modelH update: Revenue

by Kevin Riley

modelH update: CostsEditor’s note: This article is an update on modelH, the dynamic co-creation forum created by Kevin Riley and Associates, Innovation Excellence, and Batterii where healthcare innovators from around the world are building a foundation for new business models in healthcare. Their goal is to co-create an open source business model canvas that applies specifically to the US healthcare system.

Learnings on Revenue for the Business Model Canvas for Healthcare (modelH)

We just wrapped up our 15th business building block sprint on Revenue. In summary, the sprint for Project 1.15 on Revenue completed 2 objectives:

  • Questions to ask regarding the canvas for Revenue?
  • Tools needed to understand your business model’s Revenue?

Word cloud for Revenue

Questions to Ask on the Canvas for the Revenue Block

In this project sprint, we developed a list of Questions that should be answered when developing Revenue models for a healthcare business model.

  1. How will your business make money?
  2. For what value are customers willing to pay? What do they currently pay for these services/items?
  3. How are they currently paying? How would they prefer to pay?
  4. What is the total addressable market size (TAM), or the revenue opportunity? The serviceable addressable market size (SAM)? The target market size (TM)?
  5. What is the justification for your sales projections?
  6. What is your revenue cycle and how you will manage it?
  7. What is your pricing strategy?

Revenue block on the modelH canvas

What tools do you need to understand your business model’s Revenue?

This building block really presents itself as a creative problem solving opportunity. It is the exercise of defining how many ways you are able to generate money from your product, or Value Proposition.

Specifically, we are asking how your business model creates Revenue. There are four elements that your business model canvas should focus on when describing Revenue:

  • Revenue Stream
  • Price
  • Volume
  • Revenue Cycle Management

Revenue Stream

Revenue is made when you someone gives you money for something you do or sell. Revenue streams define the mechanics of how money will pass from your buyer to you, and how many other hands or business models touch it in the process. You will need to explain the value of your product/service to the consumer and how they will pay for this value. There are many combinations of how this can happen in various revenue models, some of which are explained below.

  • Traditional Model: sell a product or service from your own inventory or from a key partner.
  • Value-Add Model: add value to the sale of a product or use of a service by another.
  • Freemium Model: offer a minimum product and charge for pro features.
  • Affiliate Model: direct traffic, leads or referrals to another.
  • Subscription Model: pay a recurring fee and/or transactional fee to access the product.
  • Virtual Goods Model: selling virtual goods online in a game, app or website.
  • Advertising Model: high traffic websites sell ads for their traffic.

It is also advantageous to ask the following additional questions as part of defining a healthcare revenue stream.

  • Do you expect someone other than the consumer to pay in your Revenue model? If so, why? Who makes a payment?
  • What other revenue streams have you envisioned, apart from consumer payments?
  • Can you offer a subscription element to your Value Proposition in order to ensure repeat revenues?
  • Can you offer a base service for free and then charge for a premium service?
  • Can you have consumers pay different amounts based on how much they benefit?

The best explanation we have seen regarding the understanding of various revenue models that might exist in a business model is from our friends at Board of Innovation. You can find this very complete and detailed example here.

Price

The Revenue Stream equation is made up of two items – Price and Volume. Price is simply the calculus of how much you think your value proposition is worth, or at least how much you think someone will pay for it. How do you set price?

Price is derived from three foundational elements:

  • Costs: what is functionally the lowest price you can set?
  • Competition: how do your competitors’ price compared to you?
  • Value to customer: how much are customers willing to pay for your Value Proposition?

Once you set your price, there are many pricing models you can employ to maximize your revenue. The two main types are fixed pricing and variable pricing. The rest are just simply derivatives of these two.

Fixed pricing is setting a market price and taking it to market – such as the price of a heart rate monitor on Amazon. Variable pricing is setting a base price and then allowing Buyers to pay what they will for it – such as the auction method on EBay. Fixed pricing is easy to understand. Variable pricing can make you more money but it puts some customers off. The more sophisticated a company, the more they can make their fixed pricing act like variable pricing. That heart rate monitor on Amazon actually changes price depending on the day and time of day of the purchase.  This variance is based on sophisticated pricing algorithms that Amazon employs.

Volume

Volume is the second item in the Revenue Stream equation. Volume is affected by your market size and growth. It really depends upon two questions: (1) how much of the market you can capture? and (2) how fast you can capture it?

Your market size should define three things for your business model:

  1. Total addressable market size (TAM), or the revenue opportunity available for the value proposition.
  2. Serviceable addressable market size (SAM), or the customers that can actually be reached out of the total addressable market (TAM).
  3. Target market size (TM), or the size of the initial focus for your minimum viable product release of your value proposition.

These can be seen in relation to each other on the graphic below.

Addressable markets

The best explanation we have seen for market speed and understanding the various revenue models is found in Steve Blank’s Udacity class, which you can find here . This is simple to read but also accurate and brilliant.

Revenue Cycle Management

This is a fancy way of saying how often you are paid and the difficulty related to collecting timely payments. For example, if you receive payment as part of someone else getting paid, you have to take into account that delays will inevitably happen. A bottleneck lies with your downstream revenue chain.  Delayed payments mean you need more cash on hand to handle your operating costs. It also means your prices should reflect these delays.

In accounting, this complex structure is referred to as Receivables and Revenue Accruals.  According to Investopedia, a company records receivables as an asset because it expects to receive payment for that amount relatively soon. Long-term receivables, which do not come due for a significant length of time, are recorded as long-term assets on the balance sheet; most short-term receivables are considered part of a company’s current assets. On the other hand, revenue accruals (or accrued revenues) are treated as an asset on the balance sheet rather than a liability. This reporting is important to the valuation of a company, particularly in the service industry.  Billing typically occurs after the work or service is complete. Without this asset class on financial reports, the company could appear to have much lower revenues, and may not have a fair method to balance expenses associated with the accrued revenue. Since these items are industry specific, most companies may reserve for uncollectible accounts.  An insurance company, however, may have to set up an account for an unearned premium reserve.

Revenue Cycle also requires Key Resources. For example, most accounting systems have a billing module.  This system is based on creating a receivable and corresponding invoice for a customer.  However, the revenue side is a bit more complex.  You can only recognize revenue when earned.  Thus, many companies use a different billing/accounts receivable system than their accounting software package.  This would require using Key Resources for both systems (accounting software and billing software), as well as an interface between them.

If your business model sells directly to a healthcare consumer, your revenue model might be much simpler. However, if you sell into another business model, like an Accountable Care Organization, your payments might be dependent on them.

In conclusion

Many good business ideas have gone bankrupt due to poor cash management. Clearly defining the complexity of your revenue cycle and careful management is an important part of your business model.

Take time to incorporate these approaches into the Revenue block in your business model canvas. You must be able to clearly articulate 1) that you have an understanding of how you will make money, 2) how big your market is and how much of it you can realistically capture, 3) how you will price to win, and 4) how you will manage your customer payments.

What is Next?

We will soon wrap up our co-created business model canvas by addressing Informatics and Externalities.

Interested in what we are doing?

Time is fleeting: Step up to the plate and become involved!

This was cross-posted from Kevin Riley & Associates BLOG – http://bit.ly/modelH-revenue

image credits: Kevin Riley & Associates, modelH Business Model Canvas for Healthcare, drawings by Mike Werner; modelH.org

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modelH – Health Model Co-Creation Forum (part 1)Kevin Riley is an entrepreneur, healthcare executive, and business model innovator who works with start-ups and legacy companies across the healthcare industry. He founded and was CEO of a national health care retail company, has played leadership roles for national retail health start-ups, and served as the first Chief Innovation Officer of a major insurance plan. In 2006 he started Kevin Riley & Associates Health Model Innovation to help companies with the convergence of health care and the consumer.

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