If I Only Capture a Few Percent of the Market, I’ll Be Rich!
A common exercise new startups undertake is to size their prospective market. It is an attempt to figure out the size of the pie being pursued.
Knowing the pie size matters for 2 main reasons: 1) it provides information which either encourages the entrepreneurs through tough times, or helps them kill the startup earlier than later when they realize it is not worth pursuing, and 2) it helps potential investors understand the opportunity at stake.
The outcome of this exercise is a number. Something like, “Our total addressable market is $2B.”
A common tendency among first-time entrepreneurs is to immediately follow that outcome with a statement like, “If I only capture a few percent of the market, I’ll be rich.” For example, they do the math and realize that 5% of $2B is $100M, and $100M is a lot of money for a startup.
More seasoned entrepreneurs rarely respond in this way. They realize that there are rarely any companies (especially new entrants like startups) in a market that hold just a few percent of the market consistently. Some reasons for this include:
- If the startup has enough momentum to go from nothing to replace a few percent of the incumbents in a market, it is likely that it will have enough momentum to replace a significantly larger percentage of the market.
- If the startup does not have what it takes, it will struggle to find any foothold; even a few percent will be out of reach. Those companies holding the bulk of the market will have so much market power that they will shut out the startup from the opportunity to capture even a small percent.
This is not always the case. There are exceptions in highly fragmented markets where a startup can find its way to holding a few percent of a large market. But it is rare.
I’ve written before about right-sizing market focus.
What are your thoughts on this common mindset in startup market sizing?