How To Choose A Market For Your Startup Or Small Business Ross | November 27th, 2012

 

I’m rarely surprised when a young entrepreneur or small business owner hasn’t fully identified how their new business will make money. But I’m always surprised when that entrepreneur or small business owner has a tough time describing the potential customers for their new business’s products and services. After all, without customers, there is no revenue.

If you try to sell your products and services to everyone in the world, you will waste both time and money.

When you choose a market, you should consider five main factors:

1. How many customers are in the market?

2. Can these customers pay for your products or services?

3. Do these customers have the need you solve?

4. How many competitors are competing for your customers’ business?

5. How does your business compare to your competitors?

Let’s discuss each factor.

How many customers are in the market?

A market can be huge but dominated by only a few players. Or a market perceived to be global can be dominated by a few regions. You must know how many potential customers are in your target market.

Let’s illustrate with an example – using a fictional new online marketplace for the purchase and sale of art. How big is the market and who are the potential customers?

The global art market is believed to be about $61 billion (2011). That’s a pretty significant opportunity, but as we discussed above, the size of the market doesn’t mean that you can ignore defining who your customers are. If you don’t know which segment of the market you will target, how will you advertise? Because there are many different entities and types of customers and artists, with whom will you communicate?

You can’t simply assume that you will provide a service to the entire art industry – the types of customers in an industry will vary. For example, approximately one-half of the art market worldwide is auction sales. The other half is commercial gallery sales. Is your new startup targeting auctions? Commercial gallery sales? Both?

As you look further into the data, you find that about 2.4 million people are employed in the art trade globally, there are 403,000 dealers, galleries and auction houses, and the top five percent of galleries and dealers account for 70% of all sales.

The data is a good place to start segmenting your potential customers. Are you targeting the people employed in the art trade? Are you targeting galleries, dealers, auction houses? Are you targeting dealers who sell a certain amount of art annually? These are all very important question that will help you figure out who your customers are.

Can these customers pay for your products or services?

The prices you charge for your products and services will be influenced by your customers’ ability to pay. Put another way: not every market is the same – the profit margins of businesses in some large markets are tiny, even if the market size is huge. For example, Tom Tunguz, a venture capitalist at Redpoint, recently compared the margins of grocery stores, with restaurants and software companies (chart from Tom’s post on choosing market segments):

Tunguz wrote:

Many startups focus on restaurants or grocery stores whose ability to pay for new projects is limited by their relatively small profit pool. The average Safeway store sells about $25M of merchandise annually, but generates about $2.7M in profit.

Due to the relatively small potential contract values in restaurants, startups serving these customer segments have to build very efficient sales teams or online customer acquisition tools to aggregate many of them inexpensively. On the other hand, startups targeting software makers have more flexibility in their approach because these companies generate multiples more profit.

Let’s look again at our art marketplace example. According to a new report from The European Fine Art Foundation (TEFAF), “The number of art-market transactions in 2011 was 36.8 million, which gives an average value per transaction of $1,630.” That number isn’t trivial – but it also doesn’t lend itself to very high add-on fees.

Do these customers have the need you solve?

Customer behavior can change, and it’s important that you understand both their existing behavior and how you must adapt to the changes.

In a recent post, Fred Wilson, a venture capitalist with Union Square Ventures, revealed that USV was observing shifting trends in the consumer web space leading more momentum/late stage investors to look at startups focuses on the enterprise, rather than consumers.

[T]he consumer web has matured. we are almost 20 years into the consumer web and we have large platforms that are starting to suck up a lot of the oxygen. google, facebook/instagram, amazon, microsoft, apple, twitter, ebay, yahoo, AOL, craigslist, wordpress, linkedin together make up a huge amount of the time spent online, particularly in the english speaking world. there are still occasional new entrants into this list and departures too. tumblr and pinterest have risen a lot in the past couple years while myspace has declined. but consumer behaviors are starting to ossify on the web and it is harder than ever to build a large audience from a standing start.

According to Dave McClure of 500 Startups, Fred Wilson is wrong. McClure writes:

[I] most certainly take issue with the statement that it’s “harder than ever to build a large audience”… nothing could be further from the truth. Almost every possible internet distribution channel has MORE users than ever before – whether it be search, social, mobile, video, local, SMS, email, chat, etc. And for those of us who invest outside silicon valley and new york, the global consumer opportunity is huge as well in Asia, Latin America, the Middle East, and other fast-growing internet and mobile markets.

Who is correct? And how does this impact your new company?

Ultimately, it doesn’t matter whether it’s easier or more difficult today to build a large audience. Far more important is whether that audience has a need that you solve. Twitter solves a need – and has been able to build a large audience (but has not yet been able to monetize that audience fully). There are many other companies that solve specific needs of customers – but also millions that have failed because they did not solve any specific need.

Back to our art marketplace example. If you plan to build an online marketplace, you must understand how many of your potential customers currently shop online. This represents both an opportunity (if the number is large) and a problem (if it’s small, it means you will need to work much harder to educate people about online art sales). For 2011, according to TEFAF “dealers report that 31 percent of their sales take place at art fairs, while 43 percent take place through galleries. Online sales account for 10 percent.”

Once you pick a segment, you should figure out whether customers in that segment have the need you solve. If your marketplace focuses on online sales, galleries and dealers that choose to sell offline will not care about your products and services.

How many competitors are competing for your customers’ business?

If the market is over-saturated with competitors, it will be both difficult for you to stand out and also difficult to get funding. More importantly, if you reach for a broad market, you will need more financing than if you pick a more targeted, niche market. Understanding your competition is critical to success.

How does your business compare to your competitors?

Ultimately, once you’ve defined your market, identified a need, and assessed your competition, you should evaluate whether the value proposition you provide is robust enough to cut through the noise and be attractive to your potential customers. Keep in mind that price isn’t value – it’s very difficult to compete on price alone. Features are also not value – that’s why you rarely see Apple touting features of its products (in most cases, the products of Apple’s competitors are more feature-rich).

Do you have questions or other ways to figure out who your customers are? I’d love to hear from you in the comments below.

image credit: DonnitaMae

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