5 Questions
to Evaluate Your Startup's
Target Market

It was late 2002, and we were presenting Elogex, our logistics software-as-a-service (SaaS) startup, to leading venture capital firms on Sand Hill Road. We were on track to cross $2 million in revenue, providing the first Internet-based transportation management system to some of the largest retailers in the country. I distinctly remember these VC meetings and their consistent concern that our startup's target market was too small.
In hindsight, this point of view that our market was too small was entirely wrong. But this negative feedback played a strong influence on the decisions we made leading up to the sale of Elogex in 2003. Selling Elogex at that time was a costly mistake. It is my belief that if we were still running this business today, it would be in the $50-$100 million revenue range - making it now worth about.. I won't go there!
Castle's Todd Buelow in the summer of 2002 pointing out the first time we crossed 100 concurrent users at Elogex.
Fortunately over the last 13 years, entrepreneurs and VCs have developed a better perspective on target market size and characteristics.


At Castle, we are a partner to startups, and we see many opportunities across various markets. We are in a good place to see the impact that the choice of target market has on the probabilities of your startup's success. Your choice of market is the most impactful decision you will make. It will define the degree of your success.


The following list is a practical set of questions to apply to your new venture. Answer these questions about your target market. The more you can answer positively, the better the market you are entering.
1
Do you have the knowledge and relationships necessary to be a leader in your target market? If you do not, can you realistically hire these types of team members to join your startup?
The most common driver of target market selection is the past experiences of the entrepreneur. It is very true that your own industry experience and relationships can fuel your venture. We generally point out that if you can pencil together a plan to reach $1 million in revenue through your personal relationships, then you are most likely heading in the right direction. However, your past experiences can also be a trap leading you to a poor market decision.


The key point here is that in order to be a market leading company, you and your team members will need to outsell and outperform your competition. So ask yourself if your particular skills and relationships would be perceived by customers in this market as impressive and convincing. If you do not possess all the tools you need, are you in a situation where you can convince others to join your team and complete this picture?


A good example of this characteristic is the founding team of Castle client A2 Access. Working in one of the world's most successful hedge funds, they were in position to identify a true problem and solution that applied to their industry. Then they had the market-specific relationships, network and credibility necessary to open doors and sell into the top hedge funds and investment banks, enabling them to quickly build up a nice business, which resulted in their acquisition by Dealogic this summer. A team from outside this business would have never pulled that off.
2
Can you quickly establish a leadership position in your target market without large amounts of capital?
We recommend that you read Peter Thiel's Zero to One. It is a great reference for new entrepreneurs and gives perspective on target markets. He encourages you to find niche opportunities where your startup can be in a monopoly position:
Every startup is small at the start. Every monopoly dominates a large share of its market. Therefore, every startup should start with a very small market… The perfect target market for a startup is a small group of particular people concentrated together and served by few or no competitors. Any big market is a bad choice, and a big market already served by competing companies is even worse. This is why it's always a red flag when entrepreneurs talk about getting 1% of a $100 billion market.
Peter Thiel
Zero to One
If you look back to our old company Elogex, we were targeting a niche. Yes, there was competition in the broader logistics space, but not for our particular small "inbound logistics" market segment where we were indeed building a monopoly position.


The more efficiently you can achieve this monopoly position the better. Today, the odds of you raising millions in capital out of the gates are slim to none, so the ideal target market can allow for a market leader with relatively low amounts of investment. This line of thinking generally leads to small niche markets, the complete opposite of the conventional big market vision of the early 2000's. Once you have a monopoly position and a solid business established in a small market, your growth and expansion into adjacent markets becomes easier.
3
Will your target market have enough budget for your product to be priced so that it can be distributed effectively?
One of our Castle ventures projects is House Account, which is targeting the very-small-to-medium business (VSMB) segment, providing a sales and marketing platform to independent boutique retailers. House Account has thousands of prospective customers around the world. However, can the price point of House Account's solution support the sales and distribution model necessary to reach these customers?
You should think about the budget your target customer will pay for your service; for House Account, it is around $100-$200 per month or $1,200 to $2,400 per year. For our old company Elogex, it was $20,000 to $100,000 per month. Each solution and price point comes with a customer acquisition cost (CAC), and the balance of your CAC relative to your customer lifetime value (LTV) determines if you can scale the business.


At Elogex, we needed high paid sales people to work long sales cycles. This model worked because our sales team sold big deals with high LTV. However, if you have an expensive sales team working long sales cycles for small deals, you will have challenges. If your price point and customer budgets are small, you need to make sure you can use digital marketing, inbound, and/or distribution partners for selling your product.


So when thinking about your target market, make sure your price point and customer budgets matches up with how you can reach that customer.
4
Can your target market be a low churn environment?
Growth is never easy. However, it is harder when you have to replace churning customers (the "leaky bucket" issue). The ideal target market has a low propensity for churn.
Churn is not just a function of target market as it is largely driven by the value proposition of your solution and the degree of pain associated with the problem you are solving. However, your target market can certainly influence attrition.


Generally, the smaller the customer is, the higher the risk of churn. If you are targeting the enterprise customer, then you have a reasonable chance of low churn if you have a solid product. As you go down-market in customer size, the churn rate is likely to increase regardless of the quality of your offering. Targeting the SMB and the VSMB markets can be challenging for this reason - so it is critical that your value proposition be rock solid to mitigate this risk. Targeting individual consumers has the highest risk of churn, and here your value proposition has to be outstanding if you assume to generate recurring income from individuals.


At Elogex (now One Network), there are accounts that use the product after 13 years. At House Account, reducing churn is the top priority for 2015. Understanding churn risk relative to your market will not only help with your target market evaluation but also with your product feature strategy as well as your pricing model. With your product feature strategy, you could prioritize anti-churn value, for example. In terms of pricing model, in a high-churn target market you could consider free pricing until you prove product market fit is reached.
5
Will you enjoy working in this market for many years?
One thing that is easy to miss in all the discussions about startups and online advice is the personal factors you should consider. One of my favorite topics to share with entrepreneurs is that you shouldn't forget that your startup is not just about the great company you seek to build and the positive change you want to bring to the world. It is also about you and your family.


You are going to take much more career risk than your neighbors. You are going to always be working. Your stress level will be high, and you will have emotional peaks and valleys.


So it is critical that you pick a target market in which you will enjoy being completely immersed for years. If you love your business, you will have a higher probability of success.