Evaluating Markets, With a European Perspective

European Straits #125

Dear all,

Last weekend, my wife Laetitia Vitaud and I were invited to an event presented by the Royal Society of Arts. The RSA recently launched the Economic Security Impact Accelerator 2019 to support a cohort of entrepreneurs “who are looking to have a greater impact on good work, inclusive growth and the overall economic security of the UK’s workers”. Needless to say it resonates quite a lot with my book Hedge!

🌿 The 3-day workshop at a retreat in the English countryside was opened by a fireside chat hosted by Matthew Taylor, CEO of the RSA, in which Laetitia and I shared our vision of what a 21st-century safety net would look like. After that, I had the pleasure to reunite with Garrett Cassidy, CEO of fintech startup Trezeo, and to meet other entrepreneurs in sectors as diverse as insurance, construction, and education.

🔥 You can see a picture of the fireside chat here. And if you want to learn more about our respective visions, here are some links:

🇬🇧 Later today I’ll be attending a "New Palo Alto" Briefing at the invitation of LocalGlobe’s Saul Klein. It will be both an update about our friends at LocalGlobe moving into their new home at Phoenix Court near King’s Cross, and a discussion about how this booming area of London could become a new Palo Alto in the next 20 years. I’ll keep you posted!

1/ There’s an ongoing discussion about markets and how to evaluate them. As we know, picking a good market is a critical determinant in a startup’s success. But exactly how you pick that market has never been very clear, beyond vague ideas about the market being large and growing. We all know the type: An investor who says, “My thesis is to invest in proven teams with a well-understood business model on a large and fast-growing market” in fact has no thesis. And so we need a more differentiated approach to evaluating markets, and I think Europe can make a distinctive contribution to that conversation.

2/ In a recent thread, Village Global’s Erik Torenberg reminds us of two radically different approaches to evaluating a market. One is Peter Thiel’s: “Pick a niche you can monopolize and expand outwards from there.” The other is from Keith Rabois: “Go “horizontal”—find trillion dollar markets + build full-stack, vertically integrated solutions. Go big or go home.” The thread itself discusses the respective merits of both approaches, by way of a framework that Erik is working on with Anuj Abrol. So it’s an ongoing discussion, but it’s not too early to echo it with my own thoughts.

3/ As always in the Entrepreneurial Age, the discussion comes down to increasing returns to scale. In his seminal 1996 Harvard Business Review article, economist W. Brian Arthur explains that the different nature of returns changes the nature of competition. There are several factors for increasing returns to scale, which I detailed 3 years ago in this article: In Search for Scalability. Two existed before the Entrepreneurial Age: supply-side economies of scale and traditional (Porterian) differentiation. Two other factors are amplified by technology: built-in network effects and supply-side platform effects.

4/ A tech company will make the most of its market if its business can lean on all four factors. The best example, as always, is Amazon. They have supply-side economies of scale because of the sheer volume of their retail and logistics activity. They have differentiation thanks to their distinctive value chain. They have built-in network effects thanks to many features such as the recommendation engine and user review. And they have platform effects that originate in the marketplace. Indeed invested capital has been returned many times by this feedback-loop machine delivering on a large and fast-growing market.

5/ My impression is that most large tech companies ended up dominating a large market thanks to the Peter Thiel approach. As discussed in my article The Five Stages of Denial, Netflix initially picked a niche (renting out DVDs and then streaming series) before integrating all the way up the value chain—in this case, producing original content. Likewise, Amazon first picked a niche (selling books), ended up monopolizing it, and expanded outwards (into other verticals) and upwards (into publishing). More recently, we’ve seen that Airbnb and Spotify have become interested in moving up their value chains.

6/ By contrast, the Rabois “fat startup” approach consists in a shock-and-awe strategy whereby showering large amounts of capital spares entrepreneurs from having to deal with incumbents too much. Balaji S. Srinivasan otherwise called this the “full stack startup” approach, building on a concept introduced by a16z’s Chris Dixon. When we first learned about this concept back in 2014, my cofounder Oussama Ammar and I were thrilled. This, it seemed, was the right approach in a European market were incumbents are so strong and oppose so much resistance at every level of an industry’s value chain!

7/ It makes perfect sense, from a US perspective, to move towards the “full stack” approach. Now that software is making great progress eating the world, there are more and more large markets that are ripe for conquest by ambitious, seasoned tech entrepreneurs. But this is typically a US approach rather than a European one, for two reasons. First, you need a startup ecosystem that is so healthy that it attracts more capital than it can use, which in turn makes it possible to finance entering harder industries. Second, you need a market that is not too fragmented—and on this front, Europe is falling short, too.

8/ Because we must acknowledge that markets are more fragmented in Europe than in the US. One trend is that technology is now impacting more tangible industries, which means that assets are located closer to the customers rather than centralized in one place, as is possible in pure software businesses. Another trend is that technology now impacts markets that are more heavily regulated, and despite the EU’s best efforts, regulations tend to be very different from one country to another. And this is all without accounting for the frictions that exist across Europe in terms of language and culture.

9/ On fragmented markets like in Europe, you don’t really have the benefit of network effects and platform effects before it’s quite late in the game. And so for European entrepreneurs it seems the best approach is definitely to be extremely focused on one niche and then expand outwards—both through new products and onto other national markets. The idea that European early-stage entrepreneurs need to double down on focusing on a niche is what inspired in Oussama and I the idea of “The End of Diversification”, described in our long 2016 piece about Berkshire Hathaway (see part 5).

10/ Of course, focusing on that niche you run the risk of network effects never kicking in. This is the bad surprise that Uber has recently encountered. As early as 2014, a wise investor like Bill Gurley could still envision Uber enjoying network effects at a global scale. What has been seen more recently is that those effects exist at the scale of each city, separately—which is precisely why Dara Khosrowshahi, Uber’s current CEO, is now pursuing a strategy based on platform effects, trying to turn Uber into more of an Expedia (his former company) or an Amazon Marketplace for mobility.

So why does Europe provide a unique perspective on evaluating markets? Let me conclude by offering four short ideas:

  • First of all, as software makes progress eating the world, tech entrepreneurs will encounter markets that are more and more fragmented. If you’re based in Silicon Valley (and maybe in China), you have access to an ecosystem that can support you in conquering such markets with a Rabois approach. If you’re anywhere else in the world, you’d better focus on a niche.

  • European entrepreneurs should focus on a niche (in terms of both the problem and the geography they address) for a reason: it’s about reaching the velocity that makes it possible to escape your (likely toxic) local ecosystem and access capital and talent at the pan-European level, at which point you can finally expand outwards. Indeed you shouldn’t stop at that niche!

  • Like in many cases, this reminds us of the cardinal rule of building tech startups in Europe: while discussions originated in Silicon Valley are the most inspiring, they’re only relevant in the specific context of Silicon Valley. As we’re in a different context on this side of the Atlantic, we must take those discussions with a grain of salt and reformulate the questions in our own terms.

  • Finally, As I’m reminded by my colleague Balthazar de Lavergne, keep in mind that US venture capital firms invest ahead of the adoption curve. That makes it possible for the local ecosystem to mature and for investors to create strong brands, which in turn makes it possible to attract the best deals when adoption finally kicks in. But then, is Europe doomed to lag behind forever 🤔?

🎓 Over the past few years, we at The Family have launched quite a few initiatives to help students take their first steps in entrepreneurship. Why? Because as our Paris events manager Vladimir Oustinov explains here, students often have dreams and ambition, but a cloudy view of what launching a startup really implies: 5 things I learned from my student startup project.

🗿 When we talk about scale, we often forget just how complicated it is to do on the inside as well. Oussama talked about the key issues in scaling a team in this video: How do you scale a team? 👐.

🏰 This past weekend, our team at The Family spent 3 days at a castle in Burgundy for a “reboarding” weekend: time with entrepreneurs who are already in The Family and whose startups are growing fast. We structured it as an “unconference”, inspired by Tim O’Reilly’s , with every participant there not just to listen, but also to teach. There were product demos, community building, management, mental health and more—a great way to see the learning aspect of entrepreneurship in action! Here’s a picture.

👩‍🚀 Finally, my cofounder & CEO of The Family Alice Zagury participated in a #VeuveClicquotxWomen event yesterday, addressing a crowd of female rising stars as 2015 Veuve Clicquot New Generation Award Winner. Check out these beautiful pictures that LVMH shared on Twitter ❤️.

Here are a few more sources to reflect on evaluating markets:

Warm regards (from London, UK),