Markets are Fantasy; Customers are Real

I just read a great post by Jason Cohen entitled "4 ways to get automatically rejected by an angel investor."  In it, he exposes the ridiculousness of the five year projection that is a staple of virtually every startup business plan.  Experienced entrepreneurs hate wasting their time putting together something they know experienced VCs know is bullsh** and will discount anyways.  So why does anyone bother?  Heck, even in established, stable, public companies, no one believes anything past year 3!

But absurd as this is, there is even one bigger fantasy embedded in most business plans that makes the five year projection look like a model of sensibility.

The market size estimate.

Specifically, the total available market (TAM) size usually found in the "market opportunity" section.

As a marketeer, it has always baffled me as to the weight people place on the TAM in a startup's business plan, given how easy it is to manipulate market data.  Emergent markets by nature are typically a coalescence of adjacent fringe segments of larger existing markets.  Depending on the assumptions used to slice off segments, market researchers can cobble together anything they like.  Don't believe me?  Just tell me what size market you want and I can give it to you (see link here).

So what's the point?

In spite of this flaw, there are a few good reasons to have the TAM in the plan, provided one does not over read the "data".  Unfortunately, the five year projection and the TAM are usually the only two places in the plan that have numbers upon which financially oriented, data driven people can seize.  But numbers can imply a false sense of tangibility and precision (i.e. that $1.255 billion dollar can't just be pulled out of thin air, right?  Actually, yes it can.).  So where is the TAM useful?

• Starting benchmark and rough sanity check that the market is not too small - A TAM provides some level of benchmark for where in the market a startup is playing.  But we're talking order of magnitude level precision here (i.e. tiny, small, medium, large) at best.  It is useful to know if you are playing in a $10 million niche or $500 million dollar market. But whether the market is $750 million or $1.2 billion in size is meaningless.  Both are large.
• Market growth rate - Not how big it is, but how fast it's growing. You do want to know if you are playing into a stable or a rapid growth market.
• TAM segmentation and relative size of segments - Nothing will communicate faster how well a startup understands its target customers and subsequent product/market fit than the way the entrepreneur segments the market.  If you have a $1 billion market but can't talk about the niche segments that make up that market, you don't understand it well enough.  There is no such thing as a billion dollar single segment market (unless -perhaps - you are selling aircraft, commercial real estate, or some other market where your product has an average unit selling price >$100 million.)

Unfortunately, mandated inclusion of a TAM too often stems from bad reasons including:

• Test of the startup team's ability - I've heard some VCs say that even though they don't believe the numbers, they view the business plan as a test of the team's ability to _(fill in the blank)_ (plan, execute, ?, etc.). Absurd.  Run from this kind of VC; they will constantly be looking for pseudo-signals as a surrogate for evaluating real progress.
• As an indicator of the entrepreneur's thinking and starting point for discussion -  Is the entrepreneur thinking at the appropriate level of scale?  How is he/she thinking about the market?  Ok, maybe this is legitimate, but I would argue that this is not the best way to go about this.

So if the TAM is at best of limited utility in evaluating the market opportunity and a lousy surrogate for team performance, is there anything better?  Yes.

• Focus on customers not markets -  Customer are the quirky people who actually buy stuff.  They have likes, dislikes, and are not always irrational.  They have objections that have to be overcome.  They can be fickle or loyal, stingy or generous depending on how well your product resonates with their needs.  Markets are an abstraction.
• Focus on customer acquisition and retention metrics - These are things like product adoption rate, length of sales cycle, funnel conversion rates, repeat trial %, cost of acquisition, etc. or whatever other meaningful metric demonstrates that you have achieved product/market fit and a replicable sales model.
• A "lessons learned" based pitch - I would argue that listening to a team present what they've actually learned in the process of developing a replicable business model, acquiring actual paying customers, and solving problems are a far more effective basis for discussion as well as a better signal of the team's thinking, ability to execute, perseverance, resiliency, and overall ability to build a business than putting together some abstract "make work" TAM estimate.

Beware of five year revenue projections extrapolated from TAM estimates.