A lot of small markets does not equal a big market.
By Alex Taussig, contributor
One of the great things about moving from one place to another is all the free stuff people leave behind. A few weeks ago, Highland shuffled out of its decade-long digs in Lexington, MA and headed over to our brand new office in Kendall Square near MIT. Lying on the floor (the floor!) In Lexington was a paperback copy of Geoffrey Moore’s Crossing the Chasm. I had never read it but have always wanted to, so I dug in.
Moore was trained as a high tech marketer, so the guy has a particularly strong set of views on what actually constitutes a “market.” To most of us, defining what we mean by a market would seem like a useless semantic exercise, but Moore makes it tangible and useful.
Here is Moore’s definition of a market (p. 28 of 2002 edition):
- A set of actual or potential customers
- for a given set of products or services
- who have a common set of needs or wants, and
- who reference each other when making a buying decision.
He draws particular attention to the last bullet. Why is the connectivity of customers important in the definition of a market?
Moore goes on (pp. 29-30):
If two people buy the same product for the same reason but have no way they could reference each other, they are not part of the same market. That is, if I sell an oscilloscope for monitoring heartbeats to a doctor in Boston and the identical product for the same purpose to a doctor in Zaire, and these two doctors have no reasonable basis for communicating with each other, then I am dealing in two different markets….
The reason for this is simply leverage [emphasis added]. No company can afford to pay for every marketing contact made. Every program must rely on some ongoing chain-reaction effects – what is usually called word of mouth. The more self-referencing the market and the more tightly bounded its communications channels, the greater the opportunity for such effects.
I find it fascinating that Moore first made this point in 1991, before the Internet made such information pervasive. Yet today, even with the connectivity that social networks and search provide, a lot of small markets does not equal a big market.
Some entrepreneurs fail to internalize this difficulty. They build a product for a small market segment and plan to turn it into a $100M+ revenue business by modifying it and selling incrementally different versions of the product to customers in other segments. As such, we often hear the phrase, “Well, it’s a small initial market; but, when you add up all the adjacent opportunities, you get more than $1 billion in market opportunity.”
I take issue with this line of reasoning since it ignores what Moore calls “leverage.” If you have to reinvest in a different marketing channel to reach a new population of customers, then you may as well be selling to two different markets. In more practical terms, you need to make an entirely new investment (read: cash!) In figuring out the new marketing channel, so you don’t get to amortize the cost of your prior market development over the new set of customers.
When startups try this “adjacent market” strategy, it often feels like starting all over again. Companies burn a lot of capital, product development cycles, and management bandwidth refocusing the company. Sometimes this multi-market expansion is the root cause of a company’s failure.
Entrepreneurs are therefore better off attacking a single monolithic market, instead of lots of small ones. If that single market is large, the possibility for venture returns exists. If it is not, that’s ok; but the founders should be realistic about what it takes to expand from there. If they’re not careful, they can spend their way into oblivion and ruin what would otherwise be an effective business in a smaller market.
Alex Taussig is a Principal with Highland Capital Partnersand invests in early stage technology companies. You can find this blog post, as well as additional content on his blog infinitetoventure.com. You can also follow Alex on Twitter @ataussig.