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Shrinking Markets: Earning a Dollar by Taking Five from your Competitors

09 Jul

Product-Market fit is the primary element in the success of a startup. Software legend Marc Andreessen defined the product-market fit concept in his great blog post: “The only thing that matters” on which he states that creating a product that can fit into a great market is often more critical than creating a great product or assembling a great team for a market that is not necessarily ready.

From the different types of product-market fit models one of my favorites are companies that have the ability of “shrinking the market”. In basic terms, these are products that earn a dollar by taking five from their competitors. Market shrinking products have the capability of disrupting established market segments established by other vendors. We see it all the time with companies like Salesforce.com, Dropbox or Spotify which have started as incumbents in well-established large markets and have been able to become the dominant players by shrinking-first and then expanding the market.

The beautiful thing about product that have the ability of shrinking the market is not only that they automatically achieve product-market fit but also that they growth comes at the expense of their competitors. In the initial days, every revenue dollar earned by Salesforce.com didn’t go to the established expensive players such as SAP, Siebel, Oracle or PeopleSoft. By shrinking the market, disruptive products are able to force the bigger players in the space to compete in a smaller market that is typically more favorable to the new players. Similarly, if  a product or company is able to shrink the market and shift it in their favor, they will have the potential of capturing a bigger portion of the smaller market compared to their competitors.

Let’s illustrate this concept with an example.

Suppose that a startup is building a product competing in a well-established $20B market. The size of that market has been established by a set of vendors that charge a significant price for their solutions. Let’s say that the average deal in the space is typically X dollars. Our startup offers a simpler and technologically superior alternative to the competitors which, priced at X-M dollars, becomes accessible to companies that couldn’t afford the previous solution. Looking at those factors, we can initially think that our startup can capture $500M of the $20B market. However, if the technical superiority and pricing model of the product causes the market to shrink to let’s say $10B, our startup has the potential of earning 20% ($2B) of that market.

The interesting thing is that while a disruptive product can initially shrink the overall market size is will also expand the space based on the number of users or customers which can translate into a market expansion after certain point. The following figure illustrates this concept.

Bottom line, as a startup, if you are playing in a well-established market with a well-defined set of vendors and technologies, carefully evaluate whether your product has the potential of shrinking the market. If it does, you can be on your way to disrupt an entire industry segment.

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Posted by on July 9, 2012 in Uncategorized

 

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