One of the interesting trends at the EF6 demo day was at least four companies pitching a business model based on taking a share of the upside achieved from revenue uplift or cost savings.
In theory this seems like a great idea; take a problem in a legacy industry, improve performance X times with great technology, and take your Y% cut. I’ve seen this modelled as a significant revenue line in the outer years of startup business plan forecasts numerous times.
There are some good examples of businesses and whole industries built on variations of this model, PE/VC for one, but I can’t think of an example I’ve seen of a tech startup successfully applying this model to a new industry where it was not already the norm. A few thoughts below on why this might be:
- Clear definitions: Defining upfront what you will measure in a way that is unambiguous will likely be hard in most cases. In addition, if you are addressing a critical area of spend or revenue, it is likely that there will be other forces affecting this, and isolating the impact of your work will also be a challenge.
- Cost predictability: Customers are used to paying a fixed amount for software solutions and can easily bake this cost into their budgets, which is harder to do when there is a variable component. In addition, if this is part of a sell which includes fixed software revenue, this could make for more complex negotiations.
- Percentage share: When it comes down to negotiating on the percentage share you take, there will be a limit to how high you can push. In theory if you can create $20m of efficiencies for a large company, will they really let you walk away with 20%/$4m of that? It seems more probable that this percentage will get negotiated down to bring it closer in line with a software fee.
- Lifetime limitations: Depending on what you are improving, you may only be able to optimise each situation so much before this revenue dries up. Alternatively, other forces such as technology improvements may mean that what once needed careful optimisation no longer has much impact.
I would love to hear from any of the EF companies who pitched this model, or any others, on great case studies or plans to make this model work.