Another edition of our new series: Blog Spotlight.
We put together a short list of excellent but somewhat overlooked
blog that deserves a greater audience. Expect to see a post from a
different featured blogger here every Tuesday and Thursday evening,
around 7pm.
Up next in our Blogger Spotlight: Rob May and Business Pundit. He is the co-creator of the Carnival of the Capitalists, which was the second blog carnival. Rob has a BS in Electrical Engineering and an MBA. He has been an engineer, entrepreneur, small business owner, and currently runs the business development department of a wireless software company. He is also an adjunct professor at the University of Louisville. Rob has been blogging at businesspundit.com since early 2003.
Today’s focus commentary asks: Please Stop With Your Chinese Math
Last Wednesday I was sitting at the Louisville Venture Club
listening to a presentation by a software company. The presenter went on and on
about how huge the market was for his product, and how they "only needed to
get 3% of the market to…" Oh no. Not again. An entrepreneur friend of mine
sitting next to me turns and says "nice Chinese math." I nod. "Why didn’t
someone warn him?" I say.
I’ve written about this before, but it is so
damn pervasive among entrepreneurs maybe I need to be more thorough. Let’s start
by explaining the term (which comes in several forms, but ‘chinese math’ is most
common around here). Investors love companies that can a)stand on their own two
feet early so that they don’t require much more investment and b)have huge
market potential. So entrepreneurs try to convince investors that the market is
huge, and in doing so they somehow convince themselves (and in turn try to
convince investors) that it will be easy to reach cash flow breakeven because of
the market size. After all, they only need a small percentage of the market. The
name stems from the idea that there are a billion people in China, so if you
sell a $1 widget to just 1% of them that is $10 million in revenue. The
assumption that is incorrectly applied here is that 1% is easy to get because it
is a small number.
I fell victim to this myself a few years ago. Market
demographics told us we had over 5,000 potential clients within a few square
miles. Surely we could get 10% a year, and surely we would snag some from
outside this small area. It turns out that surely I was doing some Chinese math
because we didn’t get 500 clients anytime soon.
Chinese math doesn’t work
because small numbers aren’t necessarily related to easy success. Think about it
by removing the percentages. If you need 100 clients to break even for the year,
does it matter how large the potential market is? Probably not. If your
potential market is 10,000,000, does that make it easier to get 100 clients than
if your potential market was 200 clients? It depends. Probably not. First of
all, you have to have something of value (which many startups don’t) and you
have to be able to convince even one person why they need it (which many
startups can’t) or your market size is irrelevant. You won’t even get 1 client.
Secondly, it may be easier to market in the case where you need 100 out of 200
because it may be easier to identify your target audience if it is only 200
people. In that case you are probably in a niche that is easy to market to and
don’t just have to blanket your ads on the general public.
Think about
it this way, there are several billion people in the world you could potentially
date. And since you only need one to marry, it will be easy right (after all,
you only need .000000001% of that market) ? Only if you are willing to take any
random partner. Small percentages do not translate to easy results.
You
will impress investors soooooooo much more if you can pinpoint who will use your
product than if you use Chinese math. Don’t say 18-35 year old males with
incomes greater than $35K/year. That’s too general, but often that is where
analysis stops. Identify your early adopters and figure out what they do in
their free time. What do they read? What do they watch? What do they listen to?
Have you spoken to them? What have they said? Would they buy your
widget?
As part of my day job I deal with companies that are trying to be
super secretive as they develop the next killer product to take the country by
storm. They all think that, and honestly, you probably need some of that to be a
startup. But Chinese math can lead to marketing and financial complacency
because it lets you build these ideas up in your head that say your breakeven
point is easy to achieve. It isn’t. Stop thinking that. 98% of you will have to
bust your ass to hit breakeven.
Market numbers are important, and so is
breakeven analysis. Present these numbers as part of your plan, but don’t act
like the low percentages mean they will be easy to reach. If you are counting on
easy milestones for your success, you aren’t ready for entrepreneurship.
If I tell my wife that I was a mere .000000001% of the market she might toss me back in the pile, and take another shot at it.
explain yourself, yawn.
Barry, awesome post. Thanks much. –Bill
Yawn, try being coherent, it might be refreshing. The point of the article is that the entrepreneurs are doing crappy market analysis.
What exactly is your point? How does a venture guy evaluate “the quality of the idea”?
Good luck to you and your George Allen homeboy, btw.
yawn:
I wasn’t aware you high-flying venture types used a different bogus e-mail address every time you commented. Rob’s analysis is completely consistent with what I’ve heard from real, live venture capitalists. The only way someone skates by with a teeny slice of a big market is if they can own some smaller segment of that market.
Ask yourself ‘what customer is going to stake his personal reputation on having bought from the smallest vendor in the market?’ unless they’re getting a kickback? The answer, across time and industry is: nobody. That 3% market share business will get squeezed out of business by one of the bigger players, and then that customer has to go through the hassle of changing vendors. Users and executives alike will assign blame for any inconvenience on the original decisionmaker; risks which the decisionmaker factors into his/her decision. No one makes a potentially career-limiting decision in favor of a weak player in a market. Human nature trumps ‘quality of the idea’ every day of the week. This in part explains why Charlie Munger is a billionaire and you’re not.
Cheers,
Mike
Like Bill , I thank you.
Wonderful post, Barry. Thank you!
Another mistake often made by inexperienced entrepreneurs is to say “we don’t have any competition” (because nothing else does what our product/service does.) This just reveals that the aspiring entrepreneur doesn’t really understand all the forms that competition can take.
Good point David Foster. If you truly have no competition then it is likely at least one of the following is true:
1. What you’re doing is not worth much
2. You don’t understand what you’re competing with
You may very well be competing with the “do nothing” alternative (I was in a startup once where this was the case in spades). Do nothing can be a big winner in the minds of many potential customers. Hard to make money on that ;-).
Thought it was a great article – as a small business owner (which is a phrase that always makes me think of a dwarf with a briefcase) I was guilty for the first few years of my business of telling people we didn’t have competition. Then again, I’ve never needed outside financing and we’re in an expertise-based service niche, so we’ve been lucky to be able to say such silly things and remain in business.
Still, I found the guy’s argument to be spot on in terms identifying the kind of wishful thinking that goes on in an entrepreneur’s head. And really, you do kind of have to be that optimistic to be crazy enough to want to take on the crazy work load of starting something up. It’s human nature.
I’ve given it minutes of thought, and sadly, I cannot add anything to this that wouldn’t depress would-be startup-founders even more.
I mean, even the Kanjii is correct (and no, the prices on those vertical strips along the walls in Chinatown restaurants aren’t any cheaper than the English prices).
Successful entrepreneurs, like bees, are too stupid to know they can’t fly, so off they go. The older wiser ones are all mushed on the ground.
The wonder is that VC’s exist at all.
Oh yeah. Other people’s money.