Blitzscaling: The Lightning-Fast Path to Building Massively Valuable Companies. Reid Hoffman
It’s not easy to judge the size of a market, or what pitch decks and venture capitalists often refer to as TAM (total available market). Predicting TAM and how it will grow in the future is one of the main sources of uncertainty in blitzscaling. But predicting it correctly and investing accordingly when others are still paralyzed by fear is also one of the main opportunities for unexpectedly high returns, as we’ll see in the cases of Airbnb and Uber.
Ideally, the market itself is also growing quickly, which can make a smaller market attractive and a large market irresistible.
In Silicon Valley, the competition for venture capital exerts a strong pressure on entrepreneurs to focus on ideas that are going after big markets. Venture capital firms might raise hundreds of millions or even billions of dollars from their investors—limited partners like pension funds and university endowments—who are seeking above-market returns to compensate them for taking a chance on privately held companies rather than simply investing in the Coca-Colas of the world. To deliver these above-market returns, venture capital funds need to at least triple their investors’ money. A $100 million venture capital fund would need to return $300 million over the typical seven- to ten-year life of a fund to achieve an above-market internal rate of return of 15 to 22 percent. A $1 billion fund would need to return $3 billion. Since most venture capital investments either lose money or barely break even, the only realistic way that venture capitalists can achieve these aggressive goals is to rely on a small number of incredibly successful investments. For example, Benchmark Capital invested $6.7 million in eBay in 1997. Less than two years later, eBay went public, and Benchmark’s stake was worth $5 billion, which is a 745 times return. The specific fund that made that investment, Benchmark Capital Partners I, took $85 million from investors and returned $7.8 billion, for a 92 times return. (The initial investors in Facebook did even better, but were individuals rather than firms.)
Given the desire for home runs like eBay, most venture capitalists filter investment opportunities based on market size. If a company can’t achieve “venture scale” (generally, a market of at least $1 billion in annual sales), then most VCs won’t invest, even if it is a good business. It simply isn’t large enough to help them achieve their goal of returning more than three times their investors’ money.
When Brian Chesky was pitching venture capitalists to invest in Airbnb, one of the people he consulted was the entrepreneur and investor Sam Altman, who later became the president of the Y Combinator start-up accelerator. Altman saw Chesky’s pitch deck and told him it was perfect, except that he needed to change the market-size slide from a modest $30 million to $30 billion. “Investors want B’s, baby,” Altman told Chesky. Of course, Altman wasn’t telling Chesky to lie; rather, he argued that if the Airbnb team truly believed in their own assumptions, $30 million was a gross underestimate, and they should use a number that was true to their convictions. As it turns out, Airbnb’s market was indeed closer to $30 billion.
When evaluating market size, it’s also critical to try to account for how lower costs and product improvements can expand markets by appealing to new customers, in addition to seizing market share from existing players. In 2014, Aswath Damodaran, a professor of finance at NYU’s Stern School of Business, estimated that Uber was probably worth roughly $6 billion, based on its ability to ultimately win 10 percent of the global taxi market of $100 billion, or $10 billion. According to Uber’s own projections, in 2016 the company processed over $26 billion in payments. It’s safe to say that the $10 billion market was a serious underestimate, as the ease of use and lower cost of Uber and its competitors expanded the market for transportation-as-a-service.
As Aaron Levie, the founder of the online file storage company Box noted in a tweet in 2014, “Sizing the market for a disruptor based on an incumbent’s market is like sizing a car industry off how many horses there were in 1910.”
The other factor that can lead to underestimating a market is neglecting to account for expanding into additional markets. Amazon began as Amazon Books, the “Earth’s Biggest Bookstore.” But Jeff Bezos always intended for bookselling to serve as a beachhead from which Amazon could expand outward to encompass his massive vision of “the everything store.” Today, Amazon dominates the bookselling industry, but thanks to relentless market expansion, book sales represent less than 7 percent of Amazon’s total sales.
The same effect can be seen in the financial results of Apple. In the first quarter of 2017, Apple generated $7.2 billion from the sale of personal computers, a category the company pioneered and once dominated. That’s a great number to be sure, but, over that same financial quarter, Apple’s total revenue was a whopping $78.4 billion, which meant that Apple’s original market accounted for less than 10 percent of its total sales.
My Greylock colleague Jerry Chen, who helped Diane Greene scale VMware’s virtualization software into a massive business, likes to point out, “Every billion-dollar business started as a ten-million-dollar business.”
But whether you are creating a new market, expanding an existing market, or relying on adjacent markets to get to those “B’s” that investors want (baby), you need to have a plausible path to get from here to there. This leads us to one of my favorite growth factors to discuss with entrepreneurs: distribution.
The second growth factor needed for a strong, scalable business is distribution. Many people in Silicon Valley like to focus on building products that are, in the famous words of the late Steve Jobs, “insanely great.” Great products are certainly a positive—we’ll discuss the lack of product quality as a growth limiter later on—but the cold and unromantic fact is that a good product with great distribution will almost always beat a great product with poor distribution.
Dropbox is a company with a great product, but it succeeded because of its great distribution. In an interview for Reid’s Masters of Scale podcast, founder and CEO Drew Houston said that he believes that too many start-ups overlook the importance of distribution:
Most of the orthodoxy in Silicon Valley is about building a good product. I think that’s because most companies in the Valley don’t survive beyond the building-the-product phase. You have to be good at building a product, then you have to be just as good at getting users, then you have to be just as good at building a business model. If you’re missing any of the links in the chain, the whole chain is broken.
The challenge of distribution has become even greater in the “mobile first” era. Unlike the Web, where search engine optimization and e-mail links were broadly applicable and successful distribution channels, mobile app stores offer little opportunity for serendipitous product discovery. When you go to Apple’s or Google’s app store, you’re searching for a specific product. Few people install apps just for the hell of it. As a result, the business model innovators who have succeeded (e.g., Instagram, WhatsApp, Snap) have had to find creative ways to get broad distribution for their product—without spending a lot of money. These distribution techniques fall into two general categories: leveraging existing networks and virality.
A) Leveraging Existing Networks
New companies rarely have the reach or resources to simply pour money into advertising campaigns. Instead, they have to find creative ways to tap into existing networks to distribute their products.
When I was at PayPal, one of the major vehicles for distribution of our payment service was settling purchases on eBay. At the time, eBay was already one of the largest players in e-commerce, and by the beginning of 2000 already had ten million registered users. We tapped into this user base by building software that made it extremely easy for eBay sellers to automatically add a “Pay with PayPal” button to all of their eBay listings. The amazing thing is that customers did so even though eBay had its own rival payments service, Billpoint! But sellers were required to add Billpoint manually to each of their listings; PayPal did it for them.
Many years later, Airbnb was able to perform a similar feat by leveraging the online classified service Craigslist. Based on a suggestion from Y Combinator’s Michael Seibel, Airbnb built a system that allowed and encouraged its hosts to cross-post their listings to the much-larger