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June 23, 2010
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Selecting and understanding markets for technology innovation
We recently introduced a new business model framework for technology innovation comprising five primary components: markets, products, processes, people and economics (see What is a business model? A new approach). In this paper, we explore the first component of this framework – markets.
The goal of the market component is simple and clear: to focus your business on a large, growing market with urgently felt needs that are not being met by current offerings.
However, in practice it is challenging to accomplish this ideal. In some cases, it seems that there are no unmet needs for the new technology. In other cases, innovators can be overwhelmed by the number of apparent market opportunities for their new technologies and products.
This paper discusses the importance of finding and selecting the right market, and how to go about doing so systematically and thoughtfully so that you maximize the chances for your venture’s success.
Importance of market selection
Selecting which markets and customers to serve is arguably the first and most important business model decision, as this decision becomes the primary driver of pretty much everything else the business does. It is in this sense that Peter Drucker famously said that the purpose of a business is “to create a customer” 1.
In addition, a growing body of evidence suggests that choosing the right markets creates more value than having superior products or sales and marketing capabilities. For example, recent research by McKinsey & Company, Inc. suggests that substantially all growth in the large, multi-business companies they surveyed came from high growth market niches rather than through market share gains of slower growth markets 2.
Practical experience confirms this. Far too many new ventures go after markets that happen to be known to their founders or corporate parents, regardless of the market’s inherent attractiveness or need for the innovation being offered. As a result, these companies face long, costly battles to win customers and grow revenue. Had they followed the guidelines in this article from the beginning, many of these companies (including dozens with whom we have had direct experience) would have saved substantial amounts of time, capital and energy, and would have greatly enhanced their prospects for success.
How many markets should you pursue?
There may be many potential markets for your new technology or product. However, extensive experience, popularized by Geoffrey Moore in Crossing the Chasm, suggests that technology innovations should focus initially on a single target market 3.
Why is this? Surely new ventures need to avoid putting “all their eggs in one basket”? The reason is because superficially, markets are simple, but as you engage with them, they rapidly overwhelm you with complexity. Truly understanding and successfully navigating a market is a substantial effort – and new ventures typically do not have the resources or management bandwidth to properly focus on understanding, building a reputation in, and winning customers in more than one market, at least initially.
Moore’s prescription (which he terms the “bowling pin” strategy) is good advice for most innovations and new ventures – first secure a solid foothold in an initial target market, which will provide the foundation for a solid, profitable business. Based on this foundation, you can then enter additional markets.
Note that you may need to test several different markets before finalizing on the best one for your single focus. This is necessary both to validate your market research and often also to generate much needed revenue in the venture’s early stages. As such, it may well be sensible for start-ups to do some low cost selling into several different markets in the first few months post initial product launch. The goal of this activity, however, is to confirm as quickly as possible the one market that will help propel your business to sustainable profitability.
Identifying and evaluating possible markets
You should begin identifying and evaluating a full range of possible
markets well before actual product development begins, ideally during
the initial ideation and concept stage. Generating a first list of
possible markets is normally pretty easy for most innovation teams
– a typical brainstorming session can develop an initial list of dozens
of potential markets. This initial list can then be grouped into
a logical set of potential markets, which can subsequent be revised
and expanded through additional research and conversations. The goal
is to uncover every possible market opportunity for your technology,
and miss none.
Once you have a comprehensive set of possible markets to consider, you
need to evaluate each one to see if it is worth investigating in more
detail. This will necessarily be a first level, relatively superficial
evaluation, in order to reduce the list of possibilities to a manageable
number to evaluate in more depth.
One approach to doing this is to use a version of McKinsey’s well known
nine-box matrix first developed for GE 4. This matrix reflects Peter
Drucker’s guidance that a central principle of managing effectively is
to pursue your most attractive opportunities with your greatest strengths
5.
The matrix assesses market attractiveness on one dimension,
and business strengths on the other. Each of these dimensions
is measured through several criteria. Market attractiveness criteria
include market size, rate of growth, the urgency of customers’ felt needs
and competitive intensity. Business strength criteria include relevance
of the company’s technologies and products to the market, the company’s
knowledge of the market, the extent to which the company has demonstrable
prior experience in market, and its access to target customers and other
key contacts in the market.
While the nine-box matrix was developed for corporate strategy (managing a portfolio of business units), we have found it useful and easy to apply to evaluating market potential for innovation. A simple scoring system can be devised to rank each of the market attractiveness and company strength criteria for each market opportunity. These scores can be assessed either informally through team discussion and consensus, or more formally based on data gathered through secondary research.
The result of the evaluation will be a short list of potential markets
which score relatively high on both market attractiveness and business
strengths. Each of these now must be researched in more detail.
Note that in practice this is an iterative, not a linear, process. Normally
the first pass evaluation is based, by necessity, on many “guesstimates”.
As new information comes to light during the detailed analysis of your
short listed markets, you can go back to your initial list, change the
evaluation and perhaps change which markets are on your short list.
Understanding the current make up of the market and its likely evolution
The next step is to understand each of the markets you are seriously considering in more detail. Specifically, you need to understand where the market is on the technology adoption cycle, as well as the market’s current structure, value chain and ecosystem. Understanding the market in some detail is necessary in order firstly, to properly identify customers who truly have unmet needs, and secondly, to design an optimal business model for that market.
Technology adoption lifecycle
The technology adoption lifecycle was first developed by Joe Bohlen,
George Beal and Everett Rogers of Iowa State College 6,7,8, and it became
widely accepted in the technology industry after being popularized by
Geoffrey Moore, who identified the well known chasm that typically
exists between the early adopters and the early majority.
For purposes of market evaluation, it is important to understand that
the nature of each market, and as a result the business model required
for that market, is different at different stages of the technology adoption
lifecycle. If the market you are addressing is at an early stage, or
is only just forming, perhaps because your technology category is new,
then you face a strategic challenge that is completely different from
an established, relatively mature market.
There are also significant differences between different types of early stage markets, depending on how new to the world the technology is – for example, the challenges faced by IBM introducing the world to the PC (what do I need it for?) versus those faced by Google introducing a better kind of search engine. There is no space to detail these challenges and how to approach them in this paper, the interested reader is encouraged to consult the references.
Market structure, value chain and ecosystem
Market structure, value chain and ecosystem are related concepts that essentially help understand the participants in a market, their roles and relationships, and how total market value is apportioned amongst them. Structure is about the supply / demand dynamics, particularly the concentration of and balance of power between buyers and suppliers, as described by Michael Porter with his well known five forces framework 9. The value chain, a concept also developed by Porter based on McKinsey’s business system framework, describes the sequence of value creating activities in a business or a market 10. First introduced by James Moore, the concept of the market ecosystem is broader, encompassing customers and the oftentimes complex web of players and relationships in an industry, particularly technology-based industries 11.
All of these are valuable tools, but at a minimum it is important to gain an understanding of the primary groups of players in a market, and the basic economics of the market. First and perhaps most important is to understand the different customer segments – groups of customers with similar characteristics and buying behaviors. In addition, it is important to understand the basic value chain or business system in the market, which may include component suppliers, system manufacturers, and various levels and types of distribution channels. And for both customers and the value chain, you need to understand the trends in the market, and where it is moving.
The more you learn about the market, the better you will be able to design a successful business model for that market. You can gather much of the information you need through secondary online research. In addition, interviewing key market participants such as leading customers, channel partners, vendors, trade association executives, journalists and research analysts will provide a rich understanding to supplement your online research. Using these approaches and some of the tools described above, we have found that in practice it is possible to develop a reasonable first level understanding of a market within weeks.
Identifying target customers
Now that you have an understanding of the essential make up of the market and its existing customer segments, you need to decide which customers should be the focus for your business.
Existing customer groups can be analyzed to identify to what extent their needs are being satisfied by current offerings. In most markets, there are some segments that are pretty well satisfied by current competitors, and those competitors will fight hard to protect their position in what is likely a core segment to them. But there are also likely to be some segments whose needs are not fully satisfied by current offerings. These segments are worth exploring in more detail, as discussed below.
Several thought leaders., including Peter Drucker12, Clayton Christensen 13, W. Chan Kim and Renee Mauborgne 14, discuss the importance of exploring non-customers. These include those who buy infrequently, those who choose not to buy at all, and those who never thought to buy. Christensen explains in his seminal work The Innovator’s Dilemma that in many instances, disruptive innovations that have overturned existing markets first gained traction amongst people who had not previously been customers. The beauty of finding non-customers and turning them into a market, as detailed in Kim and Mauborgne’s Blue Ocean Strategy, is that frequently you can establish a highly profitable position for a sustained period of time with these customers before competitors come to realize what you have accomplished.