Many corporates are billion dollar entities in stagnation or decline. So they run startup programs to look for the next big thing. But big corporates need big ideas to move the needle. That is why most corporate selection committees focus on market size. They think big market is a prerequisite for big opportunity. They are mistaken. This post will explain why market size is irrelevant and how corporates should be evaluating startups.
Today most corporates have some kind of startup engagement activity. Like outplaced innovation teams, hackathons, innovation garages, and accelerators. And they should. Startups create much of the innovation today and corporates would be foolish not to attempt to leverage it.
The problem is that it’s not working. The initiatives do bring the sense of innovative spirit and fun for the employees involved, but the billion-dollar success stories keep eluding them.
The problem is that many corporates are terrible at assessing startups. And this problem is magnified because the consultants and service providers helping the corporates design and manage these programs are too focused on getting the contract to question anything. Sucking up rarely produce truth.
The fallacy of big markets
Corporates need billion-dollar ideas and this fact makes them focus on startups with big (adjacent) markets. And it makes sense. Big markets are the prerequisite for big business. Unfortunately, this logic is flawed.
The thing is that startups aren’t really businesses. Instead, they are problem-solving entities. And this fact is immensely important when assessing the potential of startups.
Businesses have markets. Startups have niche products that target niche customers with a problem no one has cared to solve before. Per definition, most startups have tiny or even non-existing markets. Like a young startup called Unity in 2005 that made it easy to create games for Apple devices. There was no market because none played games on an Apple device. That was until Apple launched the iPhone. Today Unity Technologies is a unicorn.
Or Trustpilot (an Accelerace alumni company from 2008), that made it easy to review webshops. Their market was non-existing because they had no customers. Only free users. Today Trustpilot has thousands of business customers and raised $150 million in funding.
The thing is that market size is not relevant because the product evolves and the market sentiment changes.
Still, in most selection committees I’m in, the corporate representatives will regard the current product pitched as a fixed value proposition and estimate the potential from that snapshot. It’s a mistake.
How markets emerge over time
The truth is that most startups radically change their product. It happens because startups are founder driven, and founders can enact radical changes at will. To a corporate, sudden and radical product changes is unthinkable. Thus, corporates tend to gravely underestimate the plasticity of startups products and business models.
When the product change, the potential market changes as well. Like when the high-end limousine ordering app Uber added non-luxury cars to their app and became a taxi killer. The limousine market is small. The taxi market is not.
Just like the product can change, so can the market sentiment. It happens if the product has network effects or product consumption is highly observable.
When products have network effects, the product becomes more valuable over time. In the beginning, the product is only valuable to a small group of people. Like the first computers or an early version of the crowdfunding platform Kickstarter. But as more and more people use the products the relevant market increases. And Metcalf law teaches us it can happen very quickly.
In other cases, the market sentiment changes because of trends. If the product is highly observable, it can initiate a change of perception among potential customers that suddenly redefine the market. Like electric vehicles, café latte and CrossFit.
For reasons above, market size is a terrible proxy for potential. And corporates need to unlearn the importance of it.
How to do it right
Instead, corporates must learn to construct a thesis about the future of their industry. The thesis must regard how technologies and trends will influence, reshape or even replace their industry. Once in place, corporate must target ideas and startups within the thesis.
They must learn to resist the temptation of attempting to foresee the potential of the individual startup but instead focus on executing their thesis. In all practicality, this means betting on a lot of teams doing similar things but from different angles.
The selection committee must still regard the potential, but the potential is already built into the thesis. So instead of questioning the market size, the committee members should question how closely the startup fits the thesis.
If telcos had done this in 2011, they might have caught either Line, Snapchat, Viper or WeChat. They all launched their chat apps that year, but telcos were missing a valid thesis on the future of communication. This should be a lesson for all.
- Most corporates look for billion dollar ideas.
- When assessing startups, corporates question market size.
- Market size is a bad proxy for potential.
- Corporates need to create a valid thesis about the future of their industry and start targeting a large number of startups within this thesis.