…the market size slide.
My sense is most entrepreneurs feel like they have to have a $1B+ market size for investors to get interested. And, then the more aggressive entrepreneurs, knowing that everyone else has at least a $1B+ market size, come in with the $5B-$10B+ market sizes. The means to arrive at these numbers is usually to take a generous number of possible customers and multiply that times a large spend per customer to equate to the multi-billion dollar “addressable market size“. Others might site 3rd party data sources which is intended to lend credibility to the analysis, but which are largely derived by the same methodology. It’s this approach to market size analysis which I don’t find particularly useful and can generate a false sense of comfort if you actually believe it.
When I’m looking at a prospective investment in a company, here’s how I think about market size:
The first question I ask is how much revenue do the companies that sell principally the same product or service generate today. This is the “current market size“. For example, when we invested in Ensighten in 2012, which started out as a tag management vendor, if you added up all of the revenue (from tag management software) of all of the tag management vendors, the total would have been less than $30M, but with hyper growth. That, in my mind, was the current market size for tag management. It was a small number because tag management was a new market rather than an existing market. Alternatively when we invested in Globaltranz in 2011, which is an Internet freight brokerage, the revenue of all of the companies that broker freight capacity in the US was $127B. It was a much larger current market, but with more moderate growth given the maturity of the industry.
It’s important to establish the current market size because it helps to establish whether the company is going after a new or an existing market. If the current market size is small, such as tag management was two years ago, that’s not a deal killer by definition. It just means you have to develop strong conviction that the market will grow and appreciate the inherent risk with that. Lots of investments fail because a new market doesn’t grow at the scale or pace anticipated. If the current market size is large, but not experiencing hyper growth, such as in the overall freight brokerage industry, that’s also not a deal killer by definition. It just means you have to have a crystal clear rationale on why market spend will shift towards a new upstart rather than stay with the incumbent. These are important and fundamentally different questions.
The next question I then ask on market size when evaluating a company is how much revenue, in aggregate, will all of the companies that sell principally the same product or service generate in the future (5-10 years from now). I think of this as the “attainable market size“. When you define a market size by the aggregate revenue of the competitors, it immediately juxtaposes market size against market leadership. For example, if an entrepreneur wants to say their company will have a large multi-billion dollar attainable market (e.g. $5B in 5 years), but their company “only” projects $50M in revenue in 5 years, then it begs the question why 99% of the spend in the market did not go their way. You can claim a large attainable market, but it becomes harder to claim market leadership with little market share. Alternatively, if an entrepreneur wants to call their company a market leader by generating $50M of revenue of a $200M attainable market, then it begs the question of whether the product or service has that much value if the eventual attainable market isn’t that large. It forces everyone to think through the realities of how their market will evolve and how their company’s competitive position will evolve alongside that.
Today, Ensighten is one of the fastest growing SaaS companies in the country and Globaltranz is one of the fastest growing freight brokerages in the country. Despite coming from diametrically different current market sizes when we invested, in both cases, the attainable market has turned out to be large and both have established strong leadership positions within those markets. We’ve been fortunate that the stars have aligned for both.
In summary, my biggest issue with the bloated addressable market slides we see day in and day out in company pitches, is we all know that when we fast forward 5-10 years, almost in all cases, the actual aggregate revenue generated by the companies in those markets will not come close to equaling the addressable market size. In other words, the attainable market almost always turns out to be a small fraction of the addressable market. This tells me that the addressable market size slide is too theoretical to actually be useful and should have little or no bearing on an investment decision. For this reason, in my opinion, it is generally the least useful slide in the pitch deck.
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.
It’s only taken 16 years in the investment business for me to discover my favorite value proposition. And, I admit, it’s a boring selection. First, some context. A value proposition is the value a business offers its customer such that the customer decides to buy that company’s product. To be fair, there are many categories of value props that all have great merit and can be the basis of building a valuable company. So, one is not by definition greater than another. But, we all have our predispositions, and I have a positive predisposition for one value prop in particular. I favor this value prop because, if it is structurally sustainable, it can be equally transformative as it is predictable – and those usually don’t go hand in hand. So, without further ado, my favorite value proposition is offering a customer the opportunity to buy something they already buy, but at a structurally lower price. Yes, if the options are better, faster or cheaper – I like cheaper. Why do I like this value prop? Because there’s little fundamental market risk. If a customer is already buying a product, then you know they want that product and that product benefits them in some way. You know they are ready to buy it now because, well, they already buy it now – so you’re not taking market timing risk. Whether there’s even a market or whether the market is here now is a profoundly underestimated risk undertaken by many emerging technology companies. And, in this example, you meaningfully mitigate those risks. Then you layer on top of a large existing market, a very clear reason to buy with you – you’re selling to them the very thing they already buy, for a lower price. Who doesn’t want that? The key to a company with lower price as its fundamental value prop being a good investment, is their basis for having a lower price must be structurally defensible and sustainable. It can’t be that they’re doing exactly the same thing as their competitors, just charging a lower price. That’s the definition of unsustainable. There is usually some disruption in the supply chain or some technology innovation, which they can take advantage of above and beyond their competitors which is why they’re able to offer sustainably lower prices to their customers and quickly take market share of a large existing market. When I look at our current and historical portfolio, where the ingredients of a structurally sustainable lower price value proposition is true, those companies have an inordinate propensity to be worth $1B+ in enterprise value. Xoom went public last year by offering online global money remittance at a lower price than folks like Western Union because they have an Internet front-end. Prosper offers loans to consumers at a lower interest rate because they use the Internet to cut out the banks who take a margin in the normal lending process. Globaltranz offers businesses access to trucking capacity at a much lower price due to the efficiency of their agent network, technology and buying capacity. Cortera is offering business credit data at a much lower cost than Dun & Bradstreet because of its proprietary data acquisition platform. And Chewy offers pet owners high quality pet food at a lower price than bricks and mortar competitors because they have no bricks and mortar. These companies are all taking significant steps in transforming their respective industries on the core value proposition of lower price. While I can easily fall in love with companies that have other value propositions such as convenience, selection, revenue enhancement, service, etc., lower price is a tried and true value prop which while admittedly boring, can be extremely effective if it’s sustainable.