A common question facing founders when pitching for VC investment, is what makes your idea, product or business model 10x better than incumbents?
This caveat to raising venture money often borders on cliché, to the extent that it’s become meaningless. While some perceive the ‘10x’ factor as something intangible and hence hard to articulate, having been lucky enough to come across a handful of these opportunities (out of the thousands we look at each year), it’s safe to say you know it when you see it.
That’s all well and good for investors, but for founders — who rarely get that kind of opportunity — what does it mean to be 10x better? And more importantly, how do you spot those opportunities from the get go?
Why is it important?
To provide some context to the 10x test, it’s important to understand that due to the risks of early stage investing (i.e. the high failure rate), returns in venture capital are power law distributed i.e. 10% of portfolio companies drive as much as 100% of fund returns.
This means for the VC business model to work, investors need to deliver (or have the potential to deliver) 10x their investment on every deal they do. So that, while nine out of ten might fail, one single investment could return the entire fund.
It stands to reason, for a single startup to deliver a 10x return on investment, the product or business model they are proposing (whose intrinsic value is crystallised on exit), needs be to 10x better than whatever existed in the first place.
What does 10x look like?
So, what does it mean to deliver 10x improvements?
Is it that your startup can deliver the same product or service at one tenth of the cost, without destroying margin? Or through a combination of automation and clever workflow design, you can deliver it 10x faster? It could, of course be a combination of speed efficiencies (being 5x faster) and cost (delivering it 5x cheaper). However, it doesn’t necessarily mean just being faster or cheaper…
Some startups deliver the same quantum of improvement to existing consumer experiences or business services by addressing the simplest of pain-points, which carry a disproportionate amount of emotional or cognitive effort, reducing the associated stress or anxiety by a factor of ten.
For instance, payroll automation services taking the stress away from Financial Directors required to execute payroll each month or helping home buyers sleep better at night by automating the conveyancing process — the most confusing and stressful process in the home buying process.
Other startups might automatically deliver a 10x improvement by offering entirely new products or services that have previously never existed, either by tapping into latent desires left undiscovered by incumbent players or bringing a new technology to market.
In summary, small, incremental innovations are unlikely to raise eyebrows on the venture circuit. While they can present great, gradual business opportunities for enterprising founders, VCs are looking for two types of innovation:
- Disruptive innovation — involves new entrants challenging incumbent firms, often despite inferior resources by finding a gap in the market (targeting over-looked segments in a given space with a product considered inferior by incumbent’s most-demanding customers, later moving up-market as their product improves), or creating a market in the gap (where no market currently exists, they turn non-consumers into consumers. This is not about technology alone, but rather the combination of technologies and business model innovation).
- Radical innovation stems from the creation of new knowledge and the commercialisation of completely novel ideas or products, ones that destroy or supplant an existing business model.
The different forces, processes and examples of these each type of innovation (incremental, radical and disruptive) have been well explored by academics.
How do you spot them?
Investors often pride themselves on their ability to spot these “unicorn” opportunities, investigating microtrends to predict specific markets, product or service categories with the capacity to yield 10x improvements. This often feeds into much of their outbound activity, producing extensive market maps or publishing long-winded articles exposing areas of interest in the hope they might attract founders to their cause.
From a founder’s perspective, much of this discovery depends on uncomfortable levels of serendipity, where they might have experienced the particular pain-point they wish to solve or seek a better way out of the frustrations of dealing with existing alternatives.
For more strategic entrepreneurs looking to exploit their next big opportunity, there are a few approaches they can adopt, borrowing elements from the investor search playbook. This could involve searching for spaces where incumbents currently enjoy high margins, seeking slow, manual processes that are holding back specific sectors, or new regulations requiring the adoption of entirely new solutions.
Here are a few approaches you might take:
Starting from a low base always helps
Naturally, when you’re presented with a low base (zero), delivering 10x improvement is a great deal easier. Many founders (sometimes without realising it) might be targeting slow-moving industries that have not yet been disrupted by technology, such as large industrial manufacturing or construction industries.
Other people’s margin is your opportunity
Bezos nailed it when in the early days of Amazon he warned brick and mortar incumbents with “your margin is my opportunity”. Existing retailers were including anywhere between 10–100% markups to cover expensive overheads, such as shop staff and physical stores.
Software entrepreneurs are constantly looking for opportunities in the enterprise (or indeed, SMEs) where there are large numbers of people ‘doing stuff’ that could easily be executed by a simple command script. Alternatively, vertically integrated consumer brands seek product lines where multiple hands are touching physical goods and hence extracting value through the supply chain. There are plenty of opportunities for price disruptors to be 10x cheaper, without necessarily destroying margins.
Look for seemingly unsolvable problems
One of the best sources for locating everyday pain-points is ploughing through the vitriol that crops up in everyday news flow. We’ve all read the tabloid front pages that expose widespread, visceral challenges faced by the everyday consumer. Whether it’s the cost of childcare or the inability of millennials to get a foot on the housing ladder, each headline represents a problem that could be solved through some form of business model innovation, if a smart founder was to put their mind to it.
Seek out enablers and ride microtrends
Enablers might be new sources of data, new technologies or even other startup players (such as platforms or middleware firms allowing new entrants to break into industries that were previously inaccessible). This is particularly present in industries such as fintech, where new initiatives such as open banking suddenly open the doors to new analytics or lending services. Regulatory shifts such as GDPR or MFID II have also offered ample hunting ground for regtech founders.
- French tech fund Elaia demonstrating the standard VC power-law of returns, where 10% of portfolio companies drive fund profits.
- HBR article exploring the difference between incremental, radical and disruptive innovation
- Mark Penn, “Microtrends Squared: The New Small Forces Driving Today’s Big Disruptions”