Vertical Markets 2: Customer/Market Risk versus Invention Risk

This post makes sense when you read the previous vertical markets post first.

Customer/Market Risk Versus Invention Risk
One day I was having lunch with a VC sharing what I learned from my students. “Steve,” he said, “you’re missing the most interesting part of vertical markets.  Our firm has a portfolio of companies across a broad range of markets and the way we look at it is pretty simple – the deals fall into two types: those with customer/market risk and those with invention risk.”

Markets with Invention Risk are those where it’s questionable whether the technology can ever be made to work – but if it does customers will beat a path to the company’s door. 

Markets with Customer/Market Risk are those where the unknown is whether customers will adopt the product.

Based on this insight, I updated my earlier diagram to look like this.  (The line is just a first approximation, nothing hard and fast about it.)

Invention Risk

Market Risk vs. Invention Risk - Click to Enlarge

For companies building web-based products, product development may be difficult, but with enough time and iteration engineering will eventually converge on a solution and ship a functional product – it’s engineering, not invention. The real risk in markets like Web 2.0 is whether there is a customer and market for the product as spec’d.  In these markets it’s all about customer/market risk.

There’s a whole other set of markets where the risk is truly invention. These are markets where it may take 5 or even 10 years to get a product out of the lab and into production. (Whether it will eventually work no one knows, but the payoff could be so large, investors will take the risk.)  If the product does work, and say we’ve developed a drug that cures a type of cancer, your only problem is how big is the licensing deal going to be – not about whether there will be customers. In these markets it’s all about invention risk.

A third type of market has both invention and market risk.  For example, complex new semiconductor architectures, (i.e. a new type of graphics architecture, or a new communications chip architecture) mean you may not know if the chip performs as well as you thought until you get first silicon.  But then, because there might be entrenched competitors and your concept is radically new, you still need to invest in the customer development process to learn how to get design wins from companies who may be happy with their existing vendors.

The implications for entrepreneurs is that each of these (market risk versus invention risk,) require radically different financing models, a different type of venture investor, different timing for hiring sales and marketing, etc.

I now advise entrepreneurs to add these questions to their checklist when they start a company:

  • Am I in a “customer/market risk” company?
  • Am I in a company with “invention risk?
  • Or does my company have both types of risk?
  • How would that change my company strategy?

We’ll talk about how to reduce risk in each type of market in the next post.

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7 Responses

  1. Interesting post Steve. I’ve heard investors ask about sustainable technical differentiation for companies that you put on the customer/market risk end of the scale. Personally, I think that customer acquisition, brand, reputation, etc., are much more differentiating than technology. Technology can often be dealt with through a press release (at least perception). What is your perspective on ‘sustainable technical differentiation’ for customer/market risk companies? And if you agree, how would you address this question when asked?

    • David,
      Technical differentiation is a business school checklist. It’s something VC’s can ask about, rationally analyze and feel comfortable if you can articulate a defensible technical and patent strategy. In contrast, customer acquisition, brand, reputation, etc. are much softer and much, much harder to measure (or believe) in a very early stage startup. Particularly if the VC’s don’t know you or your team and/or you lack a reputation as fearsome and successful marketeers.

      If you think your differentiation is going to be on the sales and marketing side, then look in a mirror and ask yourself, “would someone about to give a company a check for a couple of million dollars believe a sales and marketing differentiation story from this team?” Why?

      steve

  2. Hi Steve,

    Thank you for this really great blog. I have been following for about a month, and always look forward to the next post.

    Regards,
    Brian

  3. The question basically boils down to “how do you defend yur business – through marketing, technology, both or neither?”. Not only one needs to ask this qestion, but also answer it honestly and fully appreciate the outcome. If you can’t find a sustainable advantage this means that competition will likely drive the prices down and make your life miserable with below-substinence income. A good case study here is most iPhone apps.

    In this situation one must make a choice:
    1. find a different business (seriously) or
    2. be prepared to be the most lean business in the sector (which is only possible where economy of scale does not create huge entry barriers). In particular, you will likely have to do without venture funding becuase it is costly.

    I think it would make a great future post – a list of potnetial non-technical advantages one could build out to defend their business.

    I suggest first item on the list – most companies are really bad with customer service, so building the support feedback loop in from the start will achieve both reduction in support cost through continous improvement and improve experience of those who still have to ask for support. Holding founders and engineers feet to the fire will inevitably remove the rough edges from the the product, imporving bounce rates of newcomers and loyalty of established users. These two numbers have direct impact on revenue and financial health.

  4. The customer/market risk situation occurs because the vendor is skipping the early markets and going straight into the late market. SaaS is automatically a late market. Consumer is automatically a late market. Innovation in either of those two spaces should only be done if the market exists.

    In the early market customer/market risk is mitigated by strategies that assume no market exists.

    The innovation risk situation occurs because the vendor proceeds with commercialization strategies that assume markets exist.

    The real classifier here is discontinuous or radical innovation or not. It is a choice, a commitment, not a reality of the innovation itself. It is a go to market choice. The underlying innovation will be divergent or convergent. It is only in the marketing view where the distinction between discontinuous becomes the critical issue.

    Going to SaaS directly leaves money on the table. But, these days being a product isn’t cool, so we leave money on the table. Yet, going through the technology adoption process isn’t about money alone. It is about developing your product, market, and company in a balanced manner. VC money usually induces imbalances, which kill the company soon enough.

    I appreciate the categorization scheme, more to integrate into a bigger and better picture.

  5. [...] this post Steve Blank urges startup founders to consider what kind of risk they face if they want to be [...]

  6. [...] long to get the important/risky pieces of my product out the door. I don’t really have much product risk, but for those features that may not work, (such as my bayesian filter), it’s important to [...]

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