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what constitutes an attractive market? printer friendly version

sizing & validating market opportunities

According to venture capitalist and former entrepreneur Jonathan Silver, There is only one way I know to validate a market, and that’s if someone says that they will buy your product.” At this Netpreneur Coffee & DoughNets event held May 30, 2002, a panel of veterans explained how to go about assessing a market’s potential. They say that the key to determining whether or not it’s attractive is in having a clear and compelling understanding of the customer, but, even before that, you first have to ask, “Attractive to whom?”

panelists:
Clara Conti, CEO of ObjectVideo
Paul Finke, former CEO of Yafo Networks
Tim Meyers, General Partner at Updata Venture Partners
Jonathan Silver, founder and Managing Director of Core Capital Partners

moderator:
Andrew Sherman, Senior Partner, McDermott, Will & Emery  

wrap-up:
Mario Morino, Chairman, Morino Institute

Copyright 2002 Morino Institute. All rights reserved. Edited for length and clarity.

Disclaimer: Statements made at Netpreneur events and recorded here reflect solely the views of the speakers and have not been reviewed or researched for accuracy or truthfulness. These statements in no way reflect the opinions or beliefs of the Morino Institute, Netpreneur.org or any of their affiliates, agents, officers or directors. The transcript is provided “as is” and your use is at your own risk.

 

mary macpherson: welcome

Good morning and welcome to Coffee & DoughNets. I’m Mary MacPherson of Morino Institute’s Netpreneur. Thanks for coming this morning.

        Before we get started, I’d like to make two announcements. First, I want to introduce a new regional group that is with us this morning, the DC/Baltimore Chapter of the Product Development & Management Association (PDMA). On June 6th, they’ll host their first event, “Hunting for Hunting Grounds,” about the process of defining new business areas and examining the possibility of radical change through new products.

        The other news I’d like to tell you about is a project called “The Home That Tech Built,” a partnership between the IT Community Foundation (ITCF), the Habitat for Humanity of Northern Virginia, and local technology companies and professionals. ITCF is raising the money to fund the project and underwrite the mortgage for a house that will be built for a needy family in our area. They’re also recruiting and managing the volunteer component of this project, so, if you’d like to donate your time to take hammer, nails, paint, and whatever else, we’d encourage you to get involved. It’s a good way to give back to the community.

        Our Coffee & DoughNets events are developed in real time based on what you tell us about your most critical needs as you build your businesses. My colleague, Ben Martin, has been leading the team to build a great series this quarter, and I want to remind you that the streaming video and edited transcript are available on the Netpreneur website.

        This morning we’re delighted to welcome back our good friend and counsel, Andrew Sherman of McDermott, Will & Emery, to moderate our discussion about “Sizing and Validating Market Opportunities.” He’ll introduce our panelists in a moment. Following the panel, we’ll have Q&A, followed by Mario who will do the wrap-up.

                Let me also acknowledge our volunteers this morning who help us pull these events together: Paul Carney, President of ishtot, and Christina Fredette, soon to be a law student at The University of Wisconsin. Our thanks to them for helping out this morning. Finally, I’d like to acknowledge the entire Netpreneur team who make this and everything else we do possible.

 

andrew sherman: introductions

Good morning. It’s been a little while since I was up here in the moderator role. I can see a few things haven’t changed, however. For one, I am wearing a tie and most of you are not. I do see a few more ties, so the men’s clothing shops in town must not be on the verge of bankruptcy. Second, I’m still standing. Because I’m a lawyer, I didn’t get a seat. That is okay. I don’t mind standing for awhile and moderating.

        Mary mentioned that Coffee & DoughNets is programmed in real time, and there is certainly nothing more current than this topic. In fact, it is so current that in the process of exchanging emails we even updated and modified the topic further. We felt that even though sizing and validating market opportunities is our core discussion, there is a broader topic that overlays it, and that is dealing with change. All of us have been through so much, as entrepreneurs, as a society, as a region. The customer, how we assess that customer, and how we look at our intangible assets, all of these continue to change, so part of our theme this morning is not just understanding the market, but, also, understanding how to react to these market changes. These issues will dictate your ultimate success as a company, your ability to grow, and your ability to attract capital. All of them revolve around market—the emphasis on the customer, on making sure that you understand your target market, on understanding the assets you’ve developed in reaching that market, and so on. They are all relevant to today’s discussion.

        Since we have such a great panel, I’m going to cut my introductory comments short. I have some thoughts that I’ll pepper in as we go, but let me tell you a little bit about our panel.

        Many of you know Jonathan Silver of Core Capital Partners. Jonathan has been a mainstay and great supporter of the entrepreneur community here. He’s been an advisor to companies, an entrepreneur, and, most prominently, an investor in companies. Jonathan is going to give us his views on the trends he sees in the marketplace, as well as the extent to which these issues are relevant in his due diligence.

        From Jonathan, we’ll turn to Clara Conti, President and CEO of ObjectVideo. She is a seasoned entrepreneur and somebody I have a lot of respect for. Not only have I had the chance to work with her professionally, I’ve had a chance to hear her speak. She has taken a company with great technology and focused on this topic of sizing and validating market opportunities, as well as adjusting business models and product offerings around the new demand patterns and new customers.

        Next is Paul Finke. Most recently CEO of Yafo Networks, Paul has been part of six different startup companies and has a lot to share with us. Last, but certainly not least, is Tim Meyers of Updata Venture Partners. Tim, like Jonathan, has been a key player in the entrepreneur community regionally, and, again like Jonathan, has spent the last couple of years looking at companies from an investment perspective and determining how these market issues play out in the decisions to fund or not fund.

        So, Jonathan, will you start us off?

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jonathan silver: attractive is in the eye of the beholder

I’m going to begin by deferring to the two entrepreneurs on either side of me to talk about specific market analyses that businesses need to do. I’ll elevate to the 40,000-foot perspective and talk a little bit about what we at Core Capital, and investors generally, think about when we try to assess a potential investment in a company and its markets.

        The first question is: Is your market an attractive one? That question actually has more nuance than you might think, because it depends heavily upon what “attractive” is. What may well be legitimately attractive to you as an entrepreneur may not necessarily be attractive to an investor, particularly an institutional investor. For example, it highlights the distinction between a “lifestyle” company and what I will generally call a “growth” company. Lifestyle companies can be fabulous successes. You can make an enormous amount of money with them. As the term suggests, you can use them to live the lifestyle you want, but they may not necessarily generate the kinds of returns that institutional investors are looking for. The very first thing I would try to assess is whether or not the market is attractive to me as an investor, not necessarily to you as an entrepreneur. Your market may well exist, and in a form that will allow you to grow a big company, but not necessarily a particularly profitable one the way I judge profit.

        I am judged by my investors. They are my customers, and I am judged by my ability to produce an internal rate of return (IRR) for them based on our investments. Companies that grow very large but have very thin margins or companies that have great difficulty taking market share are examples of opportunities that may be attractive to you as an entrepreneur, but not necessarily to me as an investor. That is the first point.

        The second point, again at the 40,000-foot level, is to make sure that you draw a distinction between your total market and your total addressable market. What I mean is that it may well be true that there are a billion Chinese people and if you could sell a widget to each of them for a buck you’d have a tremendous business, but your total addressable market, the market you can actually go after with your product or service, is much more likely to be a subset, potentially a very small subset. Again, that doesn’t make it a bad business; it just makes it a different kind of business and a different size market. You want to make sure, particularly when you are talking to investors like Tim and me, that you speak the language we speak, which involves the addressable market. The question really is, how many people or companies or things can you realistically sell in a given time frame at a given cost?

        A third observation I’d make is that it is very difficult to predict the size of an emerging market. And, if you think it’s difficult to predict the size of an emerging market, try to figure out how to predict the size of a market for a disruptive or new technology. Who knows? It doesn’t exist. So, again, I will defer to the entrepreneurs here who have more direct experience than we do in trying to figure out how to analyze that, but it is a question that all of us wrestle with. If you are really working on something that you believe is disruptive, how are we all going to identify the market and the potential opportunities?

        Here are some general thoughts about markets that are more attractive than others. For one thing, the growth of your market is likely to be as important as the growth of your share in that market—the idea that a rising tide raises all boats. We are a lot more interested in companies playing in markets that are either big or are growing big because, although you can dominate a niche: (a) it’s hard to dominate; and (b) once you dominate a niche, you are still in a niche. To the extent that you can configure your product or service to play in a space that is itself large and growing, it will be more attractive to an investor than the ability to play in a niche. A related idea is that the growth of the market is a lot easier on you than growing your share. It’s easier when you don’t have to take share from somebody in order to grow, and there is a lot more opportunity for a young struggling company to put down roots.

        Your market growth is in your space, not your sector. Here is a strong piece of advice: Don’t talk to us a lot about your sector; talk to us about your space. For example, “We are making a widget and trade shows use 11 million widgets, and trade shows are growing at 800% a year.” What we care about are where you’re going to sell your widgets, who you’re going to sell them to, how big that market is, and how quickly it’s growing. By the way, personally, I don’t care at all about your market size projections three, four, five years out. Working in the areas that we work in, 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.

        Something else to think about, and this may sound counterintuitive, but it’s very important. If your market is growing quickly, is very disruptive, and there is a lot of turmoil, are you sufficiently well positioned to serve that market? Does your product scale? Does your management team scale? Part of how we decide whether or not a market is attractive is assessing whether or not the product and the management team can accommodate the change that is likely to take place in that market.

        Something tangential, but which may surprise you, is that I believe your market analysis is really your sales forecast. You can’t do one without the other, and, to the extent that you are developing a sales forecast based on market analysis, you’ve got to try to make your assumptions both as realistic and as conservative as possible. We’re all going to build a sales forecast off the analysis, and you might want to consider revisiting your market assumptions once you’ve built your sales forecast. Do a reality check backwards.

        Irrespective of the market analyses techniques you’ll hear about, there is only one way I know to validate a market, and that’s if someone says that they will buy your product. If you are selling product into your market, then your market exists. If you have been unable to sell your product in a period of time that exceeds what ought to be a typical sales cycle—assuming that it was ready to go to market—then something is wrong with your offering. Market validation is made in only one way, and that is by selling product into the marketplace.

        Having said that, let me urge you not to build market forecasts and, consequently, sales projections with the idea that you can or should sell to everybody. Not all sales are equal. Early on, you are principally interested in referenceable customers with the potential for repeat business. I’ve been an entrepreneur myself, and I’m very sensitive to what appears to be the compelling logic behind taking any business you can whenever you can get it, usually because you think money is money and revenues are great. Believe it or not, that is really not the case. As you build your market assessment, one of the things you want to look at is who you ought to be selling to, the product sequencing you ought to be selling them, and the likely sales cycle.

        That leads to one last point I’ll make before turning over the floor, a question we always wrestle with when we talk with entrepreneurs: Is “new” better or worse than “better?” Incrementalism is a viable form of business development, and “newness” is a viable form of business development. They get different places and they encounter and involve greater and different kinds of risks. If you are going to do something new, then you’ve got to figure out why a market is willing to take something new. “New” involves behavioral change on the part of your customers. If you cannot convince your customers to make that change, and I don’t know of any kind of change that is more difficult than behavioral change, then you might want to consider examining “better” versus “new.” Better has certain actual metrics that go with it. Is your product 50% cheaper? Does it run 80% faster? By the way, incrementalism doesn’t mean incremental incrementalism, it means a significant incrementalism. I encourage you to revisit the question because it allows you to look at your market in very different ways.

Mr. Sherman: Excellent. To build on one point Jonathan made, one flaw that I see in a lot of business plans is a lot of fancy market analysis, but not drilling down to the cost to the customer of converting to your new or better solution, as well as a lack of analysis about what it’s going to take in real time and real life for that customer to make the decision. What is the disruption and what is its cost?

        Clara?

clara conti: adapting to market change

I thought I’d start with a little bit of background about ObjectVideo. The company started two years ago under the name of DiamondbackVision, founded by three veterans of the Defense Advanced Research Projects Agency (DARPA). Its original focus was in MPEG-4 streaming media technology, which they realized sometime last year was a dead market for them. The basic competition was Microsoft and Real Networks, whose products were better and free. It was a poor business model to work with.

Mr. Silver: You don’t have to do a lot of market analysis on that.

Ms. Conti: So the company went through a rough patch last year before I came on board. They had to decide what to do with all of their intellectual property. We had some of the best computer vision people around, including the guy who wrote the book on it, known all over the world. We also have about 12 patents and a prototype system. What were we going to do now?

        The company spent a lot of time understanding what they could do with its computer vision technology, which, essentially, identifies objects in video so we can tell the difference between a person and a car and a deer. What can you do once you’re able to do that kind of thing? We realized that there is a lot of value in video surveillance technology that is not being utilized.

        The company hired a consultant, an expert in physical security, and spent three or four months on the road talking to end users and DVR manufacturers and camera companies. We showed them our prototype system and asked, “Would you be interested in this kind of a thing? Can you see it working in your organization or with your product?” We got a lot of positive feedback and decided to move forward with automated video surveillance technology. This was prior to 9/11, so the timing was perfect. We started to build the product, I came on board in the October timeframe, and, by January of this year, we had a prototype system built. Since then we have been demonstrating the system to end users.

        We started a pilot program. Basically, we needed to get feedback from the users on the very first release and decide whether it was something they could utilize within their organizations. Our pilot program helped crystallize where we were going with the product, and, subsequently, we were able to get additional orders. We’ve got some young sales people on our team, and I remind them all the time that it’s not always like this. You don’t always get a product that sells itself or a demonstration system that can build up a lot of enthusiasm. We just happen to be in a space that is getting a lot of acceptance right now and where people have the funds to spend.

        One of our key strategies moving forward with market acceptance is working with the FAA. Many of you know that there is a new organization called the Transportation Security Agency (TSA). We’re working with them in Atlantic City to get FAA approval for our product. That is going to be a very big rubber stamp because we need to be able to install this product in every airport in the country. That is one area in validating our market, getting acceptance and approval.

        The company is now at a point where it’s going to be signing additional customers, so one of the things we are focusing on is what our sales force will look like moving forward. As Jonathan said, it’s not good to be in every single space, and he is right. We are getting a lot of acceptance in aviation and transportation, including working with the New York Port Authority, but there are other areas that we’re probably not going to focus on for the short-term, although there may be a couple of customers initially. The gaming industry is one. There is tremendous potential there, but it’s probably not best for us right now to move in that direction. Our focus has primarily been in the transportation and critical infrastructure space, such as nuclear power plants and things like that.

Mr. Sherman: I’d like to reinforce a key point Clara made, and that is the importance of intellectual property in your company, as well as retooling your business plan and market demands around it. This is a great example. I also want to call your attention to the resource list that Ben and the Netpreneur team have put together. It includes some very good books, and the Porter book is a classic on this topic.

        Paul?

 

[continued]

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