How to analyze a business opportunity
Anyone who aspires to entrepreneurship spends a lot of time thinking about ideas. Let’s say you’re good at coming up with ideas. Maybe you’ve read James Altucher’s thoughts on becoming an “idea machine” and taken it to heart. At any given point, you can look around and generate ideas (some of them absurd) on how to improve the experiences and processes you see unfolding around you. Cool.
At some point, you’ll want to filter these ideas. You’ll want to decide which ones are worth taking a few first steps on, and which are better left on the notepad. Altucher’s first pass at filtering ideas is “Do a million other people have this same problem?” and that’s clever - a simple yet informative heuristic. At some point, however, you’ll want to analyze your idea at a higher resolution.
Here are a few steps to do just that. I’ll also use these steps to analyze an idea a few friends and I ran with a couple years ago - developing an inexpensive smart outlet.
Start with the user
Before anything else, think about your problem statement. How is it phrased? Are you defining the problem you want to solve in terms of adding value to someone's work or life?
Every business is, at a fundamental level, solving a problem someone has. Google's core business selling ads solves a problem businesses large and small have - "How can I advertise my product or service to the right people?" Amazon's Kindle - "How can I have a variety of reading material at my fingertips without having to lug around a bag full of books?" The folks at Samsara dived deep into the world of industrial sensing and came across a problem - "How can I monitor my equipment and operations more carefully without huge capital cost?"
In the design thinking process, we encapsulate this user-centric way of looking at a problem in the Point of View statement (or simply "the POV" for short).
This may sound basic, but it's easy to wander away from a core POV over time. Or, if your project stems from a technical investigation, you may never have considered the core user need driving your work.
For example, a few years ago a couple friends and I were working on Smartlett - an inexpensive smart outlet. The project started as a technical investigation into the landscape of home networking solutions - WiFi, Bluetooth, Zigbee, etc. At some point I realized that the smart home gadgets using these various interfaces - like smart outlets and light switches - were expensive, easily 50-100 dollars apiece. At that kind of cost, you could never realistically purchase enough to accomplish their intended purpose - like monitoring and automating the energy consumption of your home. We figured we could do one for much cheaper, and so we got to building.
The problem - our core problem statement was always "inexpensive smart outlet" instead of "generate actionable insights into home energy usage" or "eliminate extra energy cost due to standby power from smart devices." If we had rephrased our marching orders, we should have thought more broadly about potential solutions to the problem, and possibly realized that the issue of standby power isn't necessarily a very compelling problem one to begin with.
Now your idea has passed the first hurdle. The second question to ask is - is my idea strategically sound? There are a few core tenets to strategically evaluating an idea, which I pull from the first few elements of my Framework for Strategic Thinking. To recap, they are:
- Am I focused on a particular market segment, and carrying out corresponding activities that differ meaningfully from those of my competition? (Porter, What is Strategy?)
- Are there any other major strategic forces that might damage my business? (Porter, The Five Competitive Forces That Shape Strategy)
- Are there any major hurdles in the ecosystem I would need for my idea to be successful? (Adner, Match Your Innovation Strategy to Your Innovation Ecosystem)
If your idea is focused on solving a problem for a specific group of underserved people, you've got a good shot at getting a strong toehold with that market. Otherwise, you run the risk of getting lost in the noise of similar offerings. Likewise, you'll want to consider the other forces that you could hinder your incipient business. Are there barriers to entry in your market? Do buyers have many other possible solutions to the problem you're trying to solve? Are there other supporting products, services, or partners you would need on board for your solution to succeed? Etc. These three articles will help you think through your market and strategy at a high level.
We did consider these during our Smartlett project, but perhaps not as well as we should have. We thought that making an inexpensive smart outlet gave us a well-differentiated positioning. We could go after frugal households interested in lowering their energy bill who would not usually spend large chunks of money on tech gadgets. Of course, there are some problems here. The people most likely to have many smart gadgets that use up standby power are the kind of people who spend money on tech gadgets in the first place. Additionally, a major part of the ecosystem around outlets and light switches is electricians (installers) and home builders. Electricians are expensive, and hiring one to install 10 or 20 smart outlets could easily add hundreds of dollars to the total upfront cost of our solution. And homebuilders tend to be disinterested in installing new gadgets in their homes until they are well established. These problems might not have been insurmountable, but nor were they trivial.
If your idea is user-defined and strategically sound, it's probably time to think about the financial opportunity in play here. After all, if only a dozen people would benefit from this, you (probably) can't build a business around it.
A good place to start with evaluating the size of your opportunity is with an evaluation of market size. We can break our market size into three levels - the Total Available Market (TAM), the Serviceable Available Market (SAM), and the Serviceable Obtainable Market (SOM).
Renee DiResta's book The Hardware Startup summarizes these terms well. Paraphrased slightly:
TAM is an estimate of the maximum potential revenue opportunity for a given product or service.
SAM is the customers whose needs are served by a specific product offering.
SOM is the realistically obtainable market, limited by factors such as competition, cost, outreach required, distribution, etc.
TAM, SAM, and SOM are often visualized as concentric circles:
We never thought about this much during Smartlett, but if we did it might have looked like...
- TAM: Total number of single family detached homes in America * sales revenue. That's something like (80 million homes) * ($150 for 15 outlets). That's a 12 billion dollar TAM.
- SAM: Strategically, who would our product actually appeal to? That's likely middle class households - those who could afford an investment in energy monitoring while also benefitting from saving money. That cuts our TAM in half, to 6 billion dollars. We'd want to divide further by the characteristics of our market - energy conscious, eco-friendly, frugal, etc. Only 5% of Americans are especially "green", so we might cut our SAM to 300 million.
- SOM: Here we incorporate many factors such as competition in the smart home space, challenges of hardware distribution, etc. Perhaps we look at just 10% of the SAM, so 30 million dollars.
These numbers seem reasonable. If your SOM comes out much lower, you might want to re-evaluate.
Finally, you'll want to think about the direction your market is heading. Is the problem you're solving getting worse or more prevalent for some reason? Or is there a big fix on the horizon that might wipe it out entirely? This is the fuzziest element of our analysis, and will vary greatly depending on the opportunity or market at hand. You might justify your market trajectory with numbers, or with a story.
Sometimes, there may be indicators pointing in both directions. This was the case with Smartlett. On the one hand, the number of smart household gadgets that consume significant standby power is growing. Currently, as much as 25% of our household energy usage comes from standby power (this is up from much lower estimates even 2 years ago). On the other hand, there is a significant push to regulate how much standby power is acceptable, which could reduce the problem considerably.
It's impossible to say what the markets will do in the future. But, if you can come up with a story that is convincing to you, your team, and investors, it might be time to forge ahead.
There are doubtless whole books and MBA courses dedicated to analyzing and evaluating potential business opportunities; we've only just scratched the surface here. Still, this guide to spending a half-day or so thinking through your idea's user, strategy, market size, and market trajectory could give you a lot of insight into whether or not it's worth taking that first next step.