A Key to Diligence from an Entrepreneur’s POV : Know Thy Numbers

Brad Feld had a useful piece on the concept of Total Addressable Market (TAM) when speaking to investors.  Brad is “in the ‘measuring TAM doesn’t matter at all’ camp, especially in an early stage company in an emerging market.”  I understand his perspective, and in general, there’s a lot about his approach on this point that I’d agree with completely.

I think, though, that it is very important for an entrepreneur (and investor for that matter) to have a loose quantitative model in his head around how his business would work, the core markets, drivers, etc.  I call this the “Know Thy Numbers,” and I think it’s an imperative.  If done well, from my POV, even in an emerging market, you should be able to gain a sense of what the total market could be, how it might develop, key drivers, and ultimately, a realistic sense that the total market opportunity is within a zone of reality. 

Here’s a cautionary tale that illustrated to me how vital this is.  Recently, I was helping a venture capitalist look at a company focused on a segment I knew pretty well.  Without getting into any details of the business or value proposition, it became clear to me that someone had communicated an installed base (IB) for an existing product that was an order of magnitude higher than reality.  This IB assumption was pretty important to the attractiveness of the business plan.  Though someone may have had an analyst report stating this number was true, it was impossible doing a basic analysis of the market dynamics to come to a number anywhere close. 

Instead of finding analyst reports on some highly speculative emerging markets, I recommend to entrepreneurs you gain a solid understanding of the key existing market numbers that are relevant to what you do. 

Example, if you’re in the mobile space, start with how many phones there are worldwide – an IB something north of 3B and growing, with shipments of some other large number.  If you’re in the PC / internet software market, you can find out pretty easily the IB and shipments, and again have facility with those.  If you’re in SNS, well you have pretty good stats on FBK to look at. 

It’s important that from these numbers, you have a model in your head for how your business might someday fit into the world.  This exercise should help you expose holes in assumptions—if for example your business require something where you need to have an average of say, 3 PCs per household in the US, or you need 1 trillion accounts on a SNS you’re building, well then that’s a problem.  Things like this can get exposed clearly for people that take time to really get the core market data under their fingernails. 

We once did an exercise on this at MSFT for a meeting with Steve Ballmer.  We were getting ready for an Annual Strategy Review with him, and the evening before the final presentation, I was reviewing notes of a chat he’d given on what he wanted to hear from different business group leaders.  One point he really hammered on was along these lines: have a model in your head of how your business works and what needs to happen for you to be able to hit your numbers. 

It was a good catch, as we didn’t have it at this point in our prep, really.  Also, it was an easy fix, as at this point our finance people and myself (who was building the presentation) had the key numbers in our head.  We realized that it’d be pretty easy to build a stacked bar chart of what it was we thought we’d do in the next FY, and what had to happen for us to get there.  It took about 30 minutes the night before to build a slide that was a real hit.  Without giving away the business or the numbers involved, etc.  we basically built a chart that said,

next FY, we’re going to grow revenue by XX%

To do that, the following has to happen:

  • Market grows X%
  • We take Y points share from competition
  • We shift Z points of our product mix from lower rev/unit to higher rev/unit
  • We increase annuity mix by Q points, which has downward pressure in next FY, but helps us long term
  • Channel shift will lead to P points of revenue growth  Etc. 

That kind of model is one that most businesses—even in emerging markets—can come up with.   Even if you can’t, its useful to spend time trying to get your head wrapped around a quantifiable model for how your market works.  It’s not a TAM analysis, it’s a simple business modelling exercise that I recommend highly.

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