Picking the ideal market size for a startup

There may be some argument about this but I’ve read in a number of places that the fastest high-tech company to reach $1B in revenue was BEA Systems. How did they do it? They got big backers: a private equity firm called Warburg Pincus (incidentally, the firm behind Better Advertising, a company co-founded last year). BEA raised a lot of money. The first round was $26M. Upon launching they acquired several existing companies/products in quick succession: Information Management, Independence Technologies and Tuxedo. Later on they acquired WebLogic and many others. There is one other small detail: it was Bubble 1.0, the dawn of the Web. With all that cash, acquisitions and an environment where customers spent indiscriminately, it took them nearly six years to get to a $1B in revenue.

Look at it another way. Say your startup had $1M in revenue last year. It would take you five years of about 400% Y/Y growth to get to a billion. Well, you say, I don’t need to own the entire market, just be the gorilla. OK, to get to 30% of the market or $300M you’ll need over 300% Y/Y growth. To get “just” to $100M in five years takes 250% Y/Y growth starting from a million.

Statistically speaking, your startup is unlikely to grow this fast. And, statistically speaking, if you go about your business aiming to repeat the trajectories of outliers, such as BEA, you’ll end up in the dead pool.

The best early-stage entrepreneurs don’t care much about billion-dollar markets described by generic, fuzzy terms such as display advertising or consumer financial services. To them, such a market definition is an abstract notion, a vision to aim at, something to sell to investors and analysts. Investors and analysts love talking about multi-billion-dollar markets because it is easy to pontificate about the distant future using imprecise language. It requires but a vague understanding of technology, industry and customers.

What the best early stage entrepreneurs care deeply about are small, precisely-defined markets their companies can dominate. Very early on, they care about the one such market they will go after. They know that the antidote to being mediocre at many things is smart, pragmatic focus. In a startup, this automatically means not doing much and not caring much about a lot of things, such as the $123,456,789 of market opportunity your company is not going to go after this year while it’s tackling the precisely-defined market it cares about.

How big should your market be this year? Here is a simple way to guess at this:

  1. Take the important leadership metric (revenue, users, etc.) for your business.
  2. Decide where you want to drive this metric to in the next twelve months (M).
  3. Pick the smallest percentage (P) such that, if your company owned that much of the metric, you’d be the undisputed leader.
  4. The market size is about M/P.

For example, you are aiming at a monthly subscription run rate of $500K/mo in a year. In your market being the leader means owning 50% of the market. For your company to be doing $500K/mo ($6M/yr) in subscriptions with 50% market share, it must be operating in a market that is about $12M in a year.

Seems small, no? Just like any one gold mine may be small in proportion to the gold reserves in an entire mountain. More on this line of thinking in Geoffrey Moore’s and Steve Blank’s work.

What if you find (or think you have found) a much larger, homogeneous market where you have good product/market fit? Well, you can do one of three things:

  1. You can tighten your market definition. If you don’t know how to pick, make some hypotheses and test them. You are likely to find a sub-segment where you have lower cost of customer acquisition (COCA) and perhaps higher lifetime value (LTV) because of better product-market fit.
  2. You can consider ways of boosting the growth rate of the company, easing the critical constraints: hiring more people, raising more capital, partnering with or acquiring companies, etc. You’ll do this because you want to have a dominant share of this market.
  3. You can choose to not own a dominant share of the market. The question then is, who will?

About Simeon Simeonov

Entrepreneur. Investor. Trusted advisor.
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1 Response to Picking the ideal market size for a startup

  1. Nice post. Contrarian, I think. For a different point of view check out venture hacks very good post on presentations http://venturehacks.com/articles/presentation-hacks

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