Decisions about financial models for digital products can be difficult to make. Data-driven decision making is a good idea, but when a digital product is new we often don’t have the data needed to make sound decisions. In this article we will explore the basics of financial modelling for digital products and how it can help you as a digital product manager or business owner.
If you have validating the need for your digital product or service, taking the time to discover the right model for your product is important not only for the roadmap but for the longevity of your product.
What is a Financial Model?
A financial model is a simplified version of reality, but still captures the essentials for you to make decisions.
It’s important that financial models are made in order to scale your business and understand where spending will be. We can use financial modelling so we know whether or not an investment decision makes sense financially. This ensures our company’s financial goals are met.
The financial model should be an integral part of your startup’s data-driven decision making process, but don’t forget the human element too. Financial modelling for products can help make sense of things and deliver financial value to you as a business owner, but sometimes a template just won’t cut it.
Understanding financial modelling for digital products means understanding your business target audience and how much money they can spend on your products/services, so this should be done before financial models are created. When deciding upon financial models for a digital product it’s important to include financial data that captures the key drivers of your business.
A revenue model is how you intend to make money within your digital product, so this should be included within financial models as well. Think about what channels will drive customers and their spending behaviour, e.g. user acquisition, how they pay, what they pay etc.
Total Addressable Market (TAM)
Total Available Market is the total market demand for a digital product or service. It’s important to understand TAM in order for you to decide whether or not it makes sense financially to launch a product or adjust it to fit a large enough audience.
Serviceable Available Market (SAM)
Serviceable Available Market is the segment of the TAM targeted by your digital products and services which is within your geographical reach.
Serviceable Obtainable Market (SOM)
Serviceable Obtainable Market is the portion of SAM that you can capture.
Cost Per Acquisition (CPA)
Customer acquisition cost is the amount you spend in marketing to acquire each customer.
Cost Of Goods Sold (COGS)
This includes all costs such as marketing, wages and other expenses. Everything it costs to service a customer over their lifetime.
Lifetime Value of a Customer (LTV)
A lifetime value of a customer is the financial projection for how much revenue you can expect to receive from each customer over the course of their relationship with your company. This should factor all costs such as discounts, returns, lost customers and be an average across all customers.
Average Revenue Per User (ARPU)
ARPU measures the average financial return on investment per user within revenue lines for a product. This can be calculated on a monthly or weekly basis to estimate financial value for each customer.
Retention rate is a financial projection that estimates the portion of active users within a digital product. This helps you understand how well your business retains customers over time and will help you predict churn rates, growth rate and your future marketing budgets
Unit Economics is a financial projection that shows the financial return of a digital product after the service is rendered. It’s important to understand your unit economics as it can highlight financial waste and areas for improvement within financial models of a product, e.g. where you’re spending more money than you should be and how much each customer costs (CPA or CAC). A simple way to explain this is:
LTV – COGS = Unit Profit
Without good unit economics, it makes no sense launching your product.
When financial models are done well, they can help you make data-driven decisions that deliver business value. It’s important to include the human element however as financial modelling for digital products doesn’t work if founders don’t understand their audience or market conditions.
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