The importance of market analysis for early stage entrepreneurs & VCs
When assessing investment opportunities, one of the most frequent questions I ask entrepreneurs is about market analysis. Although it is a crucial element of the conversation we have, I have a feeling its relevance is often neglected (to be honest, I’m not sure what the reasons are, but that is another topic of discussion). Given the high risk associated with running a company without a proper understanding of the market, I would like to highlight the importance of market analysis from a VC’s perspective. Firstly, I would like to cover investors’ motivations behind requesting a market analysis, as well as discuss the importance for startups to do it right.
Knowledge of your market is critical, whether you are a startup raising money, attempting to find product-market-fit, launching a new product/service or targeting a new segment. It is not always straightforward; the market can be difficult to assess, due to lack of data sources or the entrepreneur’s lack of familiarity with the market analysis process. Nevertheless, you must develop a view or make an educated guess, in order to progress. Failure to do so might have painful consequences in the long term, as you make key business decisions with incomplete information.
Why market analysis is important for VCs
To begin with, you must attempt to perform a thorough assessment of your potential market when seeking external funding and speaking to investors. This is a vital data point for all VCs. Many investors will pass on an investment due to lack of a sizeable market opportunity. This rough approach is down to simple maths; to generate a large fund-level return, VCs generally must discover and fund companies which have the potential to return the entire fund. If your startup operates in a small, niche market, your chances of building a fund returning business are considerably smaller (you can build a fantastic product/service with simply little upside opportunity). Furthermore, potential investors will show less interest in investing the time and funds that your startup seeks. That said, it is important not to inaccurately inflate your market size. If the value is too high, it will draw greater scrutiny to various figures that you generate across different analyses.
Why market analysis is important for early stage entrepreneurs
Aside from an unsuccessful fundraising round (not the end of the world), please be aware that a lack of familiarity with your market (in terms of size and characteristics) will significantly reduce the learning you require to draw the right conclusions. Therefore, the risk is extremely high for you as a founder, as well as your team. The biggest mistake that you can make is sidetrack product development, misallocate focus, create features that are aligned with wrong user needs, and assign marketing and sales teams to prospects that do not have the potential to convert into customers. These factors, along with many more, can easily block your startup on its road to success. Overall, you must view market analysis as a tool and a data driven approach that is necessary to understand where and who your customers are. Once you properly identify your key segment(s), you can allocate resources to them wisely, in addition to directing their focus towards growing your venture in the right direction. If you fail, as the time will pass extremely quickly, you might end up taking your company nowhere.
How to calculate your Total Addressable Market (TAM)
So, let’s start! In some broad strokes, I have highlighted a few key factors. Typically, I would start a market analysis by exploring Gartner or other similar sources. Though the numbers you find may differ significantly, they will provide strong grounds and context for you own analysis, which consists of getting to know a) the geography (ask yourself, which territory do you cover — is it worldwide, a specific region or a country?) b) the main players (all vendors/competitors) and lastly c) pricing. The formula for your TAM (Total Addressable Market) should look like this:
TAM = (Total Number of Customers in a Market) * (Average Annual Revenue of a Customer in that Market)
As most markets are dynamic and expanding over time (hopefully), you can enhance your analysis with additional information. This will result in a larger opportunity. First and foremost, you should dive deeper into geographical expansion, as well as demonstrating potential to upsell. Though the analysis will be based on your assumptions, it is worth considering additional revenue streams, and exploring options to grow your business. Lastly, let’s not forget trends and the possibility of increasing your product or service offering through different verticals. Think about where you stand as at today, define your position when building a successful startup in a few years time and assess your gateway to scale your business towards X (if possible, not all businesses can adopt that route).
Why entrepreneurs should pay attention to customer segmentation?
Once you have estimated your TAM for your product/service, let’s go one step further: customer segmentation. It is important! Without identifying your initial segment, you run the risk of allocating your resources to the wrong clients. At the end of the day, you only have so much time, so many people, tools, a finite marketing budget, etc. So don’t follow your instinct, the inbound or (what is worse) large enterprises, that can easily sidetrack your product roadmap. Go through the exercise; segment all your potential customers with regards to their size, location, sales cycle, pricing, CAC, LTV, offering (product), and then prioritise! As your resources are scarce, make sure you choose to build your customer base where your customer acquisition makes most sense, where you can achieve the highest retention, land and expand and potentially where you can execute to obtain a product market-fit before scaling up. In other words, choose a segment that has the highest probability for you to become successful!
Also, please bear in mind that your segmentation is not a one time activity. Depending on your product development, marketing or sales capacity, your customers are very much a moving target! Once you define your framework, revisit your segmentation as often as is necessary (especially when transitioning from early stage to growth) update or enhance your data and go through the process again. The results will allow you to stay focused and execute a strategy to win!
Hope you find this insightful & good luck!
Follow our publications to see more insights featured by the InReach Ventures Team.