Editor’s Note: This post was originally published on Seattle 2.0, and imported to GeekWire as part of our acquisition of Seattle 2.0 and its archival content. For more background, see this post.

By Gerry Langeler

So, previously, we’ve talked about the first two risks VCs evaluate when looking at a new deal (People & Product). Now, on to risk number three: Market.
 
In many ways, this can be the toughest to figure out, since so often start-ups are targeting markets that don’t exist yet, or are bringing products to market that could potentially change the dynamics in existing markets.   In fact, this is the question “lisafernow” asked after my last post.  “What evidence do you have that your prospective consumer really needs and will buy what you’re offering?”  This is essentially a test of customer readiness.
 
Frankly, we put about zero weight on market research reports from the big consulting and pundit firms.  They are remarkably self-serving, are usually overly optimistic as to timing, and can’t foretell the future any better than the rest of us. So, when it comes to market analysis we go about this in the most basic, bottom’s-up way we can. We ask the customer! 
 
One of the most surprising things I’ve found over the years is how willing complete strangers are to take our calls, and share in-depth insights into their businesses, their “care-abouts” and their priorities. This goes all the way back to my days as an entrepreneur, when we emulated vaudeville and traveled the country asking these questions face-to face of potential customers.  We started with those not quite in the mainstream and worked our way to “Vegas,” which is our case was Motorola .  By the time we got there, we’d gotten feedback to our initial concept and adjusted accordingly, our “act” was polished and so when we presented our product concept to MOT they said, essentially, “If you build it, we will come.” Then we went back and asked our engineering team if they could build it.
 
As potential investors, we maintain a cadre of contacts in the industries we serve, and so when an entrepreneur gets our attention, we get on the phone and ask those key industry players to evaluate the idea.  If we don’t feel confident explaining the product ourselves, we’ll put the start-up team on the phone and play fly-on-the-wall while we listen to the pitch, and the questions that are asked.  The amazing thing is, it doesn’t take too many of these calls to pick out a pattern.  Some academics found years ago that somewhere about 20 you’ve hit diminishing returns.   We often seem to get there at about 10.
 
The most important thing you can do is make these calls before we do.   What you never want to have happen is for us to have more customer insight than you do. So, before you darken our doors, darken the doors of your prospects and be prepared to share that anecdotal insight with us.  We’ll still do our own, but you’ll have started out on the right foot.
 
Of course, sometimes if you are at the leading edge of technology,  you are explaining a product the customer can’t even fathom.  These are the really tough ones.  On our end, we do hobnob with some “futurist” type folks and we’ll certainly bring them into the mix.  Our key issue on these “change the world” deals: is the product a nice-to-have or a have-to-have.  The difference can be subtle, or time driven.  The initial cell phones were nice-to-have, because they were big, bulky, expensive and not too many people had them.  But once they hit the right form factor, cost and penetration, they became have-to-have’s.  The problem for VCs is we usually can’t wait long enough for a nice-to-have to become a have-to-have.  And when we are wrong (which is often) it is because we didn’t evaluate properly the fact that technology moves faster than people do. 
 
Another major issue besides customer readiness is market scale.  I wrote some about that in my first post on Seattle 2.0, so I’ll just refer you to that.  The key issue is if you are successful, can your company grow to a scale whereby our economics work?  There are many fine companies that create products customers are ready to buy, that are have-to-haves, but there just aren’t enough of those customers, or they aren’t willing to pay enough, to grow a major enterprise.
 
One additional thought about markets: I’ve seen thousands of product feature comparison matrices in start-up presentations.  But not once have I ever seen a company comparison matrix.  Yes, your new product may be better in certain ways, but what about your distribution channel? What are the switching costs for customers who have solved your problem in some way to date? What is the average evaluation cycle for new products in this market? How important to your customer is eco-system integration?  Do those big, established competitors have relationships with your prospects that transcend a simple product feature decision?  When they FUD you for being a small struggling start-up, how will you counter that? (a strategic partnership, perhaps?)  When they cut price to keep you at bay, how will you respond?
 
Market entry against entrenched competitors is very, very hard. Relying on product features alone to carry the day is very, very shortsighted.
 
Next time, the fourth (forgotten) risk (by entrepreneurs): Financing
 
 
 
 
 
 
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