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Do You Need a Big Market to Be Profitable?

SmartUp \ Guiding Principles \ Do You Need a Big Market to Be Profitable?

Businesses that understand their potential markets can better utilize their resources to maximize profitability at the lowest possible cost. 

Venture capitalists believe that a company cannot grow fast and reach a large sales volume without a large potential market – somewhere in the billion-dollar range.

VC funds want to capitalize on their investments in other companies either by selling them or listing them on a stock exchange.

In both cases, a given company must grow quickly in order to reach a large enough sales volume to allow it to go public or be sold for a considerable amount of money.

But is this also true for a company striving to reach profitability as quickly as possible instead of insisting on increasisng sales at any cost?

Companies built on the principle of profitability must be efficient and focused and can/should be profitable with sales volumes of 3 to 5 million dollars, sometimes even less. To reach $5 million in sales, it’s enough for the potential market size to be around $100 million and often even less.

Big Markets vs. Small Markets: Understanding Market Segmentation

Every big market splits into a collection of smaller market segments, and every small market is a gateway to many other related markets.

The question then arises as to what defines a market or market segment.

The first and most obvious definition is that a market is a collection of customers who need a product or service.

In the case of a B2B company, one can think of a market segment as a list of all the potential customers for their product offering. This large market and its hundreds of thousands (or millions) of potential clients can be segmented into much smaller groups with more common denominators.

Take, for example, a company that develops payroll management software.

Every country has different wage, labor, and tax laws, multiple tax brackets or income levels, and other unique characteristics embedded in their employment sectors. This makes each country a distinct market segment with its own pool of potential customers.

Additionally, how a product is developed and presented to each market matters. If the product in Israel is fundamentally different from the one in France, then it is also worthwhile for the Israeli product to be offered in Hebrew and the product in France to be available in French.

Even if we focus on the American market only, it soon becomes clear that calculating salaries for doctors and nurses in hospitals with shifts, weekend hours, and overtime looks completely different from calculating the salaries of manufacturing workers who work set hours, Monday to Friday or the salaries of salespeople with complicated commission schemes.

Each of these derivatives is indeed a market in itself with the need for different product specs.

This is also true in cases where the market appears uniform on the surface, but in practice, they are separate market segments. Take, for example, wristwatches.

The functional purpose of a wristwatch is to tell time, so all watches show the time. But that’s where the uniformity ends.

There are watches designed for men and women, unisex watches, and even watches for children. Some watches that are functional, like a Casio and some are fashionable or trendy, like a Swatch.

Some watches are investment pieces and are used to demonstrate wealth, for example, a Rolex, and there are collector watches that sell for $100,000, like Cartier or Breitling. Then there are watches you can buy for $10.

Some watches only show the time, and some watches, like the Apple Watch, are half computer.

Each of these watch market segments is designed for different people and fulfills different purposes. How a new watch company would approach these markets would depend on their product and the customers they’re trying to reach.

Maximizing the Market: Profitability vs. Marketing

In order to be profitable, a company has to sell its products efficiently without spending a lot of money on marketing.

When considering a company’s efficiency, one of the most important parameters is the Customer Acquisition Cost in relation to revenue from the customer over a period of no more than one year.

If a company spends $1,000 on advertising to bring in a customer who only spends $500, it is clear the company will be at a loss. This loss is actually increasing as the company invests more to bring in more and more customers.

On the other hand, if a company invests $1,000 to bring in a customer who spends $10,000, it has a good chance of being profitable if it attracts enough customers.

The cost of acquiring a customer includes all marketing activities, from the salaries of marketers to advertising costs, participation in conferences, public relations and the like. The larger the market to which the company turns, the more diverse it is and the more resources it requires. The narrower and more focused the market, the easier it is to reach the right people with sharp, accurate, and compelling messages.

Take payroll software example.

If instead of trying to sell the software to any US company with employees, we only focus  on US companies with salespeople.

While this seems like a very focused market segment, it is still too wide. There are salespeople in B2B companies who work from the office and sell relatively expensive products and services, and there are millions of salespeople who work in stores and retail chains who are also rewarded with commissions.

The difference in the software will probably be negligible, but the difference in customer type is very large. There is almost no overlap between B2B companies like SalesForce, Marketo IBM, and Boeing and chains with hundreds of stores like Macy’s, BestBuy, or HomeDepot.

You rarely see a VP of Sales from a large chain of stores going on to be a VP of a large B2B company. These are two very different professions; therefore, the marketing channels to reach them will be different, resulting in the segmentation of the ‘salespeople’ market and the subsequent marketing efforts for payroll software.

To map the market accurately, we can use a product like ZoomInfo and create a list of all US companies that sell B2B and have more than 10 salespeople. From this, we are likely to develop a list of several tens of thousands of potential customers.

Even within a B2B company there are different roles that suddenly split the target market between frontline staff, such as salespeople, sales managers, and Payroll Accountants, and those responsible for creating the commission plans, e.g., C-Suite Execs, such as the COO and the CFO.

Once we have detailed lists of the emails and phone numbers of the two target audiences, we can start developing marketing messages for our product.

Reducing the market to a relatively small number of potential customers is a critical step on the way to building a profitable company because it paves the way for lowering the cost of acquiring customers.

Final Thoughts

When identifying the initial market for a product, it may be helpful to think about it as a “bridgehead” or “beachhead.”

These military terms describe a strategic point (often a head of a bridge or a coastal position) where an attacker penetrates the defensive system of their opponent by concentrating their efforts in a narrow area where the defenders can be breached.

Once an attacker breaks through and occupies this strategic position, the rest of the attacking force can flow in and spread out. The most famous military example of a beachhead is the Allied landing in Normandy during World War II on D-Day (June 6, 1944).

When a bridgehead has been established,

In a following article, we will highlight the processes by which a company breaks into their target market and expands its activities in the most profitable way.

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