Big companies traditionally operate in mature markets. These markets are often in the billions of dollars, global, well understood and fairly stable. Interestingly, the big companies operating in these markets may have originally created them, often many decades ago, because that’s how long it has historically taken for markets to get big. New markets may get created and scale faster than ever before, but they still start small and take time, which is hard for big companies to appreciate. In a rush to hit quarterly targets, companies don’t have the appetite to create new markets the way they once did.
This is why it’s problematic to focus on market size as a key metric for deciding where and how to innovate. You’ll often hear people in large companies say, “We operate in the billions, not the millions.” As a result they only look at markets that are already enormous.
That’s not the case for startups. Not every startup will create a new market, but they often jump early into small markets and help them grow. And while venture capitalists do look at market size, it’s not the biggest factor in choosing to invest. It’s not that market size doesn’t matter, but markets for early stage startups can be very nebulous. What market was Airbnb in when they started and allowed people to sleep on other people’s couches? Hospitality? Hotels/Resorts? When Uber started it was clear they were in the transportation industry, but they started with luxury vehicles offering a premium service, so were they really competing with taxis? Today, they’re also in the Mobility as a Service industry, which is relatively new. If you Google, “how big is the mobility as a service industry?” you’ll find a wide variety of answers.
Determining market size and the risk in doing so
Market size is often determined top-down, by defining the industry or vertical you’re in and finding the appropriate statistics. Often, people will extrapolate this into such big markets that it becomes meaningless. For example, every software company that sells marketing technology solutions could say, “We’re in the MarTech industry,” which according to a quick Google search is around $250-$350B. But that’s a ridiculous definition of a market for a new startup or corporate venture. You need to segment that market into something narrower, such as Data Analytics, Advertising & Promotion or Social & Customer Relationships. Even those segments will be large, and not really representative of whatever solution you’ve built. So you can claim you’re in a $100B market and that it’s big enough to matter but does it really matter?
You can’t use top-down market size as a proxy for the actual potential of an opportunity, because market size ignores too many variables, including the problem you’re solving, target customer segment (and early adopters), differentiation (that actually matters to users/customers), go-to-market strategy, price and more. Unfortunately, it’s easy to claim the market is enormous as justification for building something in that space, without really knowing what to build and why.
Bottom-up market sizing is better, but still far from perfect. In bottom-up market sizing, you use your actual traction and any additional data you have on conversion, sales, etc. to demonstrate (a) interest in your solution; and (b) the potential to reach more customers. If you haven’t launched yet, you can still use some basic assumptions to determine the potential traction for your venture, growing year over year, often for 5 years. At least in this case you’re able to identify the riskiest assumptions to actual traction and market share (and by extension, actual market size.) As a quick aside, trying to predict a 5 year business model for a new business is borderline absurd. I’ve never seen a startup’s plan realized as expected; there are simply too many variables. And yet, within large corporations, it’s assumed that not only will you have a five year business plan, but that it’s realistic. Forecasting out for five years is an interesting experiment in stress testing assumptions, but it’s essentially nonsense otherwise. Best case scenario, try rolling quarterly forecasts (once you’re in market), looking out no more than two years. As your venture matures, the forecasts get more accurate because you have more data, but early on, assume you’re off by a wide margin.
In my experience, bottom-up market sizing is often done very conservatively, whereas top-down is done very aggressively. And as a result, corporate ventures may not look as appealing in a bottom-up market sizing scenario. It’s hard to plug in a number such as 500% Year-over-Year Customer Growth and be taken seriously.
With top-down market sizing, it’s easy to pick a very large market that’s not specific enough to what you’re actually doing, and in a bottom-up market sizing exercise, it’s easy to be too conservative and not put forward an aggressive enough model.
My suggestion: Do both with a heavy grain of salt. Both are worthwhile efforts to challenge your assumptions about the venture you’re building and think about it from different perspectives. But ideally everyone involved would recognize them as largely made up and not immediately relevant. When building a venture, your number one responsibility is finding a problem that actually matters and solving it.
Small markets aren’t bad
In 2010, Chris Dixon, General Partner at Andreessen Horowitz, wrote in a blog post, “The reason big new things sneak by incumbents is that the next big thing always starts out being dismissed as a ‘toy.’” And one of the major reasons people dismiss something as a “toy” is the market size, which either can’t be defined (because it’s so new) or looks too small. If you don’t put as much credence into market size, you free yourself to imagine a world where you can build something new, scale quickly and grow the market (or even create it!) without having to justify a “perfect 5 year business plan.”
One way to counterbalance concerns around a small market is to look at macro trends. Macro trends are a great way of sensing directionally where things are going. Macro trends are usually pretty easy to identify and are broadly known. (It’s much harder to identify a small, emerging trend that you believe will become a macro trend–which ultimately runs into the same challenges as small markets that you believe will become big markets.) The risk with macro trends is that you rely on them to justify building new ventures without really understanding users’ needs and how to solve them. But macro trends are useful as a way of articulating a meaningful future state that a small market can grow into.
To build a big, successful venture, whether internally within a large company or as a startup, you’ll need to operate in a big market. But in the earliest days of a new venture, you may not even be sure what market you’re in, or could move into. Or the market may be small because it’s nascent and emerging. Unfortunately, big companies often prioritize market size over much more fundamental criteria for building successful ventures (such as a validating problem, identifying an early adopter group, and proving the solution is creating value) and this leads to chasing less innovative opportunities that are perceived as safer, or closer to the core. New growth opportunities, those that look like “toys” today, but become future winners, are often in those smaller, less mature spaces, the nooks and crannies of emerging trends and user needs that are hard to identify and bet on, but worth it when they scale.