July 25, 2018

Why Product Differentiation Outweighs Market Size And Growth In Early Stage Investing

Prioritizing Product Differentiation


In my past career as a strategy consultant, one of the key components of every private equity due diligence project we conducted was to analyze the market size and growth applicable to the target company.

Market size and growth for many bankers, PEs and VCs alike is a key element in their decision making process. Phrases like, “If the market isn’t big enough, why would I pursue it?,” or “the last place I want to be is in a market that is declining,” are commonplace.


In many ways these are valid statements, especially when considering an investment in a well established company that has already proven what it can do within a certain market.


However, when considering early stage companies (especially in the business-to-consumer) space, the market size, though important to a degree, can take a secondary role to really understanding how differentiated the product or service offering is.


Reason being, oftentimes, the real innovators can be the needle in the haystack that accelerate markets to grow, or upend age old industries to take on a completely new form. Innovations that challenge the standard convention require deprioritization of market stats and enhance focused on the product.


Below, I lay out some prime examples of this and why taking a product focus, especially in the early days of a consumer tech company can be so important to helping you identify potential game-changers that might not have the right market stats to wet the pallet of traditional investors.


Mattresses: An old boys club upstaged by a new direct-to-consumer play


The mattress industry is not one that beckoned innovators to come running during the mid-2000’s. It was a multi-billion dollar industry growing at a snail’s pace owned by behemoths like Serta, Simmons, Sealy and Tempur Pedic. Tempur Pedic, was the only “baby” of the market leaders having been founded in 1992.


To give you an idea of how old this industry is, Serta was founded in 1931, Sealy in 1881, and Simmons in 1870. To say this is an industry that has tended to stick to the old way of doing things would be an understatement.


Despite this lack of innovation or movement, in 2014 Philip Krim and his four other co-founders burst onto the scene with a new bed-in-a-box mattress company called Casper that sells mattresses online, delivers them right to your door, and gives you 100 days to try it completely free. The customer-centric model took off more than anyone could have expected.


For years, mattress companies thrived on proliferating SKUs to make it nearly impossible for customers to be able to shop and compare products and prices across stores. The old guard thrived on confusion and lack of transparency. Casper decided to do everything in the opposite way, and in 2018 surpassed $600M in yearly revenue. Turns out transparency, simplicity and customer-centricity are winning value propositions.

The direct-to-consumer mattress world has quickly gained traction, obtaining almost 10% share of the $15B+ mattress market in the US, and we have seen the proliferation of new competitors in the space. These include the likes of Purple ($250M FY17 sales), Saatva ($220M FY 17 sales), Leesa ($150M FY17 sales), and Tuft & Needle ($150M FY 17 sales).


To be clear, some of these are competitors that entered before Casper and others after. Nonetheless, Casper was the one that put the whole industry on watch, as it reimagined the mattress buying experience for millions of Americans in what could only be described as overnight.


Had you looked at this space as a casual outside observer back in 2014, the early analysis of the market opportunity would be that there were 4 major established brands that owned the bulk of a slow growing market that was dominated by strong retail relationships.


Not considering the nascent demand for a better solution and a truly differentiated mattress offering would have cost you the opportunity to own a part of a company now valued at $750M+, and planning for an IPO.


Eyewear: The monopolized eyewear industry taken to the house


One giant monopoly that has somehow managed to stay mostly out of the limelight until recent years is Luxottica. Disguised as other brands like Prada, Chanel, Dolce & Gabbana, Ralph Lauren and more, Luxottica owned 80% share of the $28B global eyeglass wear market in 2014.


If you remember, it was pretty commonplace to pay hundreds of dollars for frames everytime you needed to replace your old pair. That was until a couple of Penn MBA students, Neil Blumenthal and David Gilboa realized there was an opportunity to sell more cost-affordable glasses to the masses by going direct to the consumer, much like Casper did for mattresses. And thus, Warby Parker was born.


By creating trendy, but affordable ($95 to $150) eyeglasses with home try-ons, they took away the pain of going to outdated glasses stores and paying at least 5X what Warby Parker was charging.


The result; the team is now valued at over $1B dollars, is doing somewhere in the ballpark of $250M+ in annual revenue and has become a household name in the eyeglass industry with aggressive expansion continuing.


Sure, the team is still only a small part of the overall industry but to go up against a monopoly like Luxottica, which not only is the creator of so many of the staple eyewear brands but also owns stores like LensCrafter is something that few would consider viable.


Had you decided it was too slow growth a market and too hard to penetrate due to strong incumbent players, you would have missed out on one of the true unicorn darlings of the VC world.


Water bottles: A stagnate, boring, commoditized industry upended overnight


If you thought of water bottles as a way to look trendy five years ago, you were probably as trendy as me at the time when it came to fashion. To be clear, I wore shorts in the winter so I would say I was in the “not” trendy category.


And most water bottles did a good job of fitting just that. Big Nalgenes, Thermos’ and Camelbacks dominated the high end of the industry, if you will for campers. But when it came to the board room or gym, these were less fashionable options. And most people, suffice to say used the water bottle they got at a 5K or bought as an impulse buy at the front of a CVS for everyday gym or office use.


To say the water bottle market was a boring industry that competed on price at best, and on nothing at worst is an understatement. Founded in 2010 by Sara Kauss, S’well water bottles has taken the industry by storm.


Since 2010, Sara has grown S’well water bottles into a $100M revenue business, and has made water bottles an on-trend item that has caused growth of the space to skyrocket unexpectedly.


Sara singlehandedly reinvented the industry to be trendy and cool in a way that it never had. In some ways she has taken the same approach as the Lulu Lemon founder who saw that gym clothing had consisted of old torn and tattered clothes from the back of the closet for years.


Sara took what was inherently unimportant and made it a focal point of our everyday lives with her stylistic approach. She has grown the company organically since 2010, and still owns 100% of it.


Her high-end price point of $20+, focus on chique design in an industry that could care less about visual, and lukewarm investor interest would have been enough to turn most people away from this opportunity. Instead Sara is sitting on an organization with $100M in annual revenue that could likely sell for at least 3 or 4X current revenues.


The conclusion:


The companies I have mentioned above are just a few examples, but they are not the only ones that should challenge you to think about what matters when analyzing an early stage company. Yes metrics like market size are important, and most of these do compete in large industries, but at the end of the day they were market movers and setters, rather than followers.


By looking at how a company would perform as a follower, you miss the point that you are trying to identify market movers and setters in the early days. It’s a different lens but an important one to consider.


As you think about identifying winning investments in the seed stage be sure to delve into how uniquely differentiated the product or service is, and think about how it can change the current way of doing business.


Thinking outside the box of the current market size or growth rate, you must ask yourself, could this company upend the current market or accelerate the growth of the market rapidly because of its ability to capture a new or nascent demand? Opportunity is abound, it’s all about identifying it with the right lens…



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About: Chris lustrino

A Boston College Eagle for life, on a mission to democratize startup investing for all people at KingsCrowd, with a passion for Fintech, investing, social impact, doing well and doing good, and an avid runner, cyclist and writer.

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