Thinking About Thinking

Nearly every company pitch I’ve seen covers the topic of market size.  And, in every serious internal discussion about a prospective investment, we talk about market size as well.  Usually, the primary topic of discussion in both contexts is the size of the market boiled down to an actual dollar figure.  Entrepreneurs and investors alike will come up with a very detailed, methodical way, to define the size of the market opportunity.  While that’s fine and worth doing, comparatively less time is spent on the topic of whether the market is an existing or a new market – and the associated risks and opportunities related to that.  And, the latter topic can be more indicative of the prospects of the investment than the former analysis on market size, itself.

An existing market is a market where customers already spend money buying more or less the same product or service that a given company is selling.  That product or service may be delivered or sold in a different way, but at the end of the day, the customer that you’re targeting is already spending money on substantially the same thing.  What’s an example of this?  Care.com is an online marketplace to find babysitters.  People already spend money on babysitters, Care.com is just helping them to find babysitters more easily.  This is an existing market.  Chewy.com is an e-commerce company for pet food.  Their target customers already spend money on pet food.  Again, an existing market.  Amazon started out selling books, which people already buy.  Uber started out replacing taxi services, which people already buy.  Globaltranz is an online freight broker for trucking capacity, which companies already buy to ship goods. Square is going after the existing market of credit card processing.  Prosper is a peer-to-peer lender, which sounds like a new market, but they’re really selling unsecured consumer loans, which consumers have been procuring for ages.  These are all existing markets.

A new market is a market where the end product or service is new – in other words there isn’t really existing demand, but there could be.  SpaceX just closed a big financing last week – space travel is a new market for certain.  When Google first came out, it was targeting a new market of online search and search engine marketing.  There really wasn’t much of an existing market in search at that time, outside of maybe Yahoo and Altavista.  Everything related to drones is a new market.  Twitter ushered in a new market that had never existed of micro-publishing.  Many location-based applications on smart phones (though there are exceptions) are more than likely to be a new market given the technology didn’t exist to do it until the smart phone revolution.  Even a lot of the SaaS companies  are selling to mid-market companies that never spent money on traditional software applications before therefore making it a new market in practice.  New markets abound in the world of venture-backed companies.

When investors and entrepreneurs go after a truly new market – the advantage is usually there are not entrenched competitors so if the market materializes as quickly and dramatically as they hope, market leadership is more attainable.  In addition, new markets can grow exceptionally quickly, far faster than existing markets – and a rising tide can lift all boats as the saying goes.  So, there is no doubt that you can win and win big in a new market.  That being said, the risk one takes with a new market actually emerging is often profoundly underestimated.  My guess is the most common reason companies targeting new markets fail is primarily because the market never really emerges at the pace and size that the company and investors expected.  You can have great management, a great product, excellent sales and marketing, but if the market isn’t there, then it’s easy for a company to get stuck.  It’s hard to have good product/market fit, when there’s no market after all.

When investors and entrepreneurs go after an existing market – the advantage is there’s little or no market risk.  You can go into an investment knowing exactly how big the market is, that customers care about the product, that there’s already a product/market fit and customers derive value from what they’re buying.  The value of that can’t be overstated.  But, the risk of existing markets is there are already companies serving those customers so there is entrenched competition.  If existing competitors have substantial customer loyalty or capital, they can be excessively difficult to displace.  A new company entering an existing market has to not just be a little bit better, but meaningfully better than existing means of procuring that product to really win.  That can be a tall order, but if that competitive distinction exists, there’s a high probability you’re onto a compelling opportunity and success is far more predictable than most companies targeting new markets.

A few companies dominate existing markets while simultaneously opening new markets.  A great example of this is Uber.  On the one hand, I said that Uber is going after the existing market of taxi services.  But, I also said most location-based smart phone apps, which Uber is, are going after new markets.  In this example, this is not a contradiction because both are true.  Uber started out by displacing the $11B taxi services market.  But, why is the company worth $40B?  Uber has become so convenient, that they have changed the behavior of how people travel – so they’ve opened a new market as well that may be bigger than the existing taxi market.  Certain studies say that Uber’s revenue in the Bay Area is multiples larger than the entire taxi market in the region – which suggests they have both won an existing market and opened up a large new market.  That’s a beautiful thing.

So, next time you see a pitch or make a pitch that says the market size is $1 billion – note that not all markets of comparable size are created equal.  And, the risks and opportunities of existing and new markets can be substantially different.