- By James Martin
July 4th, 2020
Knowing your Market
To challenge or not to challenge? That is undoubtedly one of the fundamental questions when it comes to markets. As a founder, it is imperative you know your total addressable market, how to approach it and which is the best way to demonstrate your product's purpose and potential success to an investor. In this article, we highlight the pros and cons of entering current and new markets and just precisely what investors are looking for in your pitch deck when it comes to defending your market of choice.
When Sarah Tavel from Benchmark was questioned on markets, she explained that when a startup comes to her with visions of disrupting a big market, she is far from encouraged. Tavel goes on to clarify that in order to build an enduring business, it would be better to expand a market or, even better, create a new one. Nonetheless, companies penetrating an existing market need to evaluate the opportunity within, by looking at adjacent markets to the market of interest and considering if there is the option to expand into that one. Founders must understand just how wide the market gap is and whether it is achievable. Companies competing head on with the relentless nature of large firms, such as Amazon, Google and Facebook might provoke investors to take a skeptical stance. However, startups competing with less reactive companies, such as shipping firms that have been established for years, will most likely encounter a wider market gap.
To many investors, some markets are more appealing than others. Over-time markets naturally change and so when a startup creates a product that will generate a new market, investors will need to consider whether a startup can move in the new market at startup speed. Structural reasons, such as regulations, can potentially stunt startup progression. According to Gigi Levy-Weiss at NFX, as an investor, he likes to see companies competing against other young and startups rather than coming up against the more advanced, better funded and well-resourced corporations. To Levy-Weiss, it is the combination of the size of problem addressing, the speed of product development and the quality of the asset that will define whether a particular market is worth investing in. Airbnb is a prime example; their only main competition is the hotel industry, who are not in any position to be able to launch innovative competitive assets to rival Airbnb's mode of operation. Therefore, they will undoubtedly continue to dominate that market.
In the words of Bill Trenchard from First Round Capital, prospecting for an appropriate market is the longest part of the diligence process. Founders must first identify the market gap - how wide and competitive it is and how they can drive their innovative product through the gap, to build a basecamp of something defensible. Not surprisingly, at day one, founders will have limited defense, but with speed and quality on their side, it is possible to launch a product through the gap to take hold of a position where competitors aren't playing, enabling a company to build a brand and scale up to a more defensible situation.
According to Ann Miura-Ko at Floodgate, founders who are in the process of creating a new market must, first of all, consider what the million-dollar story is. That is to say, why is a startup's product different from what already exists and why does it require a new category and market. Miura-Ko wants to know why the founders believe their company is the one to set the rules for this emerging market. It is easy for an entrepreneur to show up to a pitch and explain why a market is exciting, but for an investor to fully jump on board, founders not only need to paint a solid path of a partnership but also convince why a particular market is right for disruption or growth. If a founder cannot convince an investor on the market, it is often too difficult to place faith in an investor based solely on the team's competence and experience. Enabling trends are tipping points for innovation, and it is in this space, and these markets new companies might stand a chance of succeeding.
Total Addressable Market
One of the essential aspects founders must consider when evaluating a market is the addressability of a market, known as the total addressable market (TAM). For example, take a talented individual who has worked at Google or Facebook and has been taught to solve a complex problem. When they leave to start their own business, despite their first-hand experience in solving a specific issue, they neglect to critically consider how many people have such a problem and how much they would be willing to pay. It is essential that founders first consider how large the current market is for a particular product, how much they are paying, and, if their innovative product is successful, how many people can they convert to using their product.
Despite many investors keen to look at the market size and the approach of the team to tackle the issue, it is also essential to consider that the total size of the market today is not indicative of the market size in the future. Many successful startups were truly innovative, searching for new products and services that people aren't buying presently, but show signs of an upswing. Ultimately, this can be difficult to convey on a pitch deck, but when investors see initial indications, it can signal that it is a great market to enter into.
Top-Down or Bottom-Up
Now, there are two options to describe your TAM correctly; Top-Down or Bottom-Up. Let us first discuss the Top-Down route by using an example of developing a product for the healthcare market. By stating you are aiming to penetrate the $12 trillion healthcare market is totally meaningless, you must refine this to target a specific sector, let's say at $12 billion, then going even further to say the key players in this sector at 'x and y, giving you the belief that your segment is worth $1.2 billion. By using this method, presenting your overall market and then narrowing down, you can not only demonstrate there is a market big enough for your idea, but also that there is relevance just by simply uncovering the market. On the other hand, the Bottom Up route deals with microeconomics, approaching your TAM from the individual perspective. For example, taking another healthcare product analogy, by describing the average price of a doctor's bill, you then build this up to see how much of that value goes to debt, and then how much doctors spend on bad debt until you present your solution, taking into account the dollars and cents spent understanding just how many customers care about the problem. This method identifies how and if people are likely to sign up for your asset and why the product has value. Ultimately, people have to care about the product; it has to matter to lots of people. Knowing just how many and at what price individuals are willing to pay will ultimately define your market.
From a slightly similar perspective to the Bottom-Up approach, Pete Flint from NFX insists that the critical aspect when communicating the market opportunity to an investor is not entirely the size of the market but the size of the problem. As an investor, Flint wants to know how a startup will take the opportunity to capture the market. Furthermore, Flint also considers the momentum and growth of a business to be much faster in a rapidly growing market and that it is vital to demonstrate this clearly in the pitch deck.
Understanding your market, the reasons for penetrating it, or creating a new one, and the approach you plan on taking are all fundamental aspects to consider when creating your product. With any luck, as a founder, you have already begun asking yourself these types of questions.