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Don’t Develop Your Products Naked
Entrepreneurs Learn Why Nothing Proves A Market Like Customers

Paul Finke’s 5 Keys To Sizing Up Markets

Serial entrepreneur Paul Finke is a veteran of five technology startups. When validating a market opportunity, here are the first five things he considers:

1. Understand the need. How cool your product is doesn’t matter, the question is: Who needs what you're selling? First describe that, then determine how big the need is.

2. Who is the customer and how do you get to them? The potential of a market is only as good as the percentage that is addressable. Determine who actually says yes to the purchase decision and what channels you’ll need to reach them.

3. Define the value proposition. Explain it in terms of your customer using the language they use.

4. How will you make a profit? Even big markets aren’t attractive if they have ultra-thin margins.

5. Sustainable advantage. What are the barriers to entry that will stop someone from copying you and stealing all of your business? 

(Washington, DC -- May 30, 2002) “It's very, very important not to develop a product naked,” cautions Tim Meyers, General Partner at Updata Venture Partners.

What does that mean? Whether you’re at the earliest stages of defining your market opportunity or the later stages of product development, you need the cover of customer involvement and guidance if you expect any chance of success.

The Panel

Serial entrepreneur Paul Finke put it another way. When it comes to determining a market’s potential, most people start with analyst reports, “Since, by definition, every forecast is wrong, you have all the analysts charts on the wall and none of them converge. The best thing to do is to talk to customers. Go out and try to get somebody to say, ‘If you made this thing, I would buy it.’”

Meyers and Finke were members of a panel at this morning’s Netpreneur Coffee & DoughNets meeting assembled to discuss “Sizing And Validating Market Opportunities,” including Clara Conti, CEO of ObjectVideo, Jonathan Silver, Managing Director of venture investing firm Core Capital Partners, and moderator Andrew Sherman, author and Senior Partner at McDermott, Will & Emery. Joined by Mario Morino, Chairman of the Morino Institute, who provided a wrap-up to the session, the speakers provided a wealth of practical tips and suggestions to help entrepreneurs determine the market viability for their business ideas. One primary message came through above all others, however: Talk to your customers.

Networking

“There is only one way I know to validate a market,” said Silver, “whether someone says they will buy your product.”

Answering whether or not a market is attractive starts with a much more subjective question: attractive to whom? If just yourself, a personal passion may be much more important than market size. On the other hand, venture capitalists will expect much bigger (and clearer) potential than “lifestyle entrepreneurs” who are simply looking for enough returns to live at a certain level with appropriate financial freedom.

Either way, of course, you’ll eventually have to quantify, subdivide, and strategize, and at the center of that process should be the customer. As Morino put it, nothing replaces “a compelling knowledge of your space” earned by building relationships and working in the trenches. Silver advised, You want to do at least as much research as we [investors] are going to do, and we will be talking to 20, 30, 40, 50 potential customers about your product. You ought to be doing at least the same.”

In addition to differentiating between lifestyle or growth goals, an entrepreneur has to be able to quantify the total market versus addressable market (the portion of the market you can actually reach), the potential growth of the market versus the potential growth in your share of the market, current targets versus expansion markets, and the opportunity in your niche versus that in your entire sector. This involves knowing elements such as demographics, pricing, and competitive analysis, and should incorporate as much direct customer contact as possible at all stages, through prototyping, product testing, and beyond.

Take ObjectVideo for example, which learned that market validation isn’t just a startup function. Founded during the Internet heyday as Diamondback Vision offering MPEG4 streaming media technology, Conti explained how the company soon realized that it could not compete against industry giants like Microsoft and Real Networks. Management set off on a project to identify other spaces where their object recognition technology could find a more hospitable reception. The founders had originally come from the Defense Advanced Research Projects Agency (DARPA) and so had previous knowledge and experience in the government and security spaces. Through extensive conversations with people in the market (and before the September 11 attacks) they began to see an opportunity in transportation security which the company is now pursuing. Importantly, although executives have identified several vertical sectors that might use their solutions, they are keeping focused on transportation the near term. That’s important because your organization has to scale appropriately with your markets.

The Panel

While sizing a market will take more than anecdotal conversations, the speakers advised care when using broader, indirect, or external sources such as analysts and survey results. Not that they don’t have their place, but they must be used appropriately. As Morino put it, “I think [traditional market research techniques] have confused more people than they’ve helped. It's not that market research isn't good — it's fundamentally very good — but we tend not to interpret and integrate it very well.”

One of the biggest problems with market research, he said, is that it tends to focus you on short-term issues, not the broader analytics of the long term. Silver was even more direct about the use of analyst projections, “I don’t care about your market size projections three or four years out. Working in the areas we do it's hard enough to figure out where the market will be 18 months from now. I give very little credence to deep analysis of the number of units that will be sold of a disruptive technology four years out the door.”

The advice of financial analysts may have been even more damaging to some companies (and investors) during the Internet bubble period. “In the last two or three years,” said Meyers, “A lot of people defined their companies based on what Merrill Lynch or Goldman Sachs or Morgan Stanley said about particular marketsthat revenues really didn't matter, that this was a market that was growing. Revenues do matter.” For passionate entrepreneurs, the focus should be in the entrance, not the exit, strategy.

In his wrap-up, Morino recalled a recent effort by one venture capital firm to review its portfolio companies over the last 20 years to see what the successes (and failures) had in common. It came to two things: quality of management and markets. “No,” said one of the firm’s managing partners, “Remove markets. Good management avoids bad markets.”

Asked to name some of the markets of current investment interest to Core Capital Partners, Silver counted off high-tech sectors such a security, nanotechnology, and bioinformatics, but he was quick to qualify the list, saying “Anything is an opportunity if you have a better product at a cheaper price.”

“Just remember,” Meyers cautioned, “That “better,” “faster,” and “cheaper” have to be determined by the customer.”

Copyright 2002, Morino Institute. All rights reserved.

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