The Falacy of the Total Addressable Markets
The Chinese Market fallacy in business planning….
Most every guide to a business planning process includes a section that describes the need for identifying the potential market size, sometimes called the total addressable market. The exercise usually starts with some governmental or Gartner-like information source to identify a global or regional segment. The planner is then instructed to make some assumptions that better restricts the addressable market, but typically the remaining market is still huge. Based on this information, inexperienced (or deceiving) business champions will compare their first few years cost against some percentage of this huge market as justification for proceeding with the business plan which I believe results in the common market penetration mistake I call “Chinese Marketing”. This is a term that I intend to push into the business vocabulary: “Chinese Marketing” is the fallacy that you can create a successful business based on getting a very small percentage of a huge market.
The concept of Chinese Marketing comes from a hypothetical business case involving a business plan to market toothpaste to Chinese consumers. If there are 1.25 billion Chinese and all ultimately use ten tubes of toothpaste per year per person and each tube costs one dollar, then the Chinese toothpaste market should be about $12.5B/year. If we create a toothpaste company and get only one tenth of one percent of the market, we have $12.5m in sales per year. Does it not then seem plausible that we could launch a brand and pay salesmen, and be profitable with revenue like that? Actually no. The reality is that we will either get something over 10% of the market or virtually none. More often than not, it is the latter.
In 1981, Jack Welch took over General Electric and discovered that only a handful of GE’s 350 business units had become Number 1 or Number 2 in their respective markets. He also learned that it was the first and second tier businesses that were the profitable units. One of the main principles that brought GE back to powerhouse status was Jack’s ruthless focus on being Number 1 or 2 in every business market. If a division could not achieve Top 2 status, then GE would strongly consider exiting that market by selling off the division. In a similar way, I once worked for a VP of Sales who used to say that “markets want two strong players and one weak spoiler”. I am not sure where his wisdom came from, but I do see enough anecdotal evidence to repeat saying it myself. I somehow doubt that there is much profit to be made in digital cameras except for Cannon and Nikon. The others just work far too hard to get too little revenue.
My third attack on Chinese Marketing is based on Malcom Gladwell’s “Tipping Point” thesis where he describes the need for a core, infected group before new ideas can spread to larger markets. This means you need 70% of some sub-market before you can hope to get 15% of a larger market. While this thesis was based on “new ideas” and not something as mundane as toothpaste, I would not be at all surprised to find that brand ideas behave like “new ideas” and again I see anecdotal evidence to support this.
The correct approach to selling toothpaste in China is, I believe, to break the market into smaller units so that we can quickly reach a dominant state in one subgroup and then sequentially move to larger subgroups. Once we dominate our first, small sub-market we have “tipping point” behavior working for us and we are likely to have “Lynch #1+#2” [MATT: I DON’T KNOW WHAT “LYNCH #1+#2” IS. DO YOU MEAN LAUNCH #1, FOLLOWED BY LAUNCH #2?] profitability working for us. This first submarket domination success forms a stable state (a base camp in mountain climbing terms) that we can use to launch encore and derivative offerings that will gradually enlarge the size of the market we want to penetrate. In this way we can develop in cycles whereby each market push results in a new, larger stable state.
An example: in the early 1980‘s, a new bicycle front fork suspension was developed by Rockshox and sold to hardcore, off-road mountain bicyclists. This group was indeed a small market at the time, and the new market entrant dominated it. The total market of bicycles that could use a front suspension (as evidenced by nearly all bicycles having a front suspension now) is today huge. However, I suspect their market entrance business plan focused initially only on the hard core mountain bikers, then focused on high-end US recreational street bicycles, then European city bicycles, etc.
A business development plan needs to evolve. Total addressable markets are important for understanding that there is enough space for long term growth, but this long term growth must come from a series of successfully targeted market niches. Also don’t forget that target niches can be expanded by selling more product to the same niche and not just relying on addressing larger markets for the same product.
In short, to enter a new market we must first focus narrowly and then adapt to the larger market as the product or service becomes successful. We then need to test different market niches and additional products applied to our existing niche and where we see signs of success, we focus.