Analyzing Market Opportunities: The Hidden Variables
I heard Peter Thiel recently say that the biggest mistake startups make is overestimating their serviceable addressable market. He mentioned this being particularly true for GreenTech, a sector that has been a bloodbath for some investors. It could be that GreenTech indexes more highly towards idealistic founders with unrealistic or naive outlooks on barriers to market addressability. If true, this is understandable — these startups must account for complex factors such as government legislation and long-term contracts of incumbents. However, experience tells me this happens in many other markets as well.
I have spent the last decade in various Product Management-related roles from startups to mid-sized companies. During that time, I’ve performed many market opportunity assessments, applying the current best-practices each time. These assessments included researching and calculating things like the Total Addressable Market (TAM) and Serviceable Addressable Market (SAM). These calculations were subsequently rolled into investor pitches and operating business plans, providing the underlying framework for KPIs and business goals. With each assessment, I did the best I could with the available information and methodologies. With the 20/20 clarity of hindsight, I later checked my work against how our business actually grew. In almost every case, my analysis was quite optimistic compared to reality. This wasn’t because I was naive or overly optimistic (I have a reputation as being overly pragmatic at times). The problem was that my assessments failed to uncover some things that we really needed to know. The frameworks I used left a lot of gaps in the overall opportunity picture.
So what should I have done differently in analyzing market opportunities? What is wrong with frameworks like SWOT, Porter’s Five Forces and their various derivatives that caused them to fall short? To use an art reference, I believe the problem is that they don’t emphasize viewing the market picture’s negative space. Looking at the negative space in an image may reveal structures that you don’t perceive when viewing from a standard viewpoint. So what is in this negative-space that’s hard to see for a given market opportunity?
Examples of hidden addressable market factors.
The Do-Nothing Market Substitute: One of Porter’s Five Forces is Market Substitutes. This part of the analysis emphasizes looking at real available substitutes to your potential customers. After doing this discovery, you may feel confident that the market substitutes are inadequate to be a real threat. However, one substitute option of your potential customers is to simply do nothing — and it’s a very inexpensive one for them to choose. This ‘do-nothing’ substitute contributes heavily to long sales cycles and slow product adoption. Unless the market has an urgent impetus for change, the ‘do-nothing’ option should be the top substitute in your analysis. For example, I previously worked with a startup that had a SaaS platform that enabled brands to easily build mobile-optimized websites. In that market, responsive design was a real substitute option for our customers. Yet many of our potential customers simply did nothing about creating a mobile-optimized web experience, at least prior to the hype around last year’s Mobilegeddon. The ‘do nothing’ substitute in that market impeded our growth much more potently than did the responsive design trend.
The Market Timing Threat: One of the biggest problem innovators face is being too early to market. This is particularly true if you need mass market adoption to be successful. It may be that the infrastructure your product needs in order to be usable is just not there yet. For example, this is a big issue for a lot of Virtual Reality applications, as they typically have huge bandwidth and processing needs to be compelling. With startups, the fear of being too late always trumps the fear of being too early (for good reason). Yet being too early is no less of a critical threat, particularly if you don’t have patient investors and/or your operation requires a large capital burn. If broad market adoption for your product requires further hardware evolution or significant network speed increases to make your product usable, then your addressable market is currently capped. This will severely limit your addressable market until things change that are outside of your control. Consider also that it’s often not easy to see that you are too early. However, if your usability tests reveal problems requiring fixes by external players, this is an excellent indicator that you are too early.
The Growth Channel Discovery Weakness: In sizing the Serviceable Addressable Market, the assumption is that you will iterate your growth hacking strategy until this market segment is fully addressable. Investors and founders always assume they will figure this out — a faith-based religion that keeps Silicon Valley going. The reality is that growth channel discovery is more art than science, and will be realized in waves. Unless you have proven product marketing/growth hacking talent in house that knows your market well (quite rare in my experience), growth channel discovery will be an organization weakness that needs to be factored into your SAM.
Growth channels tend to cover some part of your SAM and then become exhausted. Organizations then must iterate the process of finding new growth channels to capture more of the market. As a result, growth channel discovery is a major gating factor for what part of the market is actually addressable over time. This typically plays out with a lot of ‘test, measure, and retest’. How quickly your organization is able to discover its growth channels is a time-dependent, constricting variable in your addressable market analysis.
The Bargaining Power of Customers for Customization: For startups or new market entrants, the product typically has significant feature gaps. If you only look at price as the bargaining power variable of your customers, you will be missing a major currency in the industry — particularly for software-based products. Enterprise customers in particularly value developer resources, as they are scarce. They will therefore happily trade on your developer’s bandwidth. This is done by asking for customizations in the name of feature gap compensation. Startups usually have the option of spending their precious developer resources to buy early-adopting customers with an offer of customizations and/or additional professional services. This leads to internal conflicts between the Sales and Operations teams, a conflict that Sales will almost always win. This is because Sales has an ace card that goes like this: “If we don’t get customers, we don’t have a business”. In reality, if this is the only way you can get customers, you don’t have a product. Instead, you have a technology-enabled service business — something investors typically disdain. Meanwhile, your product roadmap gets sacrificed.
The Luck Factor: The unfortunate truth is that startups always have lots of market forces out of their control. It is true that some luck is created, such as by building organizations able to pivot quickly towards changing market conditions. Also, there are many examples of serial entrepreneurs who have multiple successful exits with few to no failures in between. This leads some people to believe luck is not a major factor. However, serial entrepreneurs with repeated success tend to be founders who are repeating a formula for a specific value proposition. In essence, they are creating extensions of the original successful startup. So with luck being a consistent and major factor, should it be accounted for in an opportunity analysis? Statistically, it certainly could be calculated based on the relative success of competitors in your market. However, no successful organization will think of their own company falling in the median of their competitors, so such analysis will come with an inherent upward bias. Instead, your organization’s ability to experience luck is related to the culture that the startup’s founders create. If the leaders are dogmatic about forcing forward in spite of changing market information to the contrary, they are unlikely to index high towards being people who tend to experience good fortune. Research shows that lucky people don’t experience life differently, but rather react differently to life’s experiences. Lucky people view a difficult experience as creating a new and different opportunity rather than viewing difficulties merely as setbacks. Evaluate your organization’s leaders for qualities that Richard Wiseman’s research identified as predictors of those who will experience luck. This will give insight into how much luck your organization will likely experience.
Further Thoughts
Market opportunity frameworks like SWOT and Porter’s Five Forces were never proposed as being end-all utilities, and so it comes as no surprise that they have their shortcomings. My experience has shown that what these frameworks don’t readily reveal may be critical to fully understanding a given market opportunity. The quicker you are able to understand the full picture, the more effectively you’ll be able to navigate these murky waters. I’ve provided some examples of where to look more closely when evaluating a market opportunity, but they are far from comprehensive. I’d love to hear examples of things you’ve also learned that an opportunity assessment didn’t uncover.
