The Founder’s Guide to Markets

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Startups are exhausting. Founders dedicate 5 to 10 years of their life and are still expected to fail. It’s a constant uphill battle.

Venture Capitalists (VCs) invest in startups. They look for edges to improve their return on investment.

Both debate ‘what is the most important part of the startup: product, market, or team?’

Andy Rachleff, Marc Andreessen, and Elad Gil, are each successful founders and investors. They all agree: market is the most important.

“When a great team meets a lousy market, market wins. When a lousy team meets a great market, market wins. When a great team meets a great market, something special happens.” — Andy Rachleff

“In a terrible market, you can have the best product in the world and an absolutely killer team, and it doesn’t matter — you’re going to fail.” — Marc Andreessen

Given this, founders and investors should focus on great markets. Problem is, there are no clear frameworks to figure out what a great market is.

Traditional advice is to target markets that are large and/or growing fast. That’s vague.

So, what makes a great market? This is what we set out to answer.

You can follow us on twitter: @nujabrol and @eriktorenberg.

There are two frameworks to assess markets: the Peter Thiel framework and the Keith Rabois framework. We’ll explore these across picking, entering, and executing in great markets.

The Peter Thiel (niche) framework

Peter Thiel believes startups should dominate a small specialized market (aka a niche) and expand from there. He covers this in his book ‘Zero to One’.

The Keith Rabois (general) framework

Keith Rabois likes startups that attack massive markets with general, vertically integrated solutions.

It’s important to choose the right framework. You should choose a framework based on how many large companies your market can support at scale. Elad Gil told us “the market structure determines which of the approaches makes the most sense and if there is a real opportunity.”

Two market structures make sense for startups to operate in: monopolies and oligopolies.

The Peter Thiel (niche) framework is best suited for monopoly structures.

The Keith Rabois (general) framework is best suited for oligopoly structures.

Monopoly

A monopoly is when one company has greater than 75 percent market share and prevents new companies from entering the market.

These are also classified as ‘winner take all’ markets.

A monopoly market structure has the following key features:

  • Lack of substitutes and competition.
  • Barriers to entry. The monopolist has an unfair competitive advantage. This can be through intellectual property, regulatory advantage, economies of scale, or network effects (e.g. FB w/ social networking and Google w/ search).
  • Monopolist is a price maker.

Oligopoly

An oligopoly is a market in a state of limited competition. The market has a small number of producers or sellers.

Elad Gil told us bigger markets are more likely to fragment. Larger markets have more customer needs. ‘One size fits all’ solutions are difficult to develop and sell at scale. This leads to an oligopoly. You can see this in payments (Stripe, Adgen, PayPal), ridesharing (Uber, Lyft), cloud storage (Dropbox, Box, Google Drive, AWS), and payroll (Gusto, ADP, Paychex).

An oligopoly market structure has the following key features:

  • Interdependence. Companies must make decisions with potential competitive reaction in mind.
  • Barriers to entry. Companies need economies of scale, investment, access to scarce resources, etc.
  • Imperfect information. Customers have imperfect knowledge and are unclear of best price or availability.

The Peter Thiel (niche) framework

You want to pick an initial niche that you can monopolize.

For Thiel, monopolies are the condition of every successful business — there’s no competition. “Capitalism is premised on the accumulation of capital, but under perfect competition all profits get competed away. The lesson for entrepreneurs is clear: if you want to create and capture lasting value, don’t build an undifferentiated commodity business…Monopoly is therefore not a pathology or an exception. Monopoly is the condition of every successful business.”

Niches are great because it means limited competition. On the contrary, “Huge, trillion-dollar markets means ruthless, bloody competition.”

One can define a niche in many ways. Some cuts include demographics, geography, and jobs-to-be-done. Niches (and examples) can be:

  • Small (camping)
  • Boring (packaging)
  • High-end (black-car)
  • Unfamiliar (drug development)
  • Weird (online dating)
  • On-the-edge (crypto)

Niches to monopolize have the following characteristics:

  • Customers have a deep and specific need, are willing to pay, and are currently underserved.
  • A lack of substitutes and competition.
  • Limited threat of entry. Barriers are low for your company, but once entered, you can build barriers to make entry harder.
  • Force discipline and operational excellence. Sarah Tavel told us this is necessary for when expanding to less attractive niches.
  • Adjacent niches that are natural to expand to.

Facebook is the most famous example here. They started with Harvard as a niche, expanded to the Ivy league, then all college campuses, etc.

The Keith Rabois (general) framework

In this framework, you target all customer types first. You use general solutions to broadly attack trillion dollar markets.

“Go big or go home.”

Keith is the Chairman of Opendoor. Opendoor makes selling homes much quicker and convenient. Opendoor went to market with no specific customer type in mind. It could have been retirees, families, millennials, etc.

There are certain characteristics required for this approach:

  • Low NPS scores for incumbents.
  • Highly fragmented competition.
  • Can vertically integrate w/ radically simplified solution (to control the entire experience and get a high NPS score).

Vertically integrating has the following benefits:

  • Control the whole user experience. When variables are outside of your control, the system won’t be perfectly integrated. The more variables you can control, the more you can optimize to deliver something unique. Apple is the best example of this.
  • Control your destiny. Keith told us, “If I was going to bet 10 years of my life, I would want to dictate if I succeed or fail.” If you depend on others to deliver the product, you don’t control your destiny.
  • Capture more value (i.e monetize). Keith said. “When you are really good at it, it trumps getting a small fee from a lot of people.”

Timing

Both frameworks need a compelling answer to ‘why now.’ There’s no chance the business will be a ‘grand slam’ if not.

Keith Rabois says “it’s the founders job to triangulate how to get where they need to get to, with what is possible today with hacks and bridges…Typically if the timing is going to work, the founder has a really compelling answer to what has changed in the world, since there are not many new ideas.”

Charles Hudson elaborates, “I always ask people why could you not do this two years ago? Why not do it two years from today? Why now? For most startups — If you missed your window by two years either way, either you’re going to be late to market and someone else is going to have figured out things and made progress, or you’re going to be too early.”

Don Valentine also echoes the importance of timing. When asked about his biggest failed investment, he says “What didn’t work was the timing of the market…the critical thing is getting a product developed where the timing of the market’s availability and market demand are simultaneous. Otherwise you are spending lots of money on developing a market which people did not tend to spend money on. Invariably, we shut those investments down.”

Valentine warns that it’s important to not be too early. “We are not interested in creating markets. It is too expensive. We are interested in exploiting markets early.” Sequoia invests in most relevant companies in an ecosystem once there’s promise an ecosystem will grow. This was best shown with Apple and the PC ecosystem. “We don’t choose people, we choose markets. Once you choose a market, there is a primary product. We rarely ever invest where there is only one product…So if we viewed the Apple Computer as a system, we had to finance one or more memory companies, disc drive companies. We had to have floppy disks, which needed financing. Disc drives that made the memory information portable…Without memory companies, the PC is nothing. So if you keep digging away at the system, what else do you invest in?…We looked at the system — the Apple computer — made over 15 investments in that category.” Those investments include Electronics Arts, Oracle, Cisco, and NVIDIA.

There are a wide set of subjective changes that make now a good time to enter a given market, including:

  • Infrastructure changes. Regulation, government incentives, trade barriers, competitor exits, shakeouts in adjacent industries.
  • Tech changes. Emerging technologies, platform shifts, patent expirations, data availability, exclusive rights.
  • Business changes. New sales/distribution channels, unit economics (e.g. Instacart vs Webvan), economies of scale, pricing, macroeconomic forces
  • Customer changes. Shifts in consumer behavior, new communities.

Secrets

Compelling ‘why now’ answers need a ‘secret.’ Secrets are something you believe that that very few others agree with. Thiel writes, “secrets are important but unknown, hard but doable.” Founders get an edge with secrets.

Types of secrets

“There are two kinds of secrets: secrets of nature and secrets about people. Natural secrets exist all around us; to find them, one must study some undiscovered aspect of the physical world. Secrets about people are different: they are things that people don’t know about themselves or things they hide because they don’t want others to know. So when thinking about what kind of company to build, there are two distinct questions to ask: What secrets is nature not telling you? What secrets are people not telling you?” — Peter Thiel in ‘Zero to One’.

How to find secrets

“You can’t find secrets without looking for them…The best place to look for secrets is where no one else is looking. Most people think only in terms of what they’ve been taught; schooling itself aims to impart conventional wisdom. So you might ask: are there any fields that matter but haven’t been standardized and institutionalized?” — Peter Thiel in ‘Zero to One’.

Market types

Markets differ on level of consumption — the amount of existing demand. There are two types of consumption: consumption and non-consumption. Despite the binary definition, markets can lie on a spectrum. Neither level of consumption makes a better market from the outset. Founders can use both frameworks when picking within these market types.

Consumption markets

Consumption markets are pre-existing and well-known. Demand already exists. These opportunities are well defined and likely to be huge.

That said, these opportunities are also hard. Founders will be fighting incumbents and pre-existing inertia. Founders need to be ‘10x better’ to overcome this. Incremental startups will fail.

Startups operating in consumption markets are more likely to grow by stealing share rather than growing the market.

Non-consumption markets

Non-consumption markets, by contrast, do not exist yet. There are no pre-existing products nor direct demand.

For these markets, you don’t need to figure it out all on day one. You need to be directionally right. That allows startups to grow fast for a couple years before anyone figures out what is going on.

These markets are higher risk and higher reward. AT&T, GE, Apple, Google, and Facebook were all in non-consumption markets.

Market Sizing / Growth rates

Calculating market size and growth rates is difficult. There are three barriers:

  • It’s hard to predict the future. You want to be in a growing market, but it’s hard to predict how large things will grow.
  • All non-consumption markets have zero total addressable market (TAM).
  • TAM has a strong correlation with value proposition and quality of product. If product is amazing, TAM will expand. Mobility is a classic example. Uber is 3x the size of the entire taxi market. Uber reduced the friction to get a car, so more people did it.

Instead, top investors told us, ‘it’s not important to calculate exact market size and growth rates, but rather feel it can be a large opportunity.’ You can use the following to see if so:

Consumption markets

Market caps of the biggest companies in that sector. Elad notes, “The market capitalization of a set of companies reflects revenue in the market, growth rate of revenue and earnings, and the margins of the companies. These core metrics…help you understand whether a market is overall large, growing and profitable — all signs of a good market to enter…In general, you want to be in markets where multiple companies could afford to buy you for $1 billion, or where 2% of their market cap is at least in the hundreds of millions of dollars.”

Changes in pricing. Pricing changes affect market size. Charles Hudson describes when startups reduce price, they also cut their addressable market.

Effective Total Addressable Market. How much market share can the startup realistically win? Elad let us know “it can be a massive market, but if it’s already crowded with a lot of incumbents with 5 year sales contracts, maybe you can’t win any business. It doesn’t matter how big the market is because you aren’t going to get any traction. So the effective market is tiny. Think about it in terms of effective TAM — what can you really address.”

Non-consumption markets

Micro Value Creation. How much value you are creating for someone? The more value you are creating, you are going to capture some fraction of that as a company (~10–30%).

Macro Value Creation. Who are you creating value for? Is there is a reasonable amount of people in this world that have this problem? If so, Keith Rabois mentioned he can easily invest in the Seed and probably in the Series A.

The Peter Thiel (niche) framework

To become a monopoly, startups must go to market with durable assets. These are assets that withstand time, provide defensibility, and security for future profits. There are a few types of durable assets to go to market with:

Network effects. This is the big one — 70% of value in tech is driven by network effects. A network effect is when each extra user makes the product or service more valuable. LinkedIn for example, becomes more valuable the more people are on it.

According to Thiel, “Network effects can be powerful, but you’ll never reap them unless your product is valuable to its very first users when the network is necessarily small…Paradoxically, network effects businesses must start with especially small markets.”

Economies of scale. Thiel writes “A monopoly business gets stronger as it gets bigger: the fixed costs of creating a product (engineering, management, office space) can be spread out over ever greater quantities of sales. Software startups can enjoy especially dramatic economies of scale because the marginal cost of producing another copy of the product is close to zero…Service businesses [where marginal cost is much greater than zero] especially are difficult to make monopolies…A good startup should have the potential for great scale built into its first design.”

Proprietary Technology. Thiel writes, “Proprietary technology is the most substantive advantage a company can have because it makes your product difficult or impossible to replicate…

Proprietary technology must be at least 10 times better than its closest substitute in some important dimension to lead to a real monopolistic advantage. Anything less than an order of magnitude better will probably be perceived as a marginal improvement and will be hard to sell, especially in an already crowded market.

The clearest way to make a 10x improvement is to invent something completely new. If you build something valuable where there was nothing before, the increase in value is theoretically infinite. A drug to safely eliminate the need for sleep, or a cure for baldness, for example, would certainly support a monopoly business.

Or you can radically improve an existing solution: once you’re 10x better, you escape competition…Amazon made its first 10x improvement in a particularly visible way: they offered at least 10 times as many books as any other bookstore.”

Brand. Brand is a ‘weak’ durable asset.

Thiel writes, “A company has a monopoly on its own brand by definition, so creating a strong brand is a powerful way to claim a monopoly…

Beginning with brand rather than substance is dangerous…

When Steve Jobs returned to Apple, he didn’t just make Apple a cool place to work; he slashed product lines to focus on the handful of opportunities for 10x improvements. No technology company can be built on branding alone.”

The Keith Rabois (general) framework

Here, startups go to market by doing three things. Lay initial stepping stones, build accumulating advantages, and find anomalies.

Stepping stones are assets or behaviors that show what’s possible today, but also lay towards the long term vision.

Accumulating advantages are like ‘durable assets’. Both provide defensibility to the business. They differ in regards to changes over time. Accumulating advantages make running your business easier every day. Durable assets withstand time.

Unlike the niche approach, here one goes to market with a general solution. You don’t have a top down philosophy of what users you want. You first solve for all customer types and then are watching for anomalies to double down on.

An anomaly is something you didn’t expect. They can provide insight. “Oh shoot, this product isn’t suited to these people, but they are adopting it and going through a lot of pain. There must be something there.”

Rabois mentioned two examples of finding anomalies: PayPal and Square.

At PayPal, they didn’t initially target eBay power sellers to be their core market. They first provided a general solution for transferring payment. David Sacks was astute enough to notice anomalous adoption within eBay power sellers. PayPal then doubled down their efforts to focus on that user type.

At Square, they began with the initial stepping stone of the iOS card reader. The card reader was a temporary hack. It showed the behavior of point of sale payment. Square wouldn’t be long term dependent on hardware on the phone.

Square had anomalous adoption within small business merchants and peer to peer payments. 8 years later, Square Cash is now the engine which has nothing to do with hardware. Jack Dorsey’s job was to shepherd a product into the market with what was possible to do at the time. It wasn’t to wait for massive inflections in consumer behavior.

Similarities across frameworks

Assets

Both frameworks promote building assets that make your business more powerful and defensible. Thiel calls these ‘durable assets’ and Rabois calls these ‘accumulating advantages.’

Solve biggest risks first

In any business, you want to solve your biggest risks first.

Rabois told us, “what mediocre founders do is solve the easier risks first, the ones they know how to solve. The most important thing you can do for your valuation and self confidence is to take the 3 most risky things and conquer them. As soon as you conquer them, your valuation will increase, your conviction level of ‘if this is something you should do for 3–13 years of your life’ should increase, and your ability to convey that to others / persuade them should increase.”

Rabois writes down the top 2–5 risks for a business and addresses them in order of difficulty, not order of ease. Some of these risks need lots amounts of money, so it’s important to raise the appropriate amount. Top investors are willing to invest in these if the potential is there. Rabois addsVinod [Khosla] says ‘if the prize is big enough, the money is there.’ If the upside of being right is substantial, and you can decompose the logical steps and risks associated with it, within the last 10 years, there is enough capital to support those ideas.”

N of 1

Venture backed startups aim to be an outlier. This means that not only getting to product market fit, but redefining market boundaries, and creating their own category.

Arjun Sethi terms these category defining companies as ‘N of 1.’ He told us these companies have unique product-market fit. The product defies typical categorization for its market. For example, Slack saw engagement levels of a consumer app despite being an enterprise software tool. That signified customer demand across markets, in turn, creating their own category.

Arjun describes getting to unique product-market fit is a three step process. First, the company starts by solving a core value proposition that’s unique and novel. Then, the product becomes refined to become one users can’t live without. Finally, the product becomes a utility — where the product becomes a feature of other products.

Timing is a key factor here. Arjun mentioned “what’s important to understand is that markets are important, but it doesn’t necessarily have to be a big market. It has to be the right one at the right time — a small one that grows at high velocity or an old one that can be revolutionized.”

The Peter Thiel (niche) framework

Once in the market, it’s important to deliberately expand into adjacent niches.

According to Thiel, “Sequencing markets correctly is underrated, and it takes discipline to expand gradually. The most successful companies make the core progression — to first dominate a specific niche and then scale to adjacent markets — a part of their founding narrative.”

You want to be smart about what niches you expand into. Expansion should be into related and broader markets. In these markets, startups should leverage existing assets and avoid competition as much as possible.

Taking a non-deliberate expansion approach is a trap. According to the book ‘The Rule of Three’, “The lure of greater market share is a powerful one, which has caused many successful specialist companies to sacrifice their distinguishing characteristics and dilute their competencies in a headlong pursuit of growth, only to end up in the ditch. As we have pointed out, such strategies are viable only if a clear, unblocked opportunity to occupy a generalist position exists. If not, firms would be far better off deploying the same resources into a geographic expansion within existing niches or creating new niches.”

The Keith Rabois (general) framework

In this approach, you went to market with a broad solution and then looked for anomalies. Once in the market, it’s time to double down on these anomalies and then capture value.

We mentioned how Paypal and Square found and doubled down on anomalies. After that, capturing value is especially important. This approach is too capital intense otherwise.

Rabois told us, “Khosla Ventures and Founders Fund think about it in terms of payback time. A function of revenue times margin, compared to outlay. This equation works if either your cost is initially really low or your margins are great.”

If your margins aren’t great, it’s important to understand how you are going to capture value. Rabois mentions a three part process. First, you should identify the step functions to improve margins. Then, you should triangulate what they will likely get to. Finally, don’t worry initially because you know they will improve. These types of step functions can include leveraging the durable assets mentioned above.

Opendoor is an example of this. To grow fast, they doubled down on their core product, selling to Opendoor. Only afterwards did they focus on expansion and increasing customer lifetime value.

It is okay to have low margins if costs are low. Rabois adds, “if you have the entire world asking for product for free and not much you need to do, it’s not bad to have a low margin business. All your margin is going to be free cash flow. All you care about is the money coming back to you.” Examples of this are businesses that have zero to little customer acquisition cost. If these businesses can scale, Keith doesn’t worry about a 10% margin.

The Peter Thiel (niche) framework

Here, founders are more likely to achieve a successful outcome. Going to market is easier as one can get a customer adoption flywheel going with a narrower segment.

On the flip side, this approach is as hard as the Rabois approach. It can also take longer.

Regardless of outcome, it can be hard to understand why the result occurred. This approach entails prediction risk and uncertainty. If are doing well, it’s unclear whether you can pick the next great niche. If you are struggling, it can be hard to understand why. You can either have a bad product or be in a bad niche.

The Keith Rabois (general) framework

While this approach is riskier, the companies that do succeed will be bigger and better run.

According to Keith (and Anuj’s experience operating Atrium), the tough parts all deal with execution. The team needs to be very strong and well rounded. This means exceptional ambition, cross functional abilities, and communication skills.

This approach also requires much more capital. Founders here need to be good at fundraising, have a well regarded exit, or both. They need to find investors who are willing to take these bold bets.

It’s critical founders operate in great markets. Otherwise, failure (according to VC standards) is destined. We recommend the following four steps to know if you have a great market opportunity:

First, pick a framework based on how many large companies the market can support at scale. The Peter Thiel (niche) framework is best suited for monopolies. The Keith Rabois (general) framework is best suited for oligopolies.

Then, based on the framework, decide whether the market has potential. Compare the market to our highlighted market characteristics and reasons for ‘why now’. If you believe this market does not have potential, find a different one.

Next, identify how you will go to market with purpose. Determine the assets that provide defensibility and the biggest risks to solve first.

Finally, once in market, expand deliberately. Sequence the next niche or double down on anomalies.

While this post is a guide, we recognize there is room for interpretation and creativity. As Aaron Harris wrote, “The best founders imagine their own frameworks for the success of their companies and convince everyone around them that they’re right.”

Feel free to reach us on twitter: @nujabrol and @eriktorenberg.

Thanks to Keith Rabois, Elad Gil, Sarah Tavel, Arjun Sethi, Avichal Garg, and Julia Dewahl for providing inputs on this post.