Monday, March 7, 2011

How Can You Tell If Your Market Is A Good One?

One of the single most important decisions for an entrepreneur is to chose the market they are in.

From Marc Andreessen's blog on Andy Rachleff's (formerly of Benchmark Capital) Law of Startup Success:

"The #1 company-killer is lack of market.
Andy puts it this way:

When a great team meets a lousy market, market wins.
When a lousy team meets a great market, market wins.
When a great team meets a great market, something special happens."

So, one of the big questions I often discuss with entrepreneurs is, how can you tell if a market is a great one?

Questions to ask yourself about the market:

  • What has changed?  Why now?  Good markets typically have something changing in them, that allows new players to enter or emerge.   For example, GroupOn was able to capitalize on a combination of a new distribution mechanism (social media shares) and merchant and consumer familiarity and comfort in selling/buying things online.  Examples:
    • Costs have fallen or price points risen dramatically.  Many SaaS services are examples of low cost approaches to existing enterprise software businesses.  Example of rising price points driving an opportunity include opening up a new oil field when costs of oil are high enough to support more expensive extraction techniques)
    • A new distribution channel has opened up.  E.g. Zynga using Facebook viral channels in the early days, Yelp mining SEO when SEO was not yet saturated for local listings, etc.
    • New technology emerges.  This usually impacts costs or new types of distribution, or creates new services that fundamentally could not have existed before.  E.g. the emergence of truly smart phones, GPS accessibility from the device, etc. has enabled services like Foursquare (local/social) to appear rapidly and take a dramatically different take on a local service.
    • A new source of customers or demand appears.  E.g. the government starts buying cryptography systems, or Chinese Internet + credit card penetration hits a high enough % for ecommerce to take off.
  • Is a growing customer base being dramatically underserved?  
    • Palantir and government data analysis is a great example of a market segment that was underserved for a long time.
    • While an overall market may be mature, certain segments of customers may be ignored by the incumbent(s).  E.g. the traditional SaaS model is to start with a lower value, early adopter community for Enterprise Software and then to work your way up to larger customers over time as your product goes up market, and large customers' willingness to go to less complex hosted systems increases with time.  Similarly, social media startups often start with a hipster/influencer base and then grow into the mainstream as the product matures.
    • The key is this user base needs to be the growing part of the market, or the early adopters.  The worst possible place to be is to focus on a shrinking segment of a market, even if it is underserved (think e.g. of launching a product for people who only want high specialized, auto-tuned, emo ringtones for their Symbian phones).
  • Is the industry growing rapidly?  A rising tide floats all boats, and this is never more true then in the business world.  When the first wave of the Internet was being built out people needed routers, servers, etc. and a number of companies such as Cisco, Sun, Ascend, and others cleaned up, growing at a ridiculous compounding rate.  Similarly, tons of  now forgotten companies went public during the micro-computer/peripherals hey day of the 1980s, as millions of consumers and companies adopted desk top computers and work stations for the first time.  Look for an industry with lots of growth, and you can often build something substantial.
  • What is the market structure?  A bad market is usually one where there are a small number (e.g. 3-5) of large players who control the market that you are selling to.  An example of this is companies who sell to big pharmaceutical companies.  There are only a handful of large global pharmas left, so if you sell them a product for a few million dollars a year each, your upside is capped in the low tens of millions.  Furthermore, given the small number of potential customers, the pharma companies can effectively squeeze a lot of the margin out of the deal as they have disparate bargaining power relative to their suppliers (since they are a big chunk of the demand in the market).  
    • A related question: Will there ever be enough customers?   Some markets are just tiny and will remain so for many years to come. Sure, you can build specialized iPhone apps for people who want to track dog sledding teams across the Alaskan tundras.  But is this really a large or growing market?
  • Is there a lot of hype or interest in the market?  Some markets get a lot of attention.  This can be both good and bad for a startup.  On the plus side, you will get a higher valuation, more people may want to buy your company, and more smart people may want to come work for you.  Downsides include too many entrants/competitors (so it is hard to be heard above the noise), too many me too products to differentiate, and in some cases overcapacity or vicious price competition that drives the margins out of the business.

It is just as hard to build go after a small opportunity as it is a large opportunity.  As an entrepreneur, you will be working your butt off either way.  The way to maximize the return and impact on time spent is to identify something big and go after it.  It is OK to start off with a small part of a big market and to "think small", just remember to keep the big picture in mind.

Similarly, within a given market, there will be sub-markets that are more or less attractive.  You can apply the same questions above within a given market to segment it even further.

Other ways to assess a market?  Let me know what you think in the comments section.

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