Venture capital is the business of hitting home runs. But must a startup have the potential to capture the vast majority of market share in its category to earn an investment? I don’t think so.
A few days ago, the co-founder and CEO of Thumbtack, Marco Zappacosta, came on TechCrunch’s Found podcast to talk about building his home services startup. I asked him what was next for Thumbtack, considering the startup is 15 years old and was last valued at $3.1 billion. I thought he might talk about a potential exit, but his answer surprised me.
“For our industry, [the adoption of booking home services online on a platform like Thumbtack] is less than 10%. We are still in the very early days of this sort of transition in evolution. I think people don’t appreciate how big this category can and will be,” Zappacosta said. “It also speaks to what we’re still trying to do, because we think we’re still early in this whole sector.”
Thumbtack shares that 10% figure with a handful of other players in the space, including TaskRabbit, Angie’s List and other startups like Jiffy. In home services, a company only needs to grab a few percentage points of the overall market share to be a multi-billion-dollar business.
If you think about it, most established categories look more like a handful of winners than just one. In the travel sector, there is Booking.com, Trivago and Kayak. Even established categories like credit cards see both Visa and Mastercard dominating the market.
Even markets with a seemingly dominant player can support multiple winners. In music streaming, Spotify seems like the clear victor in its category, but it has only 31% of the global streaming market — that’s significant, but there’s still a good amount of market share left for its competitors like Apple Music, Tidal, Deezer, Pandora, and SoundCloud. And while some markets like treatments for rare blood diseases may not be large enough to support numerous successful players, most do.
But I do get why venture clings to its winner-take-all mentality. VC funds can’t exactly invest in their favorite four companies in a category that are all competing directly against each other. That is not only bad practice, but it also risks leaking proprietary information.
Lily Shaw, an investor at OMERS Ventures, wrote a blog post earlier this year on this topic after asking fellow investors why they always said they were looking at investing in the absolute winner and not really getting any good answers.
“A lot of people understand market competition is an important factor in building a business, but most people can’t tell you why it really matters,” Shaw told TechCrunch+.
She then pointed to Flexport’s role in changing how container shipping works as an example: While Flexport is an $8 billion business, it seems crazy to think it would be the only company that ends up innovating in the $240 billion container shipping industry, where people still do half of their daily tasks over phone and text. She doesn’t buy the notion that every company should be a platform of services for an industry, either.
This dynamic adds a layer of complexity for VCs when they’re vetting potential investments, because they have to bet on which company could etch out more market share than its competitors.
“You have to bet on a single company or a single theme or subsector or thesis that you believe is going to break out. That is where the art and science in investing comes out,” Logan Allin, the founder and managing partner at Fin Capital, said. He added that there are definitely subsectors in fintech — where he focuses — that will likely support a number of winners or have space for a large company with numerous others maintaining meaningful market share.
Fin Capital invests across multiple stages, and Allin said deciding which companies will stand out at the later stages is significantly easier than at the early stages. Late-stage firms have more information available, such as customer feedback, traction data and revenue, that help investors make a more informed choice.
With early-stage firms, meanwhile, Allin said it’s the nuances that show which companies might be able to gain a little more market share than their competitors. For one, it’s ease of integration and distribution.
“The No. 1 thing is a novel distribution approach, period,” Allin said. “You need a great product, engineering and design, but it’s all about execution.”
Lia Zhang, an investor at Makers Fund, which focuses on digital entertainment, agreed. She said that 75% of Makers Fund’s investments are in gaming studios that sometimes have some overlap. But it’s still a smart strategy, because even if two studios are building games in the same genre, different distribution models will help those games reach different audiences.
“On the community side, there could be games that are [free to play] going after very different communities,” Zhang said to illustrate her point. “[One could be] going after college students and [it could use] that as its initial hook and build a college league to start. That would likely also target a younger demographic and go about building the community in a different way.”
Shaw said she wouldn’t be surprised if this notion of investing in markets where a number of players can exist and thrive may become an even bigger part of the venture conversation, given how antitrust and competition regulation in the U.S. is developing.
The U.S. FTC has taken an increasingly tougher stance on mergers and acquisitions in the country, challenging what many think is an unprecedented number of deals this year. While the regulator has failed to block some deals in court, as recently seen with the Microsoft-Activision Blizzard case, it is still trying to implement stricter competition and antitrust rules. Dealmaking appetite has also reportedly waned following the FTC’s tougher stance.
Still, regardless of whether consolidation becomes a less viable strategy, VCs shouldn’t get too hung up on a company’s chances of winning an entire category, because most won’t. And that’s fine.