So You Think the Market is Too Small? Not So Fast.

Great Team + Mediocre Market = Mediocre Outcome
Great Team + Great Market = Great Outcome

If you are involved in venture or growth equity, at one time or another, you have probably heard some version of this. While it is absolutely true, conventional wisdom holds that one of the key criteria for being a great market is to be big. That is often the case, but it is not always the case.

There are many markets that while small, can still deliver a great outcome. The formula for a great-but-small market?

  1. It is in a protected niche that requires extensive specialized capabilities.
  2. It is early in the adoption cycle so there are considerable growth prospects in the core.
  3. When the market matures, there will likely be one dominant winner.

For investors willing to buck the big TAM trend, companies in great-but-small markets typically carry lower valuations and offer the opportunity for superior returns for 4 reasons.

  1. Winners can truly dominate niche markets. It is not unusual for leaders in niche markets to achieve market penetration (not share, penetration) of 40%, 50%, 60% or even 70%. If a company can achieve a 70% penetration of a market with an $80M Total Available Market, that is $56M in revenue.
  2. Dominant vendors have pricing power. Market sizing estimates typically underestimate the opportunity because dominant vendors can raise prices considerably over time.
  3. Dominant vendors find new opportunities. Dominant vendors typically enjoy incredibly close relationships with the industries they serve. As a result, their customers will often bring them new ideas or ask them to solve related problems that open up new opportunities to expand the TAM.
  4. Dominant vendors are ideal platforms for add-on acquisitions. With their position in the market, dominant vendors can cross-sell products in a way most companies cannot, creating unusually high returns from add-on acquisitions while also expanding the TAM.

SciQuest: Building a $100M company in an $80M Market

A prime example of a company succeeding in a small-but-great market is SciQuest. SciQuest, a dotcom bust, had successfully repositioned itself as a provider of SaaS procurement solutions for chemistry-driven research. The market was definitely a niche – consisting largely of the Top 200 research universities and the Top 25 pharmaceutical companies.

In 2004, Topline’s evaluation of the market, conducted on behalf of potential acquirers, sized the market at $80M. The acquirers went ahead and bought the company for $25.5M. Six years later in 2010, the company had effectively dominated its niche, having sold to more than half of the market. In September of that year, SciQuest went public at a valuation of $193M on $42M in revenues, giving the investors a 7.6x return. In 2014, the company posted revenues of $101M and in 2016, was bought out by KKR-Accel for $509M.

“Topline’s $80M market sizing was right on the money for what we were doing in 2004. What our investors banked on is that we would become the gorilla in our core markets and then figure out how to take the business to the next level…and that is exactly what happened.”- Steve Wiehe, CEO, SciQuest, 2001 to 2016.