Why Market Size Matters

Alex: What's up, everyone? Welcome back to another episode of Founder’s Journal. I'm Alex Lieberman, co-founder and executive chairman of Morning Brew. As I have mentioned with the new and Improved podcast, I'm going to act as your startup sherpa, reading the internet so you don't have to, and breaking down the best stuff that I find. On today's episode, I break down an article about picking your market by Paras Chopra. Paras is a multi-time entrepreneur who co-founded Nintee and Wingify, and he's the author of one of my favorite startup blogs, called Inverted Passion. Let's hop into the episode.

“Define your market as narrowly as possible,” January 18, 2021 by Paras Chopra. “It's common for entrepreneurs to cast a wide net early on and imagine their market to be huge. The logic goes something like this. If the market is worth a hundred billion dollars, then even if 1% of it is captured, the company will be making a billion dollars.” 

Let me just pause here for a second and say what Paras just described. It is especially real for second time entrepreneurs who get sucked into the pressure to take a home run swing after getting their first win. After you have a successful first endeavor, you feel so much of this narrative that you have to build something bigger than your first business. And so I think a lot of second time entrepreneurs fall into this hole of trying to go for a massive market from the start, even though starting narrow is still probably the likeliest path for them to succeed, even if they wanna succeed big. Let's keep it going. 

“All this sounds good in theory, but in practice it never works this way. Why would the market leader, the big fish in the ocean, let you take even 1% of the market? In fact, as soon as your startup shows first signs of success, the big fish will do whatever it can to crush you and snatch whatever market share you may have won by that time.”

And then what Paras basically shows with an image is he has this graph that has an x axis and y axis, and the y axis shows your probability of success as an entrepreneur. The x axis shows the size of your initial market, and basically what he shows you is your highest probability of success is by being what he calls the king of a pond versus your lowest probability of success is when you increase the size of the market and you end up being a dead fish in the ocean, is what he calls it, to avoid head-on competition with the big fish and getting eaten by it. A smart entrepreneur defines the initial market as narrowly as possible. 

And I wanna just point something out here. Like Paras, Peter Thiel has long preached the importance of picking tiny markets. He says something very similar in his book, Zero to One, to what I just read you where he says, quote, “The perfect target market for a startup is a small group of particular people concentrated together and served by few or no competitors. Any big market is a bad choice, and a big market already served by competing companies is even worse. This is why it's always a red flag when entrepreneurs talk about getting 1% of a $100 billion market in practice. A large market will either lack a good starting point or it will be open to competition, so it's hard to ever reach that 1%. And even if you do succeed in gaining a small foothold, you'll have to be satisfied with keeping the lights on. Cutthroat competition means your profits will be zero.” End quote.

To define the market size, instead of going top down and taking an arbitrary percentage of it, you need to go bottom up and actually count the number of customers that your startup is uniquely positioned to capture. Facebook's initial customer base was a few thousand Harvard University students. Their product initially was a perfect fit just for Harvard University and therefore displaced the incumbent, MySpace, in that market pretty soon.Investors like entrepreneurs who show them a big vision, but they like entrepreneurs who show specificity even more. 

And I'm just gonna stop here for a second. I think the key to building a big business is defining your market super narrowly, but having this spidey sense or taking this educated guess that whatever you're doing for your super narrow initial market ends up being transferable and valuable to other markets down the line.

So I'll give you two examples from my own experience. For Morning Brew, our initial market was literally just college business students that were prepping for job interviews, but we could imagine a world in which conversational and quick business content could be valuable to a way larger group of people. Or for my new business, Storyarb, our initial market is executives who want to build their brand on social media, but we can imagine a world in which many companies need great content to market their brand, but they don't necessarily want to build an in-house team to do that. And I'll share a few very recognizable examples of the same exact concept. In a few, all big markets have niches that are underserved by established market leaders because their products try to serve large markets. A product initially targeted on these niches can replace established products by providing superior value. And I just wanna point out, if you listen to my recent episode where Chris Dixon says that the next big thing will start out looking like a toy, and I'll link to it in the show notes. You heard a similar idea when he mentions Clayton Christensen's theory of disruptive technologies. Let's keep it going. 

Such niches are also often called beachhead markets because they provide an entry point into the large market and provide an initial shielding from competitors as market leaders discount such opportunities as too small for them to care. 

And this makes me think, this is Alex, by the way. This makes me think that one potential technique to brainstorm businesses is to find market leaders in attractive markets and try to understand what types of customers these market leaders are not adequately serving because they're not thinking of them, because they don't consider them to be a big enough opportunity. And the way to think about who's not being served is you could do something like going through negative reviews and finding patterns that reveal flaws in the market leader. It could be by looking at the website or advertising creative of market leaders and see what customer segments are being mentioned versus aren't being mentioned. And so I would do this type of exercise with market leaders, whether it be Salesforce, ADP,  SAP, Adobe, Snowflake, and AWS. Like all of these companies are generally focused on the enterprise, but it would be interesting to see who aren't they serving and how could they be served better with a very similar type of product, but better catered to the forgotten customer. Let's keep it going. 

This gives the much needed breathing space for entrepreneurs to build a business and an organization with relative peace. The first mover advantage is overrated anyway. Beyond providing a laser sharp product focus, a narrow market also allows for laser sharp distribution and marketing. Think about it. If the entirety of your potential market is Harvard University students, to get the word out, you can simply stick posters all over the campus. But what if the entire world is your potential user base? Where would you start sticking the posters and would you have enough posters doing that? 

Anyway, I wanna stop here for a second and just say, this is a huge advantage that isn't talked about enough. It's often talked about how from a product perspective, it's easier to focus on a forgotten smaller audience. But from a marketing perspective, it is huge as well. The more targeted you can be with your marketing, the more clear potential customers will be on whether you're the one to solve their problem or not, and they will be able to know very quickly. 

Let's keep it going. A common fear that entrepreneurs have is that if they define their market narrowly, they'll undershoot and build a small business. This fear is unfounded; a number one position in any market, no matter how narrow, often translates into a big enough business. Not all businesses have to and can be Google, Apple, Microsoft, or Amazon. The irony of that is Amazon started in a very small market, and I'll share that in a minute. Such huge businesses are an exception, not the norm. What usually happens is that most businesses keep on using their number one position in a narrow market to expand into adjacent markets and hence always keep on growing at a steady pace.

And just to pause here for a second, here are some examples of businesses that started in a narrow market. They became one or number one position in that market, and then they just kept adding markets on. Amazon started in books. Uber started with black cars for a luxury audience. Tesla started with a six-figure Roadster for high-end car buyers. Canva started by helping students create their own yearbooks with their designs. The recipe across all of these businesses is a hyper niche initial product that keeps the company under the radar from market leaders, but they ultimately have technology that will let the business attract a mass audience when market leaders are least expecting it.

Let's finish this up. Ask yourself, would you rather have a business that makes money and grows steadily, or a dream of a huge business that has low chances of happening? If you want the former, define your market as narrowly as possible. Count your customers one by one bottom up rather than as a top down percentage of the population. 

And that is “Define your market as narrowly as possible” by Paras Chopra, author of the amazing startup blog Inverted Passion. As always, thank you so much for listening to Founder’s Journal and I'll catch you next episode.