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.)
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.
