Will your business make money?

When I decided to start a tech company, I attended as many conferences as I could to hear as many people as possible, in the hope they’d teach me how to create the next Internet wonder.  At most of these events, some speaker would produce a PowerPoint slide with some top ten list.  ‘Ten Reasons Why Companies Fail,’ perhaps, or ‘Ten things that make a company investable.’  I noted down all them; many items were as you’d expect: ‘the team’, ‘technology’, ‘product fit’, ‘marketing’, and so on.  But the one that topped each list came as a surprise.  It was ‘market size’.  Obvious to me now, not so obvious then.

“Of course,” I thought.  “Who would purposely build a business with a small market size?  You can’t be a roaring success if you do that.”  I made notes and thought about all the other issues, but ‘market size’ was almost too crazy to write down.  My company was going to serve the music business.  We’d help promote tickets, recorded music and merchandise, and that’s a huge market!  I’d done my research, and concertgoers spend $9 billion on concert tickets in the UK, US & Australia each year.  Even if we secured just 2% market share, we’d be transacting $180 million in annual revenue.  That has to be achievable, right?  Wrong!

Most books and speakers suggest looking at your potential market size from two perspectives.  Top-down (the way I just described) and bottom-up.  I created a bottom-up model for Posse in the music industry; it looked something like this (estimates in brackets).

1. How many tour promoters can one sales rep visit each week  (20)
2. How many of these will list events with Posse  (30%, so 6 hits)
3. How many dates are in an average tour  (10)
4. What’s the average ticket price  ($40)
5. What’s the average number of tickets to each show  (1000)
6. What % of tickets are likely to be sold using Posse  (30%, so 300 per show)
7. What’s our share of the ticket price  (5% on each sale)

Then each sales rep. should generate $36,00 for Posse.   These numbers should grow as the product becomes known and promoters start listing their events online themselves.  Next, work out what it costs to run the company, what’s the scaling up plan for sales people, and build ourselves a financial model.  If we continuously ramp up the number of transactions, and the revenue, at some point we’ll sense-check this against the total market size, to make sure we’re staying within realistic limits.

It seems like a good way to do your numbers and it’s how every start-up book I’ve read suggests that you build a financial model.  But in my experience, this top-down then bottom-up method is plain wrong.   You have no idea of your total market size or how much it will cost to build your business until you try selling your product.

I thought my total market size was $9 billion.  But when we launched, we learnt that Posse would never work for large parts of the market.  For example, 5% of all shows sell out on day one.  They don’t need advertising so they won’t use Posse.   We found that many events don’t advertise for the first week because they want to see how many tickets will sell – without paying for advertising.  That first week is when most sales (around 65%) happen; all the advertising is to sell the remaining 35%.  Promoters didn’t want to use Posse in the first week because they didn’t want to spend advertising money.  Posse makes revenue as commissions, and now we only get the opportunity to sell 35% of the tickets!

I’ll go through that again.

Start with a market size of $9 billion, or 9000 million.

5% or $450 million sell out straight away.  Subtract that from the total, leaving 8550 million.

But 65% of what’s left sells without advertising, leaving a total market of around $3 billion.

Hmmm.

Now, look at bottom-up.  Here, we work out the cost of running the company (expenditure) against estimated revenue.  We guessed that each sales rep would sign up 30% of the tour promoters they approached.  Posse relies on reports from third party ticket providers (Ticketmasters, Moshtix and the like).  To get these, Posse needs to integrate our website with each of the ticket providers, which requires the time of our engineering team.   We discovered that around 80% of tours don’t just use one ticketing platform – they use many.  So, for us to reach our total market opportunity we needed to integrate with all of them (in Australia that’s over 100!).  It’s an almost impossible task, especially when many ticketing agencies use ancient technology that doesn’t generate nice reports.  Either our sales team would be restricted, selling Posse only to tour promoters using the ticketing platforms with whom we’re integrated, or we’d need to invest a ton of money doing all the integrations (engineers’ time, legal agreements, sales negotiations and so on).

My point is that a financial model – either top down or bottom up – is meaningless until you have some experience selling your product.  When I started Posse, I spoke to lots of music promoters and asked them if they’d use it and how much they’d be prepared to pay for it. The results were very encouraging.  I met with the global head of AEG in LA and we spoke about using Posse for ‘Pink’s’ US tour, I presented to all the top agents at CAA and Live Nation as well.  They were unanimous.  The idea was brilliant.

If I were starting again, I’d go through the detailed process of signing up these customers.  What were their requirements, when would we launch campaigns, how would they help us promote them?  I’d go through it exactly as if it existed.  I’d get them to sign a booking form and I’d do that several times, so I could work out all obstacles.  How much would these obstacles reduce my market size and how much would it cost to overcome them?

So here are this week’s formulas.  Your company could work if:

            r > c + a + x     AND     r < (m/100) (t – d)

t = total market size (people who are into buying concert tickets)

d = the size of that market you must deduct since they’ll never use your product

So, (t – d) is your potential market (sometimes called the addressable market)

m = the % of your total market you realistically think you could achieve (investors will rarely accept more than 2%)

c = the estimated cost of running your business

a = additional cost to overcome the obstacles you discover during the sales process

x = the projected cost of obstacles you haven’t encountered yet (otherwise known as ‘contingency’ and usually set at around 20% of gross revenues)

r = your projected gross revenue