketing not core to growth. I’ve never had to use this for a revenue model