Part 1: The Market
Starting a business is hard. As most people know, an overwhelming majority of startups fail. One of the hardest problems to have when deciding to be an entrepreneur — and often the most difficult barrier to entry for the average person — is “not having a good idea.”
First, there is such a thing as a bad idea, and there’s a ton of them, but not because some ideas are inherently bad — it’s usually because an idea hasn’t really been fully examined. At High Alpha, we see a large volume of “idea flow”: from fully-developed businesses with an existing product to an early articulation of a pain point as described to us by a subject-matter expert. Because of the wide array of ideas, we have had to develop some method of evaluating all of the concepts in a commensurable manner. Thus, we developed a 5-criteria system in order to determine the viability of a concept. Today, we’ll be discussing the first criteria: The Market Score.
Just for some context before you read this:
- High Alpha starts B2B enterprise cloud companies, thus this methodology largely centers around these types of business outcomes. However, some parts may be more broadly applicable.
- High Alpha scores each criteria category from 1–4. We do this to intentionally eliminate any neutral scores.
- The score is partially subjective and is based on a weighting of all of the sub criteria of a section. Thus, scores can change over time based on if they are more developed or our views on a topic change.
Defining a market for your business is important and a key criteria for external funding. Many companies fail to show market potential, which severely hurts their funding. When determining if a market is good, there’s a couple of things to remember: a good business can be a follower in a big market (i.e., Uber in the transportation market), a net-new idea in a smaller market (Trello in the project management market), or a company in an emerging market (Storj.io in the blockchain cloud storage market). None of these situations inherently have any more value than another, so it’s important to balance quantitative (numbers, data) and qualitative (distribution strategy, competition).
When we look at “Market”, we have a few criteria we look for:
- Total Addressable Market (TAM)
- Competitive Landscape
- Industry Movement/Funding
- Distribution Strategy
- Is the Idea New/Existing
Total Addressable Market (TAM)
TAM refers to the size of the market assuming you can reach all potential customers. This includes your target market, adjacent markets, and additional markets where your product could be sold. The TAM is essentially concentric circles with the TAM being the largest circle containing the Target Market and Expansion Markets (see diagram below). This also helps to generally illustrate a go-to-market for your idea.
When talking about the TAM, it’s important to note that your TAM as well as your target market is, more likely than not, going to change. So, when you’re calculating your TAM, you should keep in mind the different permutations and opportunities associated with the market size and potential of your idea. We use this as a metric to determine both how many potential customers we can get as well as to inform us on the economics of the idea. Do we need to sell 1,000 or 1,000,000 people to get to $100,000,000 in ARR?
Most of the time, the TAM is a decently-wide range as well, so you should try to have different assumptions and data points when building a TAM to make sure it’s more inclusive. Highlighting key assumptions is critical to TAM, as there are a ton of varying opinions on the correctness of assumptions as well as the overall calculation of the TAM.
The competitive landscape is a set of documents that show the areas of significance within a specified industry. For example, a competitive landscape for the HR industry may see a lot of discussion about the different types of software such as Applicant Tracking Systems, HR Information Systems, Recruitment Management Systems, etc. These documents help a company to determine the adjacent companies that they will be competing with as well as the general density of an industry. A good competitive analysis can often show logical entry points where there is a lack of an incumbent competitor or spaces that are largely untapped — we call it our “wedge” in the market. If those white spaces aren’t apparent, a good competitive analysis may yield some differentiation opportunities.
Additionally, competitive landscapes give heuristics about the companies that are in the industry. An industry that is extremely mature and has three big incumbents like the office suites industry (Microsoft Office, Google Docs, etc.) can inform a much different go-to-market and overall strategy than a relatively new industry with more disaggregated competitors like Customer Success.
When dealing with startup opportunities, it is important to look at the industry movement and general funding. If an industry has largely stayed the same for a while, it might convey that the industry is extremely mature and that the opportunities are few and far between. Some other examples of industry movement include consolidating (which often suggests external pressures, such as pricing pressure from customers) or emerging startups(after enough customer education has occurred in a new space that many new entrants are flooding the space with similar products).
Funding also helps to validate a market. If VCs and PE firms are funding or buying heavily in the industry, it validates interest and opportunity in the space. It also implies the presence of exit opportunities, which is critical for venture-backed businesses. When looking at funding, it is important to also take note of major acquisitions and movement of firms. Acquisition may be positive to show exit opportunities, but may also mean that firms are looking to pivot or introduce new products. Having a keen eye on this information can inform where a market currently is as well as where it is moving in the future.
Additionally, if market dynamics suggest consolidation or fragmentation of players due to acquisition or an influx of startups, it can inform where an industry is in its lifecycle which can help to dictate how you compete within a market.
Most analysis of markets lack the understanding of who the buyer of the product would be. Distribution channels are an important consideration because they potentially can be the largest roadblocks to success. An example of this might be a VR application. Without the hardware deployed to a fair amount of potential customers, it is nearly impossible for a business to succeed.
Along with distribution, it’s important to understand the purchasing dynamics of an industry. Selling a product to the head of HR is a very different sale than selling to a salesperson or a CEO. Thus, understanding the buyer power as well as the decision-making process and motivators behind the purchaser of your product is vital to creating a strong go-to-market strategy.
Is the Idea New/Existing?
This is an intriguing question for all entrepreneurs. There is a general negative disposition to ideas that already exist. At High Alpha, we regularly look at existing markets to see if there are ideas hiding in plain sight. Knowing whether an idea exists or not helps to determine how people will react. New products often take time to build a market around or require more salespeople to educate customers (or at least some net benefit), whereas an already-existing product might be able to sell based on undercutting in price, having better features and functionality, or being easier to use.
This category should be generally avoidant of “differentiation” as a mechanism for determining if a product is new, but more about the base product itself. If you are building a new CRM, it’s an existing product regardless of the new feature you may have. A good rule of thumb is whether or not a company would already have an existing solution that they would replace if they bought your product, or if there is any other product that directly competes for funding.
Combining these criteria will give you a more robust understanding of your business’s market and potential. A lot of this information is pretty easy to access with a few Google searches, analyst reports, and blogs about certain industries. Once you have all of this information, it’s good to keep track of this information in some sort of document. It’s worth revisiting this framework semi-frequently in some capacity even if your business has gained traction as most of this information is dynamic and changes over time, and may be helpful to inform strategy going forward.
Thanks for reading about how we research markets and ideas at High Alpha. The next part about Finance can be found here.
High Alpha is a venture studio pioneering a new model for entrepreneurship that unites company building and venture capital. To learn more, visit highalpha.com or subscribe to our newsletter on the future of enterprise cloud.