Thursday, February 15, 2007

Isolating Causality: Bad Market or Bad Company

Cervantes famously once said that, "proverbs are short sentences drawn from long experience." In venture capital, one often hears industry veterans say something like, "bad markets make for bad investments."

The importance of the growth, health, and timing of a market to a start-up's postive outcome is both vital and well-known. Cliched and yet, as with many proverbs, true.

When a company is behind plan, an investor must ask is it the market or is it the company? A frequent challenge for an investor is to isolate causality in a given investment. Isolating market (exogenous) or company (endogenous) causality is vital with respect to the appropriate remedial action. If it is the market, there is little chance that more money or new management will change the outcome. If it is the company, additional resources (both capital and human) may indeed impact the outcome and be reasonable.

I have seen some of the smartest people work the longest hours, code round the clock, make the most sales calls, and reap no reward. When the market does not care about your solution, or, worse yet, does not exist, no amount of management talent, hard work, or capital can remedy the situation.

If the market is the challenge, additional investment is a dangerous example of escalation of commitment that will result in capital loss. Often the signals as to the health of the market are ambiguous - are the data points in question indicative of the market's development and health or more random and indeterminant?

I have observed several key indicators that help identify market failure and that suggest further investment is a challenge:

  1. 3 VP sales...
    1. when the plan is missed, the favorite scape goat is the VP Sales.
    2. A single misfire may be legitimate, but every time that I have seen multiple VP Sales fired in a short amount of time the core problem is not sales management but the fact the market does not care nor exist.
    1. VP Sales turnover is a classic red herring.
  2. no competitors
    1. company's operating in non-existent markets are often unable to point to direct competitiors.
    2. While competitors may exist on the margin, the names vary from account to account and no clear enemy, or set of enemies, emerges. Lack of competition is a sure sign the market does not care.
  3. no RFPs
    1. no customers are soliciting the company and there is a dearth of inbound requests for proposals.
  4. no repeatability in customer deployments
    1. while good teams can generally get 2-3 customers, an early warning sign of a bad market is that there is no consistency in customer need, no common abstraction of use case, and no way to build a repeatable marketing, sales, and product positioning against a common set of needs.
  5. no partners
    1. companies in dead markets cannot explain where they sit in the market ecosystem and are characterized by no legitimate partner activity
  6. no energy
    1. the company culture begins to calcify and visitors can feel the lack of energy and nothing appears to change month to month - ie it's like groundhog day...
  7. no one knows what the company does
    1. companies that suffer from the above challenges are often the ones that cannot simply and clearly explain what they do. after 45-60 seconds of buzzwords, the listener is left bereft of any sense of clarity and their eyes begin to glaze over.
    2. when i first started in vc, i remember thinking..."wow, these guys are so smart, i have no idea what they just said." after a few years, i began to realize that if i have had no idea, then i could be damn sure the customers wouldn't either.
  8. thrashing
    1. the company begins to thrash, with constant changes to the positioning, core problem being solved, and the productand there is no longer a core mission or center of gravity
    2. tempers fray as the lack of common mission leads to each executive articulating their own and failing to agree on a direction
  9. companies that are in healthy markets close enough business to:
    1. develop a clear value proposition
    2. build repeatable marketing, sales, and delivery models around common uses cases
    3. know their top 2-3 competitors cold and see them in every account
    4. are solicited for business
    5. have real, active partners engaged in common customer accounts
    6. have highly energetic cultures where the changes month to month are signficant
    7. can explain what they do so that almost anyone can understand
    8. share a common mission that everyone in the company can articulate
If the market is dead, there is no hope. More money, yet another VP sales...will accomplish very little save to ensure further capital loss and wasted effort.

If the market is healthy, then there may in deed be logic in additional funding and new management. Understanding which of the two situations exists can help avoid unnecessary pain and capital loss.

All start-ups iterate their product and value proposition as they hone in on the eventual mission...the challenge is when to know if the challenges are part of the natural evolution or a symptom of operating in a market vacuum.


  1. Anonymous8:06 AM

    One question - what if you have a very large number of very small competitors? Looking at our experience, we look good for all the check points under 9 except for 3 - (know top 2-3 competitors).

    We've deliberately built a structure to allow us to cost effectively enter and (we believe) dominate a market that for technical reasons is currently structurally fragmented.

    Obviously the risk is that we have *not* found a way to overcome structural fragmentation in our market and will end up as another small player in a big space, but it will be interesting to see how that plays out.

  2. An absolute classic posting for anybody that has been in a start up, or worked around them. I hope this does the rounds. If I could be so bold as to add one more item: "If you cannot clearly state what customer pain your product or service addresses"....

  3. Outstanding post. Will, how would you contrast the traditional "first mover advantage" sought by many new companies vs. the perils of building a business with no market (or one that doesn't care)? Where is that line?

  4. If the market doesn't care, sometimes it is necessary to educate it. Jobs had to do that with the personal computer. However, that's easier done by a larger company with deeper pockets, which is why the PC market grew so much more quickly after IBM got into it, and why Apple still struggles for share of that market.

  5. Fantastic post, and it meshes very closely which my experiences. I have a follow-up question about timing. Many of these symptoms are true early in the life cycle and start reducing over time. At what point do you need to be worried? A year after product launch? Two years?

  6. Quite rightly, people have emailed me or posted comments asking when to start worrying? In new markets, it may not be immediately obvious if there is an issue.

    In my experience, the time to start worrying is roughly one year after the product has been in the market (ie GA). By that time, there will have been a sufficient number of sales calls, market tests of need and fit, etc and by then company's hitting a healthy market will be beginning to see good customer, parnter, PR, prospective employee, etc traction.

  7. Anonymous6:48 AM

    Hi Will.

    Having gone through half a dozen start-up initiatives myself, I would add a couple other comments:

    1. Knowing your competitors must go far beyond knowing pricing, features, and customer base. Classical SWOT exercise does not cut it. You have to figure out your competitor's strategy or you're "toast." I have seen start-ups blown out of the water by failing to align their early market advantage with primary target market. A recent notable IPO example is Acme Packet. Dozens of companies shaped and created the market, yet Acme (…a late entrant) capitalized on the opportunity. With a management of entirely MBAs, I am sure they saw an obvious opportunity.
    2. You can have a dead or radically declining market and still be able to capture sufficient sources of competitive to make a decent business mode. Good example is Skype.

    I agree with your overall posting. Start-ups get too dependent on technology advantage, innovation, intellectual property, rock star developers, and their own Kool-aid. One of the biggest deficiencies I have seen at both start-ups and even multi nationals is sound strategic alignment, some real-time BSC type mechanism, and closed loop process. Too many start-ups seem to be afraid of the keeping things simple and asking some of the fundamental questions ahead of coding.

    Kameran Ahari