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Published by Vassil Terziev and Roberta Tihomirova.
Getting to a dominant market position is essential for long-term success. This is why when working with startups, one of my favorite questions is “How will you get to 30% market share?”. And some of the teams hastily start laying out the details of how they will execute without really understanding that it’s a trick question. Some of the teams, however, reply with a question – from what market? And that takes them on the right path.
Most of the young CEOs (myself included at the beginning of Telerik) make a cardinal mistake – they extract the market size from Gartner, Forrester, McKinsey, and what not reports and see big numbers. Millions, billions, trillions. While it might be tempting to play with big numbers, it doesn’t help much as in reality this is NOT your market. The fact that someone else is making this much money or that there is a big potential does not make it your market. And your strategy needs to be squarely focused on your understanding and winning YOUR market.
An example of how someone else’s market is not your market
As a first step, let’s try to understand how those big numbers come to life. Let’s say that you are eyeing a market in which there is only one incumbent and they make $1B a year in revenue. Is it 1,000,000 customers x $1,000 or 1,000 customers x $1,000,000? It is quite important to know as those two variables form the market size. Let’s say in our example it’s the former – it’s a simple “buyer is user” model and the lifetime period is 1 year (all of the CLTV is realized in Year 1).
Say you want to disrupt the competitor with an amazing, new-age product that is licensed in the exact same way but is better and is priced at $50. What just happened? The $1 Billion market that your competitor had and you found so appealing just shrank to $50,000,000 (1 million customers x $50). There’s nothing bad with dominating a $50M market that you can clean up as long as you are mindful that it’s not a $1B market and you and your investors know the ceiling of the current market opportunity. Unless you find a way to further democratize the product and bring it in the hands of 20x more people, it’s not a $1B market anymore!
As a side note, what happens in real life is that due to price sensitivity or accessibility you unlock a segment of your market that has never used such a product because it was out of reach. A very good example is UBER – when the service was launched, it was estimated that the value of the taxi market in San Francisco was $150M and everybody thought that UBER would crush the market; 3 years later UBER was making $500M in San Francisco. The opposite is also true – if you were to find a way to offer a much bigger value to those 1M customers and you could charge them $5,000 per year, this would expand your market to $5B.
The key learning
Market size is heavily dependent on your business model! The proper way to estimate the market opportunity (in $ terms) is the following:
Reachable market size = [# of consumers/companies for whom your current value proposition is relevant] X [real or expected CLTV per customer]
The good news is that this way to calculate market size works even if you are first in a market and there’s no competitor against which to benchmark (think VMWare in the early days).
Dissecting the variables
- One of the most important things is to remember that a market is NOT defined by the product. You compete on who will do a better job delivering the value proposition. If you obsess about the product, then you are suddenly surrounded by all kinds of competitors when in reality you are not. Say you sell hammers – while you can use the hammer (the product) to soften your steak it’s not really your market. Your market is the construction industry for which the specific hammer was developed. So when you are calculating your market size, you should be calculating it based on the construction workers who would need that specific hammer in a work environment and not through the prism of all the potential uses of the hammer. Yes, this example might sound funny or crazy but it’s equally funny or crazy when founders don’t see the same picture when looking at their business.
- CLTV: “but I don’t know how I will make money?!” If you don’t know the answer, you don’t have a business model and a well-defined reachable market. It’s not a problem as long as you are trying to find the answer and are cognizant that at present you don’t have a market opportunity you can calculate in terms of $$$. We have seen examples where companies get acquired for different reasons and many times they did not have revenue or a well-defined business model. Ultimately though, even technology-centric acquisitions are centered on growing revenue and/or lowering costs. The more you know how your asset (your company) can be monetized directly or within a different context (think WhatsApp within Facebook or YouTube within Google), the more value you can create for yourselves. So, don’t be lazy – try to do an empty Excel file with lots of hypotheses and validate each variable over time. Obsess about users, growth, technology, etc. but do think about how you, or someone else, will start monetizing what you are building at some point.
Key takeaways
1. Your market size is heavily dependent on your business model.
2. If you don’t have a business model (yet), you don’t have a defined market opportunity in terms of $.
3. You compete for customers based on value proposition, not based on product.
4. Don’t obsess about being a rounding error in someone else’s market – aim to be the dominant player in YOUR market; a market where you are significantly differentiated with your value proposition (and its derivatives: product, business model, and GTM strategy).
And a final note – don’t be discouraged about small numbers. Picking a small, narrowly defined market segment (within a big market), which you can dominate and where you have a sustainable differentiation is many times the best strategy when starting a company. Have your big vision but always focus on the next small step. As they say, appetite comes with eating! Once you are close to dominating a small market you will have already identified a path towards a much bigger market.
