Sand Hill Road sign from 280 north. (Photo credit: Wikipedia)
When a start-up opens for business on the first day, it could sell its product to anyone. And that unlimited flexibility presents a huge strategic problem. The way an entrepreneur solves it will determine whether the start-up prevails or goes up in flames.
That’s because if a start-up is selling a product to a company--or even an individual consumer--it will encounter stiff resistance. Why? People don’t like buying a product or service from a new venture that is probably going to run out of money sooner or later.
Not only that, but new ventures can also run into another problem if they are trying to raise outside capital. If they target a market that is already very big, there’s a good chance there are plenty of competitors going after the same customers.
That is going to make it hard for a start-up CEO to persuade a venture capitalist that he is going to get in on the next big thing.
So unless an entrepreneur picks the right market, she won’t be able to sell her venture's product and won’t be able to raise outside capital to finance its growth.
It’s a tough problem to solve. But when the going gets tough, the smart entrepreneur picks markets with these four characteristics.
1. Unrelieved customer pain
To persuade nervous potential customers to try a start-up's product, entrepreneurs must pick the right problem to solve.
For the problem to be right, it must satisfy three tests:
- The entrepreneur must feel a passionate need to solve it;
- The venture's target customers also find it painful; and
- Competitors are not offering solutions to it.
Consider Axcient. Its founder had lost a significant amount of programming work in a previous start-up after a problem at the office where its computers were stored. He tried to find a service provider who could make it easy for him to back up all of the company’s operations and restart them quickly in the event of a fire or other disaster.
He could not find a decent solution and decided to start Axcient to solve the problem.
2. Viable business model
Targeting the right problem to solve only takes an entrepreneur part way to picking the right market. After all, plenty of start-ups have a product or service that people are willing to use but not pay for.
One common way that start-ups overcome this problem is to create a freemium business model. That’s where a company lets people use a simple version of its product for free. It’s not a bad way to go because it means that if your product is good, lots of people will use it.
So how do such start-ups generate revenues? They charge customers to use a more advanced version of the product. And if they get enough people to use the product, they can generate a significant amount of revenue from the 1% or 2% of total users who buy that upgraded version.
Consider AVG - the maker of security software. In 2012, it sold $355 million worth of software and services and earned a 13 percent profit margin. But most of its customers don’t pay anything for its product.
3. Strong supporting trends
Figuring out a business model, does not solve the second problem of attracting investors who don’t want to invest in a start-up going after a market that is crowded with competitors.
And by competitors, I mean other venture capital firms that all see the same opportunity. The best venture capitalists want to discover an opportunity before their competitors do. To do that, they want to invest in a start-up that is going after a market that’s small now but will get big fast.
Such markets have strong supporting trends. For example, if in 2007 start-ups that had identified a big opportunity for mobile advertising would have been on the cusp of an opportunity that would soon get big fast.
It's easy to see now that social networks and smartphones combine to make a big advertising opportunity. But the smartest start-ups see and exploit such opportunities before their competitors do.
4. Passionate pioneers
Finally, these big trends don’t just happen. A start-up must find early adopter customers -- like Google or Amazon -- that are always looking to be buying the latest in technology and are big enough to influence lots of other potential customers.
If a start-up gets such passionate pioneers to adopt its product and they get big benefits from it, the start-up will ride the wave of opportunity created by those supporting trends.
Start-ups that pick markets with these four characteristics will boost their chances for success. Ignoring them when picking markets could endanger a venture's viability.
