One of my partners and I were discussing our need to invest time and money in companies building solutions for large market opportunities. He paraphrased someone important: “Are we sitting at the right poker table?”. How do we know a particular industry or space is large enough that if our hard work eventually leads to success, it has a chance to be a super success?
How big is your market size is a question VCs often ask entrepreneurs. The answer they are generally looking for varies primarily by the size of their funds and the kinds of spaces they invest in. Typical VC firms like to fund startups that can some day be worth hundreds of millions of dollars, if not billions of dollars. If an addressable market is too small, it can’t support a large company. The math they are likely doing in their mind is: (a) if market size is $1B, this company can likely capture 5-10% market share, (b) if the industry can support 5-7x revenue multiple then $50-100m of revenue will result in a $250-700m in exit value, (c) if a VC owns 20% of the company, they get $50-140m back to their fund.
So how big is big enough? Is a market size of $1B big enough? $10B? While a $10B market opportunity is almost always better than $1B one, there is no one-size-fits-all answer. However, in my (humble) opinion there are few things that can be helpful for entrepreneurs to keep in mind when thinking about market size for their offering:
- Products are not built for markets, they are built for customers. It is important to focus on solving real problems. Staying close to the customers and hearing what they are saying and building a product that at least your core customer base really really wants, likes to use, and agrees to pay for the use. Many entrepreneurs are unfortunately also often too optimistic about the difficulty they will face in acquiring and retaining customers, and get caught up in how awesome their technology or product is. While the tech world has come to glorify visionary founders, we haven’t done enough to promote this focus on execution chops.
- Proliferating on product roadmap too early to increase available market opportunity can result in a loss of focus that can be lethal to a company. I have seen quite a few companies find themselves lost in large markets because they ended up building too many products too early, or tried to stretch across several steps in the value chain.
- Initial market size for the core product should be large enough to sustain fast growth for at least a few years. Once a company is able to build strong momentum, revenues and profitability with product finding traction, then the company can start thinking of itself as a platform for further products as well. Additionally, if you are selling over $100m+ in revenue with 20%+ ebitda margins you are doing something right. And will find yourself with access to currency to diversify in related spaces via new development or acquisition.
- What may be too small a market size for a large VC fund may still be an incredibly exciting market to build product(s) for, and may result in great financial success entrepreneurs and investors. Besides, what might appear small-ish today could be a much bigger opportunity tomorrow as more people come to realize the potential and build on top or around your offering. It is no surprise that some of the biggest tech companies today were addressing much smaller (but still interesting) problems when they first began (e.g. Amazon, Ebay, Facebook, Twitter). How big do you think the market size was for personal computers when Apple was founded? Did Rovio think they would be making more than 50% of their revenues by selling merchandise around the world based around characters of a mobile game?
- When pitching VCs it can be helpful to describe what your competitors and incumbents have been able to achieve in the market you are planning to enter, but don’t let them walk away thinking of your product as just a replacement product for an existing one. That hardly ever ends well. Help them understand how this is your wedge into the market to wow your initial customer base and to build a strong business with a core audience, and then you plan to expand your offering from a position of commercial strength.
- Visionary entrepreneurs don’t just look 10 years out and imagine how the world could look in the future. They also try to imagine, and then create, a path leading to that future. So don’t just focus on “one day we will change the world”, but start solving problems that actually change the world one shipped product at a time.
Solve real problems. Hire great teams. Build to scale. Win.