Using Market Type to Guide Startup Strategy
The Four Steps to the Epiphany by Steve Blank
Identifying your market type
Understanding your market type is a key success factor for startups and new product development. When creating a new product or service, it’s important to understand whether you are entering an existing market, creating a new one, or trying to carve out a niche. Many of the strategies presented in The Four Steps to the Epiphany are based on the four market types (new, existing, low-cost resegmentation, niche resegmentation) that a startup will face. The type of market affects customer relationships and positioning, cost of entry and marketing launch, distribution channel and sales cycle, and financial requirements. Overall objects are different as well: market share for existing markets, market adoption for new markets, market reframing and new market share for resegmentation.
Market Type changes how you evaluate customer needs, customer adoption rate, how the customer understands his needs and how you would position the product into market
Market Type choices affect the way the company will deploy its sales, marketing and financial resources.
In the Customer Discovery phase of Customer Development, a Market Type hypothesis is created. Depending on which type of market you believe you are entering, you will have a different set of questions to answer in Customer Validation.
It is in Customer Creation that startups who do not understand Market Type spend themselves out of business.
Entering an existing market
In this type of market, you are selling your product to existing customers based on a better or faster performance characteristic. Incumbents are the greatest risk since they must be displaced to gain market share. Blank’s definition of an existing market is that “your product offers higher performance than what is currently offered.” This makes the basis of competition the attributes of the product and its features. Positioning is done in comparison to incumbent competitors.
Questions in this type of market center around competitors because incumbent companies and products define the market. Key questions to answer include: how do your competitors go to market?; how much will they spend to defend their market share?; what product characteristics are most important to your customers?; are there any relevant technical standards in the category you are entering?
Blank suggests using a cost/benefit matrix as a tool to position against competitors. This helps analyze competitive positioning and trajectories for improvement.
Entering a new Market
New markets are defined by the ability of customers to do something that was not possible before due to lack of functionality or prohibitive cost. Because there are no competitors initially, product features are not the basis of competition. Rather, a startup’s priority is convincing potential customers that your product or service has value. Finding that large set of potential customers is an important hypothesis to validate. New products in new markets frequently require a large cash outlay so managing burn rate becomes a critical activity. The biggest risk in this type of market is adoption; competition comes from non-consumption and other startups. Positioning is focused on communicating your vision and passion about the change your want to make.
Key questions to consider when entering a new market are: which existing markets will be the source of your customers?; what compelling needs and features will draw customers to your offer?; how will you drive demand?; how much money do you need to finance your market education activities?; what barriers exist that will prevent an incumbent from stealing your market share once you have developed your product or service?
Low-cost resegmentation is Clayton Christensen’s classic disruptive innovation strategy. It involves finding a large group of underserved customers who are willing to pay for a “good enough” solution. If done successfully, the disruptive innovator will find its higher cost competitors willingly moving upmarket to find higher profits. Positioning for resegmentation involves communicating about value and customer need.
Questions to answer include: from what existing markets will you get your customers?; what needs and business problems define those customers?; why aren’t incumbents offering what you are proposing?; how long will it take you to educate the market about your offering?; what are your market share goals?
Niche resegmentation “attempts to convince customers some characteristic of the new product is radical enough to change the rules and shape of an existing market.” Low-cost resegmentation targets underserved buyers while niche resegmentation goes after the most profitable customers of market incumbents. Blank gives the example of In-N-Out Burger which offered a very limited menu of fast food items and was able to enter a market which was dominated by McDonald’s and Burger King. Because it is an existing market play, he notes that this strategy “faces entrenched competitors who will fiercely defend their profitable markets.”
For niche resegmentation, the questions to answer are the same as low-cost resegmentation.
Blank outlines New Lanchester Strategy as a method for determining market type based on market share dynamics. The theory provides market share numbers which indicate market type as well as estimated cost of entry. For instance, if a single company controls 75% or more of the market, the entry strategy must be either new or resegmentation with a 3x spend against the incumbent’s market and sales dollars. At the other end of the spectrum, if the market leader has 26% or less market share, they are unlikely to have a material impact on entry and existing or resegmentation strategies can be used at at 1.7x cost of entry multiplier.
The Four Steps to the Epiphany is a very thoughtful and methodical book. Much of what Blank prescribes is intended to get you to think through key attributes of your market and customer before spending dollars in product development and marketing. The foundation of Customer Development is the idea that companies must create a process for discovering markets, locating first customers, and developing business models through a iteratively validating their assumptions. He stresses the importance of Market Type because it drives downstream investment decisions and is required for effective customer acquisition.