I want to share with you some important revenue generation concepts that will help you in your strategic analysis and planning efforts.
You’re unlikely to read about these concepts in a traditional business planning textbook, and very few accountants even know about them. Yet they are crucial to the development of your business. What’s more, come to grips with these concepts and you will see business growth and development in an exciting, new light.
To illustrate these concepts further take a look at the following matrix:
As shown in the visual, revenue in your business can be classified into four categories – of which one category offers you the greatest potential for long term success. Let’s take a closer look at them.
First of all, a business can generate front end revenue and back end revenue. Front end revenue is that which you receive from first-time customers, while back end revenue is what you get from existing customers.
Next is low value revenue vs high value revenue. Low value revenue is that which is generated from products and services where the unit sales transaction value is low, as is the gross margin. And high value revenue is that which comes from products and services where the sales transaction value and gross margins are high.
With these definitions in place we can classify the sales revenue in these broad terms:
Front end/low value revenue: Low margin/transaction revenue to first-time customers.
Front end/high value revenue: High margin/transaction revenue to first time-customers.
Back end/low value revenue: Low margin/transaction revenue to existing customers
Back end/high value revenue: High margin/transaction revenue to existing customers. These are your high value customers.
In the visual I’ve given each type of revenue a color, which is a rating of that type of rating. Red = bad, orange = ok, Green = great.
Now, here’s what I’d like you to do. Take a look at your revenue for say the past 6 months and segment it according to the definitions I’ve given you. Put simply, work to identify what proportion of your revenue is green, red, or orange.
When you’ve done that, answer this question:
It’s true, in business the bigger the back end the better. And all highly successful businesses have big back ends.
The cold hard reality is this. If you generate mostly red revenue, it means your revenue stream model is severely flawed. Businesses with mostly red revenue operate what I call the churn and burn model because it requires them to churn through customer after customer just to stay afloat. The model is very short-sighted.
On the other hand, if a significant portion (over 60%) of your revenue is of the back end variety then it means you have a well structured revenue stream model and that it is operating effectively. Naturally, the ideal situation to be in is when most of your back end revenue is green revenue.
And one other point. If you have a lot of green revenue you will likely find that it is being generated by a small proportion of your customer base (anywhere from 5-20% of your customers).
Take another look at the matrix at the two blue arrows. They are there to remind you of the direction you need to head in your revenue generation efforts. You start out in the left hand side by generating front end revenue.
But, to develop your business you need to need to move diagonally to the right and vertically. That is you need to generate back end revenue/high value revenue.
Some keys to developing back end high value revenue?
- Develop a strong strategic position and strategy
- Develop a back-end focused revenue stream model
- Create and develop a powerful sales process