I can’t tell you how many times I’ve heard venture capitalists and executives insist new businesses should target big markets. They also love chasing “hot” markets that are en vogue. There was the renewable energy wave, “the Facebook of…” and early SaaS. More recently we have 3D printing, the Internet of Things, mobile everything and “the Uber of…”. We have FinTech, MedTech, EduTech, CleanTech, AdTech and even FashionTech.
While some have found success chasing big, hot markets, our statistical research shows an inverse correlation between the size and popularity of markets, and the odds of survival for startups entering them. In other words, if you want to increase your business’s odds of success it’s better to avoid big, hot markets rather than chasing them. Who would have thunk it?
Think of it this way; if you’re the only coffee shop in a town, you have 100% odds of capturing the town’s coffee shop customers. Then, when Starbucks moves in across the street, your odds go down to 50%. Two days later, when yet another Starbucks opens three blocks away, you’ve been reduced to 33%. This is obviously a hypothetical example to keep the math easy, but you get the idea. The number of firms competing in an industry reduces individual probabilities of winning.
Beyond arithmetic, consider some of the biggest venture-backed companies of all time. When Uber started, the taxi industry was hardly a hot market. Taxis and private car services hadn’t changed much in nearly a century. When Uber showed up in 2009, it stuck out like a sore thumb.
The same can be said for Airbnb – in 2008 hotels were the definition of an innovation dead-zone. The business model of nightly dollars for beds had been frozen in time. Dollar Shave Club had a similar impact in the razor market, where a few huge vendors (ex. Gillette) had been selling to consumers through the same retail channels for generations.
The point is: bringing unique business models into frozen innovation wastelands creates higher odds than flocking to what’s hot and steamy.
As a VC it’s a lot easier to fund unique companies that stick out like a sore thumb in their industries. Nothing’s worse than trying to pick the winner in a saturated hot mess of startups with more in common than distinct. For example, there are gobs of startups using analytics to try and help advertisers deliver targeted ads to mobile customers. Sure, a few firms will inevitably rise to the top, but let’s face it – predicting the winner can be like trying to pinpoint a spec of dust in a sandstorm.
Along these lines, our data suggests startups tend to do better starting with little markets rather than big ones. Big markets can have big competitors, big customers and big problems. Instead, startups should look for little niches they can more easily dominate. The goal is to become the biggest kahuna on the smallest island, as quickly as possible.
Only after capturing a small market should startups expand to other small markets. By “island hopping” from one small market to another, startups begin to gain critical mass. Think of it this way – add up enough islands and eventually you end up with Indonesia. Our research suggests this is a faster and higher-odds path than taking big markets head-on right away. A great example of island hopping was Amazon. Remember when it was just a book company? Once it won in books (farewell to Borders Bookstore) it was able to expand into other segments. Now it sells everything and anything. It’s better to win smaller fights before working up to bigger ones.
There are obviously counter-examples to the rule. Plenty of startups have successfully attacked big, hot markets. Entrepreneurs are obviously free to do whatever they choose. However I think it would be a mistake to confuse the exceptions with the rule. For every startup that succeeded by plunging head-first into a big, hot market, there are mass graves of others just like them that died along the way.
This point gets lost because we tend to forget the failures and fixate on survivors, which is a tragic tendency in management science. It’s the “benevolent dolphin” problem: sailors lost at sea have been pushed to shore by dolphins, making us assume dolphins like saving people. However we never hear the stories of people who were pushed away from shore by dolphins, because they die and can’t tell us what happened. Dolphins may not be benevolent, just playful.
Similarly, although many startups have survived by chasing big, hot markets, most fail. They just die quietly so you don’t hear their stories.
If you’re interested in making the odds work for you rather than trying to sail against them, I hope this has been helpful or at least a little provocative. Don’t believe the hype about big, hot, sexy markets.
Rather, if you want to increase your statistical odds of success, it’s better to bring something special to a market that’s small, cold and un-sexy. Don’t worry about having a tiny initial market, so long as it creates near-term advantages and positions you for bigger wins over time. Statistically speaking, it’s better to start small – especially if you want to finish big.