Building the Bottom-Up Model: Your Path to Startup Success

Finding customers is hard, but finding your first-ever customer can feel like scaling a mountain. How do you find someone who is going to be the first one to take the leap of faith with you?

So, today, let’s dive into how to build a bottom-up model to set your startup on the right path and help reduce the number of nos you encounter before the yes.

Why a Bottom-Up Approach Matters for Startups

Imagine you’re developing a Recruitment platform to help international MBA students and grads find credible internships and jobs. Your first instinct might be to assess the size of the HRTech Recruitment market, determine what percentage comprises international MBA students and grads, and estimate how much of that market you can capture. This gives you your TAM (Total Addressable Market), SAM (Serviceable Available Market), and SOM (Serviceable Obtainable Market). But are those numbers realistic? Probably not. Capturing 1% of a $1B market within 1-2 years of launching sounds ambitious, but is it logical? Not really.

One of the main things you ignore with a top-down model is that your customers will be spoiled for choice. When a customer chooses your product, they are essentially "firing" another solution. Even if you are one of the pioneers of a new technology, there is always an alternative. If customers are replacing other methods with your solution, the value of your product must exceed the price they pay.

So, for most startups, a bottom-up approach is not only more realistic but also provides a deeper understanding of your customers and sets achievable expectations.

Building a Bottom-Up Model: An Example

Let’s take our HRTech platform example and build a bottom-up model.

You’re building a recruitment platform to help international MBA students and grads find credible internships and jobs. One critical lesson from my business school professors was that today’s entrepreneurship seems overly focused on raising money, forgetting that the goal of a business is to make money. So, before you build your business model, you should already know what is it going to take to set up the business, how you’ll reach your customers, and what it costs to convert them.

Step 1: Determine Variable Costs

First, calculate your costs to acquire customers. For simplicity, assume:

• Cost to acquire an MBA student: $45

• Cost to acquire an employer: $50

These are your variable costs.

Step 2: Define Your Revenue Model

Decide on your revenue streams. Is it a subscription service? Will you charge both students and employers? For this example:

• Monthly subscription fee for students: $15

• Monthly subscription fee for employers: $25

Assuming it is a subscription service, we need to calculate how long are we expecting the user to be on the platform i.e. what is their lifetime?

• Average lifetime for MBA students: 3 months

• Average lifetime for employers: 6 months

Then we need to calculate what is the lifetime value for each type of user. Customer Lifetime Value is the total revenue expected from a customer over their relationship with your product.

This helps you calculate your average revenue per customer.

Step 3: Calculate Fixed Costs

List your fixed costs, such as:

• Website domain: $200

• Servers: $9,000

• Developers: $150,000

• Founders' salaries: $150,000
  

These are your yearly fixed costs.

Step 4: Perform a Break-Even Analysis

Using the variable costs and revenue, calculate how many transactions you need to break even. For instance:

• Total variable cost per transaction: $95

• Average revenue per customer: $195

• Profit Margin per customer: $100

• Total fixed costs: $309,200

To break even:

• Yearly customers needed: 3,092

• Monthly customers needed: 258

• Daily customers needed: 8
  

Now, although my numbers were guesses, yours should not be! Customer interviews play a crucial role in this process. They help you understand industry standards, validate your assumptions, and gain insights into customer behavior. For instance, knowing the average duration a customer might stay with your platform shouldn't be a guess—it should be informed by direct feedback from potential users. This kind of information is invaluable for refining your business model.

The goal here isn’t to craft a flawless spreadsheet but to test your assumptions. This approach is far more grounded than assuming you'll capture a market percentage without understanding the required effort. This level of analysis shows investors that you understand the effort needed and are ready to take it on.

I have created a downloadable Excel sheet that allows you to easily change your assumptions and see how it impacts your model. Use this tool to apply the bottom-up approach to your business idea and keep refining it as you gather more data.

In our next blog, we will discuss how to conduct effective customer interviews.

Keep hustling, and remember: every 'no' is one step closer to your next 'yes'!

Have you used a bottom-up model in your startup journey? Share your experiences and insights in the comments below!