Forget Huge Markets; Your Startup Needs to Dominate a Niche to Be Successful | by DC Palter | Nov, 2021

The leader in any category can make huge margins. Everyone else loses money

Can You Spot the Niches? Image by Igor Ovsyannykov on Pixabay

Trick question: which is a better business plan:

If you answered #1, you’ll have a hard time attracting investors.

Simple math says #1 is worth $1 billion while #2 is only $300 million. But building a startup is not a math problem, and nothing is ever simple.

As a startup investor, I see hundreds of pitch decks. The ones that show the company aiming to take a tiny sliver of a huge market do not get funded.

There are 3 reasons why targeting a small sliver of a huge market is a bad business plan.

First, every investor has it drilled into their head a maxim of Business 101: the leader in any market can make huge margins. There’s room for a second player to do reasonably well, too. Think Coke and Pepsi. Android and iPhone. Nike and Adidas.

After the market leader and a follower, the business is tough for the rest. Player #3 might break even. Everyone else loses money.

Whether this maxim holds true in every market doesn’t matter. Investors believe it’s true. Nobody wants to invest in Player #25, no matter how enormous the market.

Second, the conventional wisdom about profitability being highly correlated to market position isn’t just myth. The market leader has so many advantages that they’re nearly impossible to compete with head-on.

Imagine I invent a new, better tasting cola and decide to take on Coke. Right, good luck with that.

The engineer in me says that if I invent a better mousetrap, or a tastier cola, customers will flock to me in a kind of divine revelation. The engineer in me is a clueless dreamer who doesn’t understand the challenges of building a business.

I can’t match Coke on price because their volumes are a million times larger. They have volume deals with all their suppliers and control over their highly optimized factories.

Instead, I have to compete with a higher-priced, better tasting product. That’s tough, too. Coke has billions to spend on advertising to convince the world their product is better. Or cooler. Or more refreshing.

The grocery stores are already stocked to the rafters with a dozen different flavors of Coke. The last thing they want is yet another cola.

All I’ve got is me and my website, and maybe if I work hard, I can convince the local gourmet shop to give me a tiny tasting table for a couple hours.

Through word of mouth and expert use of social media, I might be able to eke out a few sales. The Coke executives in Atlanta are hardly quaking in their boots.

In the end, here’s the problem: to compete head-on with Coke, I have to spend as much as them on advertising and distribution, and probably twice as much on production. With a tiny sales volume, it’s a foolproof recipe for losing money.

In other words, with the same costs, the market leader with the biggest volume is highly profitable and #2 can do okay. Everyone else (except a store brand) struggles to keep the production lines running.

Third, the goal of a venture-based startup is to get acquired (or grow big enough to go public in an IPO). Wil Coke acquire my business to get their sticky hands on my secret formula? Ha! Will Nestle buy my business to take on Coke in a battle of Godzilla vs. Mothra? Double ha! If they can’t acquire the market leader, they might acquire #2 or #3. Everyone else is too small to bother with.


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