We're excited to feature Daniel Shi as a guest writer - Daniel Shi is an angel investor. Previously, he spent six years as an operator at Remitly, an international payments company, from early stage until IPO. He's also worked at Tencent and Amex Ventures, investing in gaming, e-commerce, and Fintech.
His previous article on S-curves framework can be found here.
So after writing my S-curves framework, a friend was asking me: how should I think about the next S-curve that I should be focusing on? This particular friend was a social media influencer and had built up a really strong following in a niche audience on social media, but was now thinking about how to expand from there. He could opt to expand into new audiences or he could try a different medium entirely (for example, writing a book).
That got me thinking back towards some of the different exercises that I had done on opportunity sizing in previous roles.
A lot of operators will focus most of their attention on Total Addressable Market (“TAM”). It’s the easiest thing to think about. There will oftentimes be lots of readily available data out there from consulting firms or governments to tell you things like payments volume globally for businesses and individuals or the growth rate of E-commerce payments vs traditional retail. You can Google a lot of this stuff. One trick I like is to search for images, because that turns up a lot of infographics.
In theory, Total Addressable Market is usually the easiest thing to size, but in practice, it can be incredibly deceiving. The largest TAM markets oftentimes have the lowest ROI because they are some of the hardest to enter, grow, and make a profit. Here’s a couple of my theories as to why:
- Competition - the largest markets tend to draw the most competitors. You may look at a big market and think “Hey I’d love to get me a piece of that.” But then you find yourself in a situation where your revenue and profits are consistently competed away to zero.
- Slow rate of change - large TAM markets often have gotten big because they have been compounding over a very long time. But, by the time that they have gotten big, the market may have also gotten very mature in terms of players, customers, suppliers, etc…and the way that they interact with each other. The way the market works may be incredibly calcified.
- Regulation - the largest markets also tend to have the most customers, which will ultimately attract government attention in order to (rightfully) protect those customers from harm. But then those regulations will become barriers to entry and change.
There may be other drivers that I am missing here, but those were some of the biggest drivers from my experience.
I would like to propose a more holistic framework for S-curve expansion. You don’t necessarily have to plot these out on a spreadsheet and try to calculate a ranked scoring for all expansion projects (although I've done it before). It’s probably enough to hold these as a mental framework for most situations, especially in the early days of a startup.
- Revenue take rate
- Rate of change
- Product-market fit
- Resource availability
Let’s unpack these a little bit:
It turns out, TAM is still important. You’re not going to get very far if you are operating in a small and unchanging market. If there are no customers to buy your product, you will learn nothing and earn nothing. Small markets are usually that way for a reason. However, the exception to this is when small markets are changing or growing quickly (see below).
Revenue Take Rate
It’s very important for operators to not mistake things like total processing volume for revenue. Revenue take rate is fixed and variable revenue as a percentage of the total volume (For example, a card processor in the US may charge 1.5% and a fixed $0.10 per transaction. On a $10 transaction, that’s a 2.5% take rate). I like to think in terms of take rates because that helps you to be able to compare different markets on an apples-to-apples basis. The largest TAM businesses will often have the thinnest of take rates. The classic example of this is in global cross border payments.
Payments made by individuals (e.g. remittances) is a tiny fraction of business payments (ex. Boeing paying for jet engines). Payments between individuals is on the order of hundreds of dollars, while businesses can pay each other thousands to millions of dollars. However, individual payments can have take rates of 2-3%, while businesses payments on general have take rates on the order of basis points.
Rate of Change
How fast is a market growing? A big market that’s not growing (or shrinking) will often be very painful to operate in. A fast growing market can have wonderful dynamics, even if it is still small. All markets start small, but the ones that are growing fast are usually experiencing some kind of disruptive change because of new technologies, demographic change, regulations being liberalised, etc. Those are often some of the best times to enter the market if you can get in before any one else notices and can ride the waves of change.
The rate of change does not have to relate to growth either. It can be things like costs decreasing thanks to new technology or economies of scale. It can also be liberalising regulations that are opening up new opportunities.
Again, some of the largest opportunities are also the ones where there is the most competition. I would often ask my colleagues, “Do we want to own 10 percent of 100, or 100 percent of 10?” Both net out to the same value of 10, but have very different trade offs. The 10 percenter has to face stiff competition, but if they excel, they have more room to grow. The tiny monopolist can enjoy great market power, but has to search for new S-curves if they want to keep growing.
I have come to appreciate that regulations are challenging, but they also represent barriers to entry that can impact things like competition, time-to-market, and profitability. In the US money movement business, you have to get state-by-state licenses to operate. This takes time and energy. Meanwhile, in the European Union, there is the opposite effect. A single license in a EU state allows you to passport to multiple countries (although you now need a separate license for the UK, which is too important of a market to ignore). This means that in Europe, even as competitors threw in the towel, new entrants would constantly enter the market to try their luck, competing away profits.
Product Market Fit
With the exception of new product expansion, all other S-curve expansions involve your existing product. Assuming you found product market fit, you are likely feeling pretty good about expanding into other markets. But I have found operators consistently underestimate the amount of change and localisation that they need to make as they expand to new segments and markets. This is especially true for international expansion, where it is easy to believe that customers all over the world are the same (they’re not). One classic mistake is expanding from the US to the UK (and vice versa). Your product may only need 10% localisation and stay 90% the same. But that last 10% will inevitably be what you need to localise your product enough to be able to scale and effectively compete in the new market. And trust me, the 10% will also require way more effort than you realise.
This is a factor which is internal to the company. Do you have the resources (and capital) to execute an S-curve expansion? Do you need to focus on what you have right now, and not distract teams with a new initiative? In my experience, it is always better to break off small teams rather than look for fractional support from core teams. But for scrappy startups that are already small, lean, and moving fast, that may still not be possible. You may also have to raise more capital in order to support that next S-curve of growth, which is an intensely distracting strategic project on its own.
These are the factors that I believe are most important, based on my accumulated learnings. You may have others that you may want to include as well.
When you're building a startup, it's tempting to focus on the biggest possible market. It can feel like the widest opportunity and the clearest path. But for all of the reasons outlined above, that can lead to trouble.
So instead of just thinking about TAM (total addressable market), I encourage you to think about opportunity sizing holistically: what are the most important factors for success? Hopefully this will present a good framework to set your team up for success and make good decisions.
This post was originally published on Daniel Shi's LinkedIn.