When considering launching a new line of business, how can you figure out if there's really a market for a product?
The technique that's served me extremely well is one that I like to call "Market Validation." Market Validation is a systematic approach to evaluating your market before you jump in with a product. I call it the "Ready, Aim, Fire" approach to getting your product out. Most companies' take more of a "Ready, Fire, Fire, Fire, Aim" approach, sucking up huge amounts of capital and lots of management bandwidth. Like Yosemite Sam indiscriminately using his six-shooter, eventually, by chance, you might hit a target of one sort or another. Using Market Validation, you're more like a sniper, taking a little bit of time to sneak up on the target, study and evaluate it, aim, then take your shot. This gives you one product, one market; versus the alternative of multiple products, and no market.
How do you do this? It's a combination of tactics that involves thinking and doing a little bit of rational thought before heading off to market; thinking before you act. I can hear the entrepreneur moaning now: "Wait a minute, I've got to get to market now before the window of opportunity closes." Well, I'm gonna give you a good hard dope slap and tell you that if your supposed market opportunity can't stand a time investment of 60 days to get it right, you really don't have a market to begin with.
Let's look at the first step. Revenue is the ultimate measure of success here, so how much revenue do you want to generate? You should build a three-year forecast of what you expect it to be. Then you need to answer some fundamental questions. How big is the market? Is it big enough to meet the revenue expectations you've set for the product? How much market share do you need in your first three years to stay on target with your revenue plan?
The reasoning here is pretty straightforward. I can't tell you how many product plans I see where, in order to be successful, a new product needs 200 percent market share in Year Three. That's nuts. You've got to understand the current size of the market and figure out if it's big enough to justify getting into. For example, say the U.S. market for a certain kind of widget is $100 million a year, and growing around 6 percent a year. What kind of penetration do you need in Year One to be successful?
If the answer is $1 million dollars in revenue, that's probably doable with a strong product and a real marketing budget. But if the answer is $10 million (or any other double digit penetration number in the first year), that's pretty doubtful for a new product, even with a huge marketing budget.
Let's look out three years. We've already established that the market in this example is growing 6 percent a year. What's your expected growth rate? If it's at or below 6 percent, and you have an average sales and marketing budget, assuming a competitive product, you could reasonably hit that. But if you expect to grow faster than 6 percent, what kind of additional investment in sales and marketing will you make to justify it? If your competitors spend 40 percent of gross revenues on sales and marketing to grow at 6 percent, how much will you spend? Can you reasonably expect to devote a sum equal to 60 percent of sales in order to hit a growth rate above 6 percent? Where will that investment come from? How long will you have to make it to be successful? How much market share will you need in Years 2 and 3 to hit your numbers? The rule of thumb I've always followed is single digit market penetration in the first three years of a new product is doable; getting to double digits requires a lot of sales and marketing money and an incredible amount of luck.
The conclusions here? Make sure the market you're going after has enough room in it to support your product ambitions before you build and launch that product. And make sure you're budgeting enough dollars for sales and marketing to grow at the same rate as the market.