August 7, 2011

One of the powerful elements of the internet is the amazing efficiency through which commerce, advertising, and information flow can be facilitated. As a result, many successful companies on the web have been ones that have significantly shrunk markets. Josh Kopelman was one of the first to really articulate this investment thesis, and his incredible success as an entrepreneur and investor speaks for itself.  He blogged about the concept here.

However, I”m starting to develop an opposite paradigm around expanding markets.  Whereas companies that shrink markets take $5 in revenue from competitors for every $1 they earn, I think companies that expand markets create $5 in revenue for every $1 their competitors used to earn.

This happens when product or marketing innovations turn non-consumers into consumers.  Much like what Clay Christensen often describes when he talks about disruptive innovation.  VC’s and entrepreneurs often miss these opportunities because it doesn’t lend itself to good top-down market size analysis.  Usually, VC’s want to see a $1B market, so that if you assume 10% market share, a startup could conceivably achieve $100M in revenue.  If you are shrinking a market, the market better be $10B+, so that the shrunken market can be $1B+

But this assumes an existing large market from which one is stealing share.  But most of the really disruptive technology companies created or expanded markets.  Search marketing was not an established market at the time, and even though Google stole share from direct mail or classifieds, they definitely expanded those markets significantly overall.  The same thing is true for Zynga – the dollars flowing into virtual goods for their games may steal some share from EA or even old fashioned board games, but the company has expanded gaming much more broadly.

There are non-tech examples as well.  There was a time when the wine industry was much smaller, much less global, and much less accessible.  It was intimidating for the average consumer to purchase wine for fear that the quality would be terrible and they would look stupid.  But modern growing techniques has reduced some of the variability in the product, and vineyards like YellowTail marketed products that were accessible to the masses.

So, we often think about other similar markets where mainstream nonconsumption might exist. You might also call it democratization of markets that previously had consumption concentrated only in the most affluent buyers.  That’s part of the thesis around our investments in TurningArt and Boundless Learning. Also, often, markets that are shrunk are then later expanded because the company that has done the shrinking gets such significant market share and new opportunities are made available.

The balance of this strategy is that we are probably moving into an economic period of weaker consumption broadly. It’s something that gives me pause, but I think the promise of expanding or democratizing markets will continue to hold.

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