When you open your start-up for business on the first day, you could sell your product to anyone. And that unlimited flexibility presents a huge strategic problem. The way you solve it will determine whether your start-up prevails or goes up in flames.
That’s because if you’re selling a product to a company--or even an individual consumer--you are going to encounter some stiff resistance. That’s because 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 you can also run into another problem if you’re trying to raise outside capital. If you are targeting 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 you to persuade a venture capitalist that he is going to get in on the next big thing.
So unless you pick the right market, you won’t be able to sell your product and you won’t be able to raise outside capital to finance your start-up’s 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
If you want to nervous potential customers to try your product, you have to pick the right problem to solve.
For the problem to be right, it must satisfy three tests:
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
If you target the right problem to solve, you are only part way to picking the right market. After all, what if you 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 you generate revenues? You charge customers to use a more advanced version of the product. And if you get enough people to use the product, you 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
If you can figure out a business model, how are you going to solve the second problem of repelling 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 that you do. 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 you had identified that there would be a big opportunity for mobile advertising you would have been on the cusp of an opportunity that was about to get big fast.
That’s because the combination of the popularity of smart phones and social networks would mean that online advertising would shift to mobile devices and would be most effective if it was tied to social networking.
4. Passionate pioneers
Finally, these big trends don’t just happen because you look into the future. Your start-up must find early adopter customers - like Google or Amazon - who are always looking to be buying the latest in technology and are big enough to influence lots of other potential customers.
If your start-up gets such passionate pioneers to adopt your product and they get big benefits from it, you will have an easier time riding the wave of opportunity created by those supporting trends.
Pick markets with these four characteristics and your start-up will boost its chances for success. Ignore them when picking markets and your venture could be doomed.