An Attempt to Explain the Most Difficult Concept in Entrepreneurship
Most people think the purpose of entrepreneurship is to build and sell a product. That’s wrong. The purpose of entrepreneurship is to capture a market opportunity. The building and selling of products is a mechanism entrepreneurs can use to capture market opportunities. This may seem like a subtle distinction, which is part of what makes it difficult to grasp, but all great entrepreneurs understand the difference. If you want to become a great entrepreneur, then you need to learn the difference, too.
Why entrepreneurs focus on their products
Prior to launching their own ventures, all aspiring entrepreneurs have the same relationship with businesses as everyone else in the world: they experience businesses as consumers. Whether the restaurants our parents took us to as toddlers or the first time we pointed toward a toy in a store and said, “Mommy, I want that,” our formative relationships with businesses are as consumers of their products. Because we spend most of our lives purchasing and consuming products, we tend to think products are the focal point of every successful business, and everything else about the business orbits around the product.
Think of your relationship with businesses like your relationship with our solar system and the broader universe around it. As a person living on the planet earth, your perspective of the solar system is one in which you and your planet are the things around which the rest of the solar system revolves. For thousands of years, this perspective — called the geocentric model — caused humans to assume the earth was central to everything in the universe. However, as science eventually proved (to most of us, anyway) the earth is not the center of everything.
Six hundred years ago, if I asked you to build your own universe from scratch — an admittedly strange request, but humor me — you probably would have started by creating some sort of earth-like planet and then built outwards from there. Meanwhile, the 21st Century version of you would think you were ignorant, point at you, and laugh.
Similarly, aspiring entrepreneurs — like everyone else — grow up interacting with businesses by using the businesses’ products. As a result, when launching their own ventures, they assume their primary focus should be their own products. But placing a product at the center of your new business is like trying to build an earth-centered version of the universe. You’re seeing and interpreting the structure of businesses from your personal perspective rather than understanding their structures from a broader, omniscient perspective.
Why product-focused entrepreneurs fail
To better understand the proper way to approach starting a new business, I want to guide you through a thought experiment I often give my students.
It begins by forgetting about whatever business you’re currently trying to build and imagining, instead, that you’ve decided to open a restaurant. Take a moment and start planning your restaurant in your head.
Go ahead… I’ll wait…
Are you ready? Great! What kinds of things did you think about first?
If you’re like most people, the things you thought about included:
- Type of food
Those are all parts of your product. Yes, all of those things matter, but none of them should be your first concern. Here are some examples of what happens when you focus on those kinds of things — your product details — as the first step in developing a new venture.
Let’s imagine the first decision you made about your hypothetical restaurant is that it’s going to be a pizzeria. After all, lots of people enjoy pizza, right? Plus, you’ve been cooking pizzas using your grandmother’s secret pizza sauce recipe for years, and people have always raved about it. Clearly, everyone is going to love your new pizza restaurant.
So you spend your life savings opening a new pizzeria in a strip mall near your house. On the weekend of the grand opening, you host a big celebration — giving away lots of pizza and coupons in the process — that gives you a decent first jolt of revenue and lots of positive Yelp reviews. People are writing things like, “Best pizza in town! And don’t forget to try the cheese bread. It’s super-duper-amaze-balls!” You’re excited. Your dream of being a restaurateur appears well on its way. You even start imagining the potential of franchising.
But, after the first few weeks, business begins to slow. Some other restaurants open nearby. They aren’t pizza places, but they’re still pulling away business. And, for some reason, tomato sauce prices skyrocketed, driving up the price on one of your main ingredients. Pretty soon, you’re not making enough money to cover your costs. Six months later, you sell your last pizza and shut down.
When you try to figure out what went wrong, you look more closely at your idea and start to see some faults. First of all, that strip mall where you opened your pizzeria isn’t in the greatest location. It’s miles off the highway in a lightly populated, semi-suburban area, and three other pizza places are within a few miles. Also, those tomato sauce price increases shouldn’t have been a surprise. The entire industry had been experiencing problems for years. A little research could have shown you that.
Even Yelp, the online forum where everyone loved you and gave you glowing reviews, started mistreating you. The site admins began flagging your reviews as “fake” unless you agreed to pay Yelp money. Who knew Yelp was really just a platform for extorting small business owners?
In other words, your pizzeria didn’t fail because your pizza was bad — a.k.a. a bad product. Your pizzeria failed because of all the factors that had nothing to do with your pizza. It failed because you focused on your product rather than your market opportunity.
Understanding market opportunities
When people describe the work of entrepreneurs, they usually use words like prototyping, building, selling, marketing, fundraising, and hustling. But I rarely hear them use the word that should be the starting point for every venture: researching.
Researching isn’t just for scientists and scholars. Great entrepreneurs begin their work by researching potential market opportunities.
I like to define a valuable market opportunity as a combination of high demand and — here’s the important part — cost-effective access to that demand. The access component is critical. Without cost-effective access, no amount of demand is valuable. Need an example? Consider North Korea. It’s an entire country that’s been closed to much of the outside world for decades, meaning it’s probably got enormous amounts of demand for new goods and services. However, even if the people in the country would welcome an amazing new product, there’s no access to the market, so there’s no market opportunity, and great entrepreneurs wouldn’t consider creating a product for North Korea.
Because great entrepreneurs understand the early success of a venture comes from capitalizing on a great market opportunity rather than building a great product, they don’t build products until after they’ve identified a valuable potential market opportunity. They then use the market opportunity they’ve identified to tell them what product to build.
Let me repeat that concept because it’s critical: Great entrepreneurs don’t start with a product; they identify a market opportunity first, and then let the market opportunity tell them what to build.
Why market opportunities are more important than products
Let’s return to the example of starting a restaurant. As I described earlier, the first step a bad entrepreneur takes when launching a restaurant is to decide what kind of restaurant to launch. But the first step a great entrepreneur takes when launching a restaurant is to research potential opportunities in the market.
So let’s pretend you’re a great entrepreneur launching a restaurant in Austin, Texas. As a great entrepreneur, instead of thinking about the kind of restaurant you’re going to launch, you start searching for a market opportunity. Again, market opportunities are a combination of demand and cost-effective access to that demand, so the first thing you’re going to do is look for large pockets of unfilled restaurant demand.
You begin by researching restaurants in downtown Austin using Google maps. After a few days of research, you identify a 10 block radius in a mixed commercial and residential area with no pizza parlours. That could represent an area of high potential demand. Excellent!
Even though you personally enjoy pizza and believe most people do, to be sure demand for pizza actually exists where you’re considering opening a restaurant, you do some additional online research. You join a local Facebook group and see if anyone is asking for and/or giving local pizza recommendations. And you browse Yelp reviews and see if people are making comments like “worth the walk” on pizza places far away. Those are both good signs. Though, again, be careful about putting too much faith in online reviews.
You also attempt to do some historical digging to see if a pizza restaurant had ever been in the area. If one recently closed, you’d have a warning sign that demand doesn’t exist. However, you can’t find any record of a previous pizzeria in the area. That’s good news.
Finally, you take a trip to the area to see if you’ve missed anything by searching online rather than in-person. For example, all the bars in the area might serve pizza. This could be either a good sign of market demand (i.e. people want pizza and aren’t getting it from the usual places) or a bad sign (i.e. people rely on the bars for their pizza and aren’t likely to change their ordering habits). You have to judge based on what you see and who you talk to. Note: don’t be afraid to talk with lots of people. But don’t ask them if they want a pizzeria. Ask them what kinds of restaurants they currently like and if they’ve ever had a food craving they couldn’t easily satisfy.
After your research proves that you have, indeed, found market demand for a new pizza restaurant in Austin, it’s time to determine whether you can access that demand in a cost-effective way. In other words, you have to figure out the cost of opening and running your new pizzeria.
You start by researching real-estate in the area to make sure rent isn’t too high. Great news! It’s an “up-and-coming” neighborhood, so rents are still low. Next, you have to figure out the costs of starting and operating a pizza restaurant. Remember, you chose pizza based on a gap in the market you identified, not because you enjoy making pizzas, so you’ve got lots of research to do in order to understand the product. But it’s not like you’re inventing a completely new type of food. The answers are available, you just have to figure out how to find them.
You start your research online to learn about the kinds of expenses you should expect to incur when running a pizza parlour. You can also talk to other pizzeria owners. If you want to avoid direct competitors in Austin, why not cold call pizzeria owners in other cities? Presumably, the logistics of operating a pizzeria in Austin isn’t too different from the logistics of operating a pizzeria in Miami or San Diego.
Based on your research, the menus and recipes are relatively simple, the food is cheap to produce, and the ingredient costs are stable. Your research uncovers what appears to be some turmoil in the tomato industry, so you account for a potential rise in the cost of tomato sauce in your financial modeling. The biggest up-front expense is going to be a pizza oven, but, if everything goes badly, at least you can resell the oven without taking too much of a loss.
The biggest problem you see is that you’ve never made a pizza before in your life. You have no idea how to make the actual product.
In the mind of product-focused entrepreneurs, not knowing how to make pizzas would prevent them from even considering a pizzeria. In contrast, as a market-focused entrepreneur, you understand that your knowledge of the product isn’t as important as the market opportunity. You can either learn to make pizzas yourself, or you can hire someone who knows how. In other words, of all the reasons your pizzeria might fail, the pizza itself — your product — is the easiest issue to deal with because millions of people around the world know how to make pizzas.
With your thorough research complete — which may have taken you months — you’re confident you’ve found demand, and you’re certain the cost of accessing the demand isn’t too expensive. Now you can finally do what most entrepreneurs think is the first step of entrepreneurship: start building. You invest your life savings and lots of time. A few months later, you open your new pizzeria joint. Congratulations!
Thanks to your thorough research, you accurately identified a source of demand. As a result, without any advertising, your pizzeria is packed with locals starting on Day 1. Sure, some of your Yelp reviews could be better — someone even wrote, “I’d rather eat cardboard with ketchup on it,” — but that doesn’t seem to have hurt your business at all. Plus, you can always just pay Yelp a few bucks and they’ll flag bad reviews as fake and bury them, so who cares?
Within a few months, you even have to sign a lease on the storefront next door in order to expand your dining room. All this, despite the fact that your restaurant serves mediocre pizza. Why? Because the product wasn’t the most important part of the business. Instead, you identified a valuable market opportunity and created a business able to capture it. Selling pizzas was merely the mechanism to do so.
Business success comes from market opportunities, not products
I’ve used the above example of launching a pizzeria because most entrepreneurs have a basic enough understanding of restaurants to appreciate how products and markets relate to each other in relation to opening a new restaurant. However, the same relationship between market opportunities and products applies to every type of business.
Are you building a B2B SaaS company? Find a market opportunity, and let the market opportunity determine the product you create.
Are you building a CPG company? Find a market opportunity, and let the market opportunity determine the product you create.
Are you launching a medical device? Find a market opportunity, and let the market opportunity determine the product you create.
To be fair, I realize this isn’t always how businesses get developed. In fact, I suspect the reverse is true. I suspect most people start their entrepreneurial ventures by developing a product and then trying to find a market for it. I have two explanations for why this happens and why it occasionally seems to work.
First, I’d argue that sometimes people get lucky. Consider this: over 500,000 new businesses get started in the US each month. If even a tenth-of-a-percent of those businesses succeed (which may actually be an overestimate according to recent data), that’s 500 successful businesses each month. More importantly, it means half a million businesses failed. I’d argue a huge portion of those businesses fail because the entrepreneurs launching them started by building products rather than identifying viable market opportunities.
The second reason product-first ventures sometimes succeed is that they only appear to be product-first ventures. In reality, the entrepreneurs themselves never realized they’d been conducting market research for years. However, instead of calling what they’d been doing “research,” most people refer to this kind of unintentional market research as “experience.” That’s why the average age of a successful startup founder is 45. After decades of experience in a given industry, entrepreneurs are able to intuitively recognize demand and understand the cost of accessing the demand. When they finally do begin developing products, it’s not that they’re product-first entrepreneurs. It’s that they spent decades researching their market opportunity without realizing it.
However, you don’t need decades of experience before you can launch a successful business. And you certainly don’t have to be lucky. You just have to stop thinking about businesses like a consumer and start thinking about them like an entrepreneur.