How Important is Market Size?

I’ve been doing a lot of learning around the Venture Capital model lately. If you haven’t seen the documentary Something Ventured, I highly recommend you check it out. It stars a cast of VC legends like Arthur Rock, Don Valentine, and Tom Perkins. (Side Note — I have actually been lucky enough to email with Mr. Rock. As an HBS Rock Fellow this summer, I am directly benefiting from his kindness and generosity! He actually gave me a couple of leads as I develop Squashprep.io).

Anyway, a big theme that comes out in VC investing is market size. Don Valentine (of Sequoia) and Scott Kupor (a16z and Secrets of Sand Hill Road) talk about market size as the thing VCs look at first when determining if they want to invest in a startup.

And this totally makes sense. The VC model is all about hitting home runs, and if the market is not big enough, then it’s virtually impossible to do that.

So this information comes into direct conflict with what we are currently doing with Squash. Right now we are targeting primary and secondary school teachers. They are liking the product and they are telling other teachers about it. It’s very exciting for us. However, this is a small Serviceable Available Market (SAM).

With about 4 million teachers in the United States, and given the very small budgets these teachers have, I estimate the market to be about $200M in total. How did I get that number? Well, some teachers do actually have budgets they get to spend on their students, while other’s simply pay for resources out of their own pocket. In general, I estimate that the average teacher gets $2K to spend on their students. Squash, therefore, cannot charge big sums of money like we see in the SaaS world. $50 per student is just not going to happen here. So, I am conservatively estimating the we can get $50 per teacher per year.

So yeah, $50 x 4M teachers is not very big. Should we be worried?

The answer is, I don’t think so. I was chatting with a friend about this and she pretty much said, “David, you are not a VC. You don’t have to create this huge business that needs hundreds of sales people and continually burns through millions of dollars every year.”

And you know what, I think she’s right. If we are able to grow Squash at a reasonable rate, we can actually be profitable and create a nice business. The big assumption here is that we do not need to increase head count drastically. But even if we hired 10 employees, if we captured just 5% of our target market I think we would be sitting pretty. The beauty of software is that the cost of producing one additional unit is very low. And AWS makes this process even easier, and cheaper. In a way, the software business might be a great small business.

A lot of people do not think this is possible because the software world does seem to have a winner take all mentality. If you are not growing fast and capturing all the customers, you will eventually fizzle out and die. In this way, it’s not possible to have a small software business. It either has to be huge, or it won’t work.

Here is how you now if you are in winner take all market:

1. Economies of Scale make the firm very competitive. The more it grows, the easier it is to create and distribute products at less cost.
2. Switching costs are high for customers. So once they pick a solution, they are in it for the long haul.
3. Network effects are strong, so the more users the business gets, the more sticky their customers become (like Facebook).
4. Products in the space are not differentiated, so there is no way for new competitors to stand out to take market share.

If you hit on all these 4 factors, then you are likely in a winner take all market, and you need to scale very fast.

Looking at these factors, I do not think we are in a market like. Not even close in my opinion. In particular, points 2, 3, and 4 are not satisfied. Switching costs are relatively low for teachers, as they are largely in control of what tech they use with their students. Network effects are not super strong in this space, as there are a multitude of tools teachers use to connect with each other and find classroom content. And finally, in our case product differentiation is not that hard to do, as there are so many different ways to help students learn.

And If we think about it, our SAM and even our TAM (Total Addressable Market) can actually be a lot bigger if we 1) are able to get tutors and learning centers to use the product and/or 2) are able to expand geographically to countries like India and China and/or 3) are able to facilitate some district wide sales deals.

So yes, our market is small now, and has the potential to be huge. But maybe we actually prefer it to be small!