I l l u s t r a t I o n b y h a n k o s u n a

revenues and headcount usually grow in a one-to-one ratio.

The wrong way to think about a market opportunity is to describe a huge industry (like U.S. healthcare or business intelligence software) and argue that the startup needs to get only, say, half of 1% in order to be viable. Size alone does not make a market attractive. Structural factors are more important. Then the entrepreneurs need to convince investors of their particular advantages over competitors, and how their firms will reach customers and capitalize on those advantages. High failure rates suggest the most likely percentage a startup will get of any market is zero!

3. A Compelling new
Product or service

A compelling product or service ap-
pears as a “must-have” to a specific
type of customer. Some entrepreneurs
have a deep familiarity with a market
customer), they must be structurally
attractive. This means there should
be high enough entry barriers to keep
out new competitors once you enter.
Rivalry should not devolve into cut-
throat price wars because of too many
competitors or one firm that gives
away the product for free. Neither buy-
er power nor supplier power should
be strong enough to negotiate prices
downward too easily. There should
not be good substitutes for the basic
product or service. 4 These “five forces”
were made famous by Harvard profes-
sor Michael Porter. Many startups also
require “complementary” products
(such as software applications for a
new hardware platform) or infrastruc-
ture elements (such as Wi-Fi availabil-
ity)—what Andy Grove of Intel called
the “sixth” industry force. 3 If needed,
these additional factors must also be
available for a startup to succeed.

Horizontally packaged Software as
a Service (SaaS) offerings can be rela-
tively easy to scale up, but they usually
have high customer churn, high costs
of customer acquisition, and small
monthly payments from customers
who can easily cancel. As a result,
these businesses can take many years
and lots of funding to become profit-
able. Even Salesforce.com, a SaaS pio-
neer, needed vast amounts of venture
capital and many years of effort before
it created a large installed base, and
it still has difficulty earning a profit.
Horizontal markets also attract a lot of
competition because they are so large.
A startup can spend all its money try-
ing to be everything to every customer
in such markets (see “Beware the Lure
of the Horizontal,” Communications,
July 2003). Professional service firms
targeted at specialized vertical seg-
ments (for example, tailoring enter-
prise software products for financial
services or the retail industry) are eas-
ier to establish and run at a profit, but
they can be difficult to scale because