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Like many others, I’ve been enjoying reading the Peter Thiel class summaries on the Blake Masters blog. There is lots of wisdom captured in the posts, including the fantastic manual on how to pitch VCs, which is a must-read for any entrepreneur.

There has been one idea that I’ve been thinking about for a few days after I read it. From the fourth class entitled “Last Mover Advantage”, the idea discusses the right types of markets for startups to pursue:

The Goldilocks principle is key in choosing the initial market; that market should not be too small or too large. It should be just right. Too small a market means no customers, which is a problem. This was the problem with PayPal’s original idea of beaming money on palm pilots. No one else was doing it, which was good. But no one really needed it done, which was bad.

Markets that are too big are bad for all the reasons discussed above; it’s hard to get a handle on them and they are usually too competitive to make money.

Combining this idea with the notion that the last-mover in a market has an advantage, I can explain many of the biggest Internet successes:

  • Google – last mover in search and search ads. The search ads market was roughly half of the $8B market – not too big, not too small.
  • Facebook – last mover (at least for now) in social media. Social media ad market was less than $1B when the company started.
  • Dropbox – near last mover in consumer storage. The industry was considered unprofitable by investors given Mozy and Carbonite’s trajectories and was at most $2B at the time the company started.
  • Apple – near last mover in portable music players and computers. What a turnaround we’ve seen.

Common across all these examples is significant market growth driven by one company who brought much better product design, strategic management and effective sales processes. It’s easy to point to the product differentiation – later founders used previous product generations and built something significantly better. But it’s also easy to overlook the importance that sales had on most of these companies.

  • Google had a team which mechanized closing and on-boarding large search partners growing the revenue base dramatically.
  • Dropbox focused significant fractions of their engineering team on optimizing conversion-to-paid funnels. And they maxed out the refer-a-friend program.
  • Apple built the best retail experiences which today drive a huge, but undisclosed fraction of sales.

All of this ties back to another one of the classes: distribution. More than building great products, the last movers who won knew or figured out how to distribute their products the best. They could see which strategies had worked and which had struggled.

These last movers also had the advantage that they were selling to an educated market. Their end customers were already aware of the problems these companies sought to solve. Online advertising had gained some scale. Online backup was early in its market development. Social networks had been through a few iterations and users were familiar with the concept. And Rio had brought bulky MP3 players to market. This implied some latent market demand for better products and ultimately faster sales cycles.

My take away: When picking your market, make sure it’s not too big, not too small. Make sure you know why your product is better. Then focus on the most effective path of distribution. Lastly, try t o sell to the previously educated customer.

I’m curious also to find counter-examples – companies who were first to market with a product that were eventually massively successful. Do you have any?

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11 thoughts on “How to pick your startup’s market

  1. Pingback: Start-Up Key: Sell to Educated Customers « hippotential

    • Good point. Maybe the hardware market has different characteristics than the pure Internet since start up costs and barriers to entry are much higher.

  2. Thank you Tom for great post!

    It was stuck in the back of my mind, but I could not articulate it. Companies with as good products as previous players but with much better sales win and become the last companies in the market.

    Looking on this subject from another POV. Peter says that we should seek secrets and pursue them but at the same time, as outlined above, first mover advantage is not so important. What do you think is the right balance between attacking existing markets and innovating their structure and creating new ones?

    • Jarek,

      Thanks for reading! Thiel talks about secrets not as undiscovered truths knows but goals that are perceived to be impossible. Take an extreme example: SpaceX. Everyone knows it’s possible to build a spacecraft, but very few believe it could be done in a private company and profitably. The company wasn’t secret about its ambitions.

      Another example: Expensify. Their major competitor is a publicly traded company called Concur that serves large enterprises. No one believed that SMBs could be acquired cost effectively – only large companies can justify enterprise sales. Yet Expensify tried and is succeeding (1M users, 140k businesses) with a new model.

      A secret isn’t unknown. It’s just not widely believed to be achievable. That’s the target of the entrepreneur – reversing expectations – aka disruption aka guerilla warfare.

      • Thank you for great examples and clarification! The last paragraph should be entered into Blake’s notes:)

        So, can we state the question in a following way, when looking for the right market:
        What secrets, that are perceived as unachievable, about existing market are true and may disrupt its structure? Emphasizing that secret itself should be big, there should be existing market, but not too big.

  3. Pingback: How to pick your startup’s market. | Hearticle

  4. Pingback: Startup Judo – What to know when starting a company | ex post facto

  5. I’ve been dreaming of starting my own business for a little while now, and this information was very helpful. It answered questions I wasn’t sure how to verbalize and brought to mind a possible startup idea.
    Thank you very much!

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