Defining Your Market
Choose the right peak before you start climbing the mountain.
Intro
If there’s one message I took away from this session by Shekhar Kirani, it was the message that picking the right Market and customer segment is probably the most critical ingredient to building a large successful business.
It’s not a new message for me since this was also my learning from my last start-up journey — that the Market trumps all else! But it was a high reinforcement as I set out to build my second venture. Personally, if I don’t find the momentum or have doubts over the market segment and size at any point, I’d not think twice to spend time validating again, and pivot if I don’t have a conviction on the Market.
As second-time founders, you probably learnt a lot in your previous journey — building a team, building product, GTM (go-to-market) motions, etc. If you have a good grip on hiring and understanding your strengths and weaknesses, chances are you will be able to build a complementary team that can develop your product and takes it to Market. So the real risk, in fact, is in selecting the right problem space and market segment, and not execution.
So why waste your best years chasing the wrong Market? The only consolation for a first-time founder is that even if they picked the wrong Market, the journey of starting up in itself probably has enough learning to offer. But the second time can’t be about just the learning again — it should be to succeed. Or at least increase your probability of success.
Conviction
Building conviction on not just your idea, but also the market potential, is challenging, and yet crucial for any early-stage start-up. “How big can this be?” is a question you should have a good answer to before committing 7 to 10 years of your life to the idea.
I’ve seen many start-ups struggle with setting themselves down a path and then being unsure of whether to continue down that path or pivot. It’s harder to give up on something, and you start wishing for the Market to grow or accelerate. This may even lead to founding teams having rifts amongst each other. When they don’t have the same conviction and world views, it can lead to one believing in the Market’s potential, and the other starts thinking it is ‘too small a market,’ etc.
So let’s do our groundwork and build conviction together as a team.
Notes from the Session
When my friend Aravind Gopalan said he attended a session by Shekhar on market segmentation, I was curious and asked him to share his notes from the call.
Here’s an expanded version of the notes:
Choosing the right market segment is pretty much the key to setting yourself up for growth. You don’t get this right; most other things may not matter.
Choosing the right market is the most critical thing to get right early.
What does Product-Market Fit look like today?
If you do enough groundwork and maintain a very disciplined, consistent approach to your GTM and product development, you can achieve PMF even when you get to your first 100K / 200K of ARR. However, in most cases, PMF happens only by the time you reach 2M$ of ARR. That’s a good benchmark to use. By then you have established repeatable GTM motions to acquire a certain kind of customer, and the ability to retain and deliver value to that customer. You can potentially scale this to $4M and then to $8M and $16 in the following years — that’s what good growth looks.
You always have a decision to make — do you want to raise VC money, or bootstrap to build the business?
Here’s how you can think about it:
- If the market segment you choose is a niche area and does not have a strong momentum already, then bootstrap. This business is not suitable yet for VC. Focus on profitability. So, you need to acquire customers who can become profitable for you within three months.
- If the market segment is already huge and has good momentum or competitors that are growing fast, then go the VC route. The focus, in this case, is on growing fast and keeping the CAC in check — your customers should be sticking with you, and payback should happen in under 12 months. You can then spend money to grow aggressively.
You can also bootstrap initially and then decide to raise money when you feel the market size has increased, and it is time to scale fast.
Q: What if it’s a new category?
In a new category, the size of the market segment again matters. If it is small and you can build it under the radar, then you bootstrap. If you see others enter the category and get funded, then VC money will flow into the category and makes sense for you to raise also.
It’s tough to determine the size of the Market in a very early stage blue ocean idea. You need the imagination to see if this can grow into a large SAM (serviceable available Market) if it clicks. In an existing space, a red ocean idea, it’s much easier to figure out the TAM. Spends are standard; you can see how much other companies are doing, what’s the momentum like, etc.
Q: If you want to raise money, what does a VC expect from your startup?
VCs invest in companies only when they feel “if this works, it can be big!”.
In SaaS, if you build a 75% gross margin business, at 100M$ ARR, you make 75M$.
In B2C, if you build a 1B$ GMV with 10% gross margin, you make 100M$.
If your company can get to 50M$ revenue, then it makes sense for a VC to invest. Else you will get stuck at series A or series B.
If the Market is less than 500M$, then it’s tough to see a company getting to 50M$ revenue. Only if the TAM is 500M$ to 1B$, then there’s a chance you can get to 50M$. Say ten years down the road — making the company 250M$ to 500M$ in value by capturing 5% to 10% of the market share. So work out the math for your TAM.
The category and market segment is often what makes the difference between companies that scale and those that don’t scale.
Remember, don’t start with “product.” Don’t even start building the product before you figure out the rest of it. Pick the right peak, and then start climbing.
(1) First, figure out the Market, and the customer in that market, that you are targeting. What’s the segment of customers there that matters to you?
(2) Next, you figure out how to market to those customers or generate demand — which will then translate to sales
(3) Once you’ve spent enough time on the first 2, you figure out the right product for this segment, and work on your product marketing activities and building the product
(4) Lastly, figure out the funding needed to go after this problem
Picking the right customer segment
Picking the right customer segment within the Market is essential; to be able to set yourself up for the scaling well beyond the initial success you may have. If you don’t focus on picking a segment carefully, you may get traction, but you won’t find the right repeatable motions you need, to grow fast and to accelerate your business.
Here are excellent characteristics to look for in a market segment:
(a) Uniformity
Pick a customer segment that has “uniformity.” Uniformity brings repeatability. Customers should be similar in most ways. Parameters look the same; the buying behaviors are the same. The same pain points and problems should resonate with all of them. Their thinking and decision making should be similar.
Uniformity helps you form the ideal customer profile. We should be able to build the ICP before we make the product. After talking to 10 customers with a hypothesis, refining the hypothesis, and then going back to the next ten customers, we can ensure that we get uniformity. Uniformity is essential to build a repeatable process, which is again necessary to be able to scale.
If you take VC money, make a product and business, get to $2M, and then find that the customers are of different kinds, & in different places, etc., you won’t have the repeatability. So, you will be stuck and won’t be able to scale. Non-Uniformity is fine if you are bootstrapping, but if the idea is to scale, then first focus on repeatability and finding the uniformity.
Of course, if you are bootstrapping, this doesn’t matter — just collect all the money you can, focus on profitability and getting referenceable customers.
(b) Size of the segment
You need to have enough customers to go after, in the segment that looks uniform. If you have a 1B$ TAM with uniform customers, that’s like striking gold. However, it’s hard to come by. Usually, you should be able to get to 10M$ | 100M$ TAM in that stable base. Then expand to more segments.
The upside is another factor. Can you develop the use cases you are solving for the same set of customers and sell them adjacent products? If you can sell more products to the same uniform customers, that’s great too!
© Are they reachable?
You should be able to reach these customers efficiently, which means the cost of acquiring the customers should be 2–3 months of revenue if bootstrapped and less than 12 months if VC backed. There should be a way to reach them at a larger scale, too — since you would want to accelerate the rate of acquiring customers. Also, factor in your business model. For example, does the lack of a middleman in your model (who takes a percentage of revenue), affect your decision in outspending competition that is paying the middleman to reach more customers?
Q: How to calculate TAM?
If everyone knew about your product, how many people are there who can buy it? Use the right market segment you have chosen to determine the TAM (Total Addressable Market)
Q: How do you see if the customers are reachable at scale?
Reachability at scale is not easy to figure out. Your business model is factored.
As you set out to build a venture, here are some ways to think about new ideas that may be low hanging fruit:
(a) On-prem to Cloud transition:
For example, Zenoti and Carestack built cloud solutions for Spas & dentist clinics, respectively, and could easily capture Market from large on-premise players
(b) Existing functions for a new medium:
Ex: “Mobile.” Uber, Swiggy, etc. are all great examples for enabling a use case on mobile. On the B2B front, Clevertap can be a good example — they allow push notification based engagement solutions for mobile apps
©Customer behavior change :
Customer Behaviour is about the spotting of a wave early. Ex: Zomentum identified a wave first where software resellers were starting to look for solutions to manage their cloud / SaaS sales. The software sellers were previously selling on-prem software and needed something built for the SaaS world.
(d) New needs from Cloud usage :
With the growth in cloud and SaaS, the need for subscription billing management was growing. Chargebee bet on the SaaS wave by offering this, so SaaS tools could build their billing and invoicing with ease.
(e) Poorly executed large companies :
ANSR can be an example here. Global Fortune 500 companies wanted to in-source technology work and have their R&D teams set up in India and Europe. They couldn’t rely on traditional models of hiring and did not want to outsource to the regular IT shops. ANSR helps them set up their GIC units globally, including the initial staffing.
(f) Verticalization of large markets :
Veeva is a great example — taking a very large market-like CRM and building something specifically for the pharmaceutical industry, they made a large business out of it.
From your uniform segment chosen, you still want to identify the right companies to “build alongside” for any new product. You want to pick customers who are already thinking about the problem, and also ones that are mature and reference-able for you to unlock future growth.
Co-creation is a process of working closely with a customer to define the product capabilities, build and show it to them, collect feedback, and iterate again. You’d usually want to work with a set of 5 customers for B2B, and maybe a close group of 100 for B2C.
Getting the right reference-able customers also brings in a trust factor when you want to grow to a larger base.
Ensure you pick customers who are “alike”. Usually more success happens when you work with customers.
Pick customers who are open to taking risks, trying new solutions.
For Blue Ocean, find and iterate with a few customers, figure out all their use cases entirely, and build a complete solution for them.
For Red Ocean ideas, enter sideways. They don’t depend on you but will use you as complementary to a solution they use already. Find a small use case to solve, and with a high polish for that use case, you should optimize for not being rejected. And, build trust elements using advisors & customer commitments.
How do you get a customer champion aligned with you? If your product can have an impact and show them in good light, it’s great. They may get a promotion, or look cool in front of the company, or save a lot of money for the company, that’s great. Make it such that it’s zero or low risk for the person making the decision. Pilot it in one store, roll out in one geo or department, etc.
For B2B companies, when you get to 2M$, understand how it went from 1M$ to 2M$. What was the gross expansion, churn, and new ARR added? The most important thing for B2B is that net expansion = gross expansion — churn
This is what creates big companies. Without that net expansion, getting to a larger scale is very, very hard. When you do something like a “site license,” and customers don’t have to pay per employee, then this expansion is hard. As the customer grows or use cases grow, you need to make more money. For example, Chargebee and stripe make more money when their customers grow. Similar to e-commerce logistics companies. Slack, zoom, etc., have a great expansion, and it shows in how they are valued.
By region & size
Look at your TAM segmentation region-wise, and also by small, medium, or large customers to figure out which Market to focus.
You can do this based on your analysis of where you are growing/winning, combined with what the market size looks like in that region, for that size of the customer.
For example: If you are not winning in Germany, Spain, France, UK, and Italy, you probably shouldn’t be focusing on Europe. Or, if you succeed in the US, it is 40% of the market, you can focus just on the US.
Before entering a new region, ensure you see yourself getting to 5M-10M ARR in that region and only then commit to a market — not based on just getting one customer in the area. Unless you are bootstrapping, in which case just take all the money that comes your way. Look at your SEO cost, CAC per region, the growth you see per area, and then look at expanding.
Do your segmentation based on ARPU buckets as well.
Bootstrapped businesses needn’t care about ARPU (Average Revenue Per Unit) segmentation. Go for larger customer sizes where it is possible since profitability is what matters.
For scale, pay careful attention to which ARPU (Average Revenue Per Unit) segments you are prioritizing — since every aspect — GTM, business model, expansion, all vary based on where your sweet spots are. Even your positioning, lead gen, conversion, retention & development can all be different per ARPU segment.
Doing these thought exercises before you get into scale-up mode helps you figure out where you want to operate and increases your chance of success.
Domain Segmentation
You can succeed with a decidedly horizontal play across domains if your lead generation is inbound — content-based, SEO based, etc. So you are just fulfilling a need.
If you don’t have inbound leads, then even if your product can serve many domains, it makes sense to focus on only one or two domains. For outbound, reference ability works best, and if you are referencing customers from the same domain, it is the easiest way to gain credibility and get a conversation going. So pick one or two domains where you also know there are enough customers, and focus on that for outbound.
You can choose an area that’s large and comfortable for you. It may be only API companies, or companies running only on a particular cloud infra provider, or companies in manufacturing, or digital agencies, or new age start-ups. When you mention one customer you got, the next ones should feel excited to work with you; based on them knowing they are similar in many ways.
When you get to 3–5M$, you can look at picking the next domain. You’d already have some customers you have from other domains, so start looking at their characteristics. Based on the characteristics, you can decide which domain to choose next. Growth is one metric to optimize for early on
Lastly, focusing on all of the factors above is what leads to substantial growth each year. So, selecting the right market segment and doing your groundwork is crucial for increasing the odds in your favor, and setting yourself up to scaling your business fast.
So pick the right Market and start climbing your mountain :)
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