If you want to get rich, the irony is that small markets are often better than large ones.
Sometimes I am asked “why are you still in Singapore?” The question behind the question is: “Cedric, I want to aim for a billion dollar outcome. I cannot imagine being a founder if the upside is not at least a billion dollars. Why are you still in Singapore, where the upside is so small?”
I suppose another point I should have clarified in this piece is that small markets don’t necessarily mean local markets — you could be in a niche market that also happens to be global. Much of the Mittelstand is like this, for instance. The important thing is that your market is contained, and you have some advantage that ensures a continued hold on it. Knee, of course, argues that this is mostly some kind of (relative) scale advantage. His argument is worth taking seriously.
My first thought, which I’d love to get your reaction to, @cedric , is a contrast with effectuation. In Action Beats Prediction, you quoted Sarasvathy:
In fact, several of the expert entrepreneurs I studied explicitly stated that being in a market that could be predicted was not such a good idea, since there would always be someone smarter and with deeper pockets who would predict it better than they could. But being in an unpredictable market meant that the market could be shaped through their own decisions and actions working in conjunction with pre-committed stakeholders and customer-partners.
To me, Knee’s analysis presented in this article seems to assume that markets are more-or-less fixed. Whereas the entrepreneur assumes that his own actions will influence and change the market, and hopefully to his benefit.
Does Knee take into account things like innovation or disruption that change the texture of markets?
Knee does take innovation or disruption into account, because the book focuses on analysing the defensibility of platform companies in the digital world. But in this particular case/chapter, he doesn’t — he merely provides an analytical framework to explain why certain markets like these exist. I found this incredibly helpful because I’d been searching everywhere to explain the supernormal returns my old company and boss enjoyed, but I couldn’t find anything … for years. And then I met George Ho, and he pointed this out to me, and I was like “Ahhh … yes. This makes sense.”
I think you can reconcile Sarasvathy’s and Knee’s views this way: you can recognise these dynamics that Knee describes in existing markets once they emerge. However, the journey to discover that market and realise that these dynamics are possible is definitely effectuation.
Take my old company as an example. We had no idea the end point would be this defensible, stable market state that allows for reliable annual returns. (Well, not for me, but for my boss.) And that’s ultimately why we had a shot — nobody knew this configuration was stable, and we faced sloppy, low-skill competitors.
My favourite cc article so far!, helps to explain why we have so many wealthy SME owners and they are not getting disrupted by bigger companies. Also to add-on, there are also regulatory opportunities that can help build and maintain this advantage I.e when your company is better than your competitors at understanding, navigating the regulations and profiting from it.
Also one of mine! Been thinking about it ever since. I’ve been so steeped in startup culture/expectations, excited to dig a bit more into this side of the business world. The book looks great outside of this chapter too.
I do recommend reading Hidden Champions — that’s probably more aligned with the ‘small-to-medium-sized companies that are super successful’
But, yes, The Platform Delusion is really not bad, as I’ve mentioned elsewhere.
@cedric Curious what is your takeaway is if you operate in a very fragmented medium sized market? In healthcare services in the US there is often a long tail of profitable companies able to meet the definition of the owner being able to dividend out a few million annually to themselves. Maybe services businesses are a bit of a different animal in comparison to the product based businesses discussed here?
This is a super interesting scenario.
I like how Knee’s framework is out there now, so we can use it as a jumping off point to discuss other market structure setups.
So I’m willing to bet there’s some kind of:
I don’t think this is necessarily a services vs product company dynamic. Some types of services business can benefit from supply-side scale economies. Similarly, I can think of one or two services businesses in Singapore where the principals pull out single digit million high six digits in cash each year, and there’s no moat — but both operate in such small, overlooked niches that they don’t experience competitive arbitrage for say 20 years, because not enough folks know that it’s lucrative to compete.
Edited because I’m wrong: these are not million dollar businesses in terms of owner earnings!
There has been a lot of private equity rollups in markets like the US and Europe, where you buy up hundreds of business in waste management or vets or dentists or whatever and consolidate. More recently VCs started doing AI rollups, where you use AI to manage these businesses more efficiently. Heartland Dental bought thousands of dental practices for example. These consolidate lots of small local markets into larger businesses. And often increase prices and grow monopoly powers…
The distortion in pricing is real because the consumer of services (the patient) is typically not bearing the cost of the service - their health insurance payor is, and by proxy their employer is. This dynamic + local monopolies from Health Systems often leads to crazy pricing like $1,000 billed for a toothbrush and $400 for a box of tissues (PPOs and the $444 Box of Kleenex | Insurance Thought Leadership) as part of $180,000 surgery bills. These pricing dynamics in the industry cascade down to smaller provider groups.
Additionally, US licensing boards artificially constrict the supply of providers to maintain a supply / demand imbalance that keeps prices high.
However, the long tail of industries that allow for millions to be pulled out annually extends outside of the medical field in USA. There is a whole eco-system of micro private equity, called Search Funds that targets buying companies that generate hundreds of thousands to low millions in EBITDA. Stanford tracks how these investments perform and they have been the one of if not the highest returning asset class with an average internal rate of return (IRR) of 35.1% across companies studied - https://www.gsb.stanford.edu/faculty-research/case-studies/2024-search-fund-study. There are a variety of businesses (roofing / HVAC / landscaping / micro-SaaS / Health Care Services) that are popular search targets.
Maybe this is a function of how wealthy, and expensive, America is?
Does anyone know anything about Henokiens? Seems like it could be a treasure trove of case studies in longevity within small markets.
@TylerD this is a fantastic find!
I don’t know them too well, but they are connected to INSEAD’s family business club - which is a fairly well known one at the business school.
Example of an AI rollup here in Singapore.
I’ve also recently become kind of obsessed with these companies, but I also think there’s a gigantic element of survivorship bias, that actually makes this less actionable. I got obsessed because I was talking to a friend about this company that was purchased by a private equity firm. The husband-wife founders had something like 12 employees (almost entirely call center folks, who are not expensive) and they were pulling in $10M a years in revenue! The business probably wasn’t going to take over the world (though maybe the PE firm disagrees), but unsurprisingly, the founders were pulling in a shitton of cash annually from this business before they sold it. I’ve been looking for and talking to people about these types of businesses since.
One pattern I’ve seen is an almost absence of patterns. The husband-wife founders happened to be parents AND lawyers and started a business that mixed the two in an interesting way. Another founder was a guy who’d dropped out of tenth grade, worked a bunch of random jobs, then happened to work for a large payroll processor where he found this incredibly niche business related to payroll processing that was insanely lucrative and that none of the payroll processors themselves wanted to touch. A third was a garbage truck driver in LA who realized that people would pay to have their garbage bins cleaned professionally. The common thread from a bunch of these stories seemed to be someone who had some weird mix of experiences that opened a door and a very unique and weird insight up to them.
I’m not knocking any of these founders — making money doing anything is really fucking hard, so all these founders are clearly special. But it doesn’t seem like a story that’s possible to try to emulate without relying on massive survivorship luck. And for all the VC-funded businesses that slowly die off, I think there are many more of these types of “small market” businesses that both die off, and — unlike the large-market businesses with some external funding — also result in the founders losing their home because they literally mortgaged the house.
This question of minimizing survivorship bias, btw, is why I liked the Heart of Innovation so much — I view that book as a way to maximize control in what is otherwise a hyper-parlay bet, founding a company. I don’t think any of the companies HoI talked about are ones that will ever land on the cover of some glossy magazine, but they definitely do not seem like the kind of companies @cedric is describing that will cap out at a “small” revenue but generate meaningful annual free cashflow (like single-digit millions or more).
I think the summary of my stupidly long post: I don’t see is a very practical to intentionally try to build a “small market” business. One, I suspect what we see is a result of massive survivorship, but smaller markets are, I suspect, order of magnitude more difficult to accurately spot than larger markets (it’s a lot harder to spot an ant than a cockroach!). Two, while a VC-driven business is still not likely to make its founders billionaires, they are also far less likely to put the founders in a position where they haven’t been able to pay themselves for years and/or have mortgaged their literal house. Third, I’ve come to believe (but don’t have good evidence) that businesses below some threshold, say $5 or even $10M annually, are just inherently more sensitive to some fickle market dynamic utterly wiping them out, whereas businesses above that threshhold are less sensitive (closer to what Mark Suster refers to as “unkillable”, though I can’t find where he said that, so maybe I’m imagining it).
I’m partially posting this because I’d like to be shown otherwise, as I really want to start a business exactly like what Cedric is describing!! But I suspect it’s like that Buddhist metaphor about how grasping at a handful of sand too tightly actually just causes you to squeeze it out. In other words, it’s really fucking hard to architect that type of business, you just either create it or you don’t.
$10m is the figure usually quoted for startups, once they get past that they have a reasonable chance of surviving, below that they don’t.
I really should write a blog post about how ‘survivorship bias doesn’t apply to the calibration case method’ because the point is idiosyncratic survival. But I digress …
@spal you’ve actually touched on the main lesson we wanted to deliver in Speedrunning the Idea Maze. I’m not sure I can communicate this as well in an essay, or in a forum post, but here goes. (It’s more impactful when delivered in a weekly cadence, with cases as shared ‘synthetic’ memory).
First: idiosyncrasy is the point.
Every successful business is a unique configuration that works for that specific market, founder, opportunity set, and so on, and only at a specific point in time.
What you want is an explanatory framework that explains how founders find that unique configuration that works for them. The only framework that I’ve found to have such explanatory power is effectuation by Dr Saras Sarasvathy. It is the primary conceptual framework in the Idea Maze concept sequence (with 28 cases now and counting; you can read this framework and then randomly read a selection, I guarantee that you should be able to see the framework in just about every case).
The framework is very simple. A longer explanation is available in the following two essays: 1) The Idea Maze is a Useless Idea (which talks about the lack of patterns) and 2) When Action Beats Prediction (which explains the theory). If you prefer a YouTube explanation, see here where I kinda nerd out about it a little too much.
A short explanation follows:
You can also invert the three principles to get at three common mistakes more novice entrepreneurs make:
So why do I bring this up? If you take a step back, effectuation is the only reasonable method to find a viable, cash generative, moat protected business that works! If it were possible to look at a situation analytically and come up with a quality business idea in a single glance, someone would have already done so. A high quality business must be built around some kind of odd configuration — that makes you go “huh, I never would’ve thought that could’ve worked”. And in fact that explains my experience with the Point of Sale company also.
Fortunately, reality is weird and full of hidden detail that can only be uncovered through action. So entrepreneurs know that the right way to find such a business is to take action to generate information. It is therefore quite easy to figure out who are the entrepreneurial types:
I think you’re quite entrepreneurial, Syam, so I’m preaching to the choir here. So the answer to ‘how to find businesses like this is’:
Don’t do this analytically. Do it by taking lots of affordable loss bets, and be prepared to do it over decades. Basically: think like an Asian tycoon.
I am not an entrepreneur, so no credibility there, but most of my work hours are taken up by open ended research on the one hand, and working on emergencies with no clear solution at the outset on the other
The short short version of what Cedric has laid out that I try to keep in mind is Herb Kelleher’s famous quote:
We have a strategic plan, it’s called doing things.
It’s not meant to denigrate strategy or vision (Kelleher’s track record was good on both counts) but to point out that what Sarasvathy calls effectuation is critical to progress in business
Kelleher and his cofounders started in a small market, providing regional passenger air service between 3 cities in the U.S. state of Texas (after four years of litigation to secure the right to operate) and he ended up a billionaire. Another idiosyncratic case that may be worth looking into
Wonderful post @cedric , having read some of the articles where these ideas are referenced I think this post does a great job of tying it all together.
How do you reconcile effectuation and “the idea maze is useless” with sales safari, JTBD, the heart of innovation?
My own takeaway is that these techniques all fall into the “turn folks into partners” part of effectuation. Start placing bets and use conversations with stakeholders before, during and after making those bets to parlay into more interesting opportunities if they present. But avoid getting caught up in “research” with these techniques, without actually getting some skin in the game.
Is this how you see things too?
I fall firmly into the “oh that can’t possibly work because …” bucket, so trying to figure out how I can avoid doing that and create more of an action bias in myself without feeling like I’m wasting time.