## Startup Advice: Conquer “Toy” Markets

Co-Founder Ai

# Many of the world’s largest companies started in markets so small they seemed toy-like. Over time, each of these companies either grew within their existing markets or created new ones to secure leading positions. Despite this, founders often spend time trying to demonstrate that the markets they are targeting are already enormous.

It’s understandable that founders focus on the size of their markets. It’s much easier to claim that a superior product can displace industry leaders in a static market than to assert that something entirely new will create or transform a market. The first argument is based on logic, while the second requires faith.

Founders frequently discourage themselves from creating new things because they cannot fully answer the question, “How big will this become?” Founders who push forward and build a product without a clear answer to this question are often stalled by investors.

Investors need to recognize the importance of betting on toy markets. These are the individuals who repeatedly discover that the biggest companies initially appeared toy-like.

Amazon was created to sell books online when relatively few people were using the internet. Google was a search engine built on search algorithms, which themselves were not massive enterprises. eBay was founded to sell Beanie Babies.

Unfortunately, investors who achieved similar successes tend to have hindsight bias. Today’s markets are so large that it’s hard to remember that they weren’t always so. It’s easier for leading investors to pretend they knew from the start how scalable something would become rather than admitting it was a risky venture. Meanwhile, new investors find it challenging to believe that markets can grow as rapidly as they do now.

Founders also need to overcome investors’ aversion to risk. The idea is that investors aren’t punished by their bosses or senior partners for following the crowd. When no one else wants to fund a social network, financing one represents a significant risk. If the investor makes a big bet and it doesn’t pay off, they may look foolish for taking such a crazy gamble. An investor could be fired or unable to attract another fund.

On the other hand, if an investor finances a social network while no one else does, and that company becomes worth tens or hundreds of billions of dollars, the investor is hailed as great and extraordinary. Many top investors are reluctant to risk their reputations in this way. Many new investors are unwilling to risk their future careers on such speculative bets.

Founders targeting toy markets who want to raise funds must find the right investors and tell them the right story. Finding investors is merely a matter of talking to many of them to determine who is optimistic and confident enough to take the bet. Reviewing their past investments can help in this endeavor. Once a founder identifies the right investor, there are two different types of stories they can use to illustrate how a toy market can become enormous: “Adjacency” and “Behavioral Change.”

# Adjacency

Arguments for adjacency are the easier path. Founders describe how their product will dominate a small but valuable set of customers. Once the company achieves dominance in that area, it can use this niche as a foundation to capture another, larger set of users who share characteristics with the original group. The company can repeat this process repeatedly, while the actual market it operates in remains vast.

Uber is a good example of this method. Initially, Uber was simply a way to order a black car on demand. This was a market, but not a huge one. Over time, Uber expanded, and the founders revealed their true ambitions—they wanted to handle all transportation options, including those not yet mapped out. They achieved this by moving into adjacent markets: black cars, idle vehicles, logistics, international markets, trucks, and autonomous vehicles.

# Behavioral Change

Behavioral change is a more radical step. It works as follows: “There is no market for what I’m building. However, by creating my company, I intend to change people’s lifestyles. By doing so, I generate endless demand for what I’ve created and reap tremendous rewards.”

This foundational story applies to companies like Standard Oil, AT&T, GE, Apple, Google, and Facebook. Telling such a story as a founder is more about appealing to faith than demonstrating evidence.

Most behavioral change arguments evolve significantly over time, and that’s okay. What’s important is that founders clearly define what will change and are flexible enough to manage the changes they create. For most of its existence, GE was much more than just electric light bulbs.

Companies that are now enormous rarely stick to one narrative. Typically, companies that start as adjacent companies they bet on change user behavior, and companies that change behavior find new clients in unexpected places. It’s sensible to consider both sides of this equation, but at least initially, it’s better to focus on either one model or the other.

# Stock Markets

While most successful startups that provide one of these arguments ultimately raise large sums of money, the market conditions regarding financial mobilization when building a company can greatly influence its trajectory. One of the odd things happening in the startup world is the ever-increasing volume of capital available at all stages of a company’s life. This seemingly heightens the danger of markets being overthought, as founders and investors strive to justify large volumes of investment and the accompanying valuations.

This disadvantages founders. An early-stage company targeting a toy market doesn’t need a large amount of money to start proving it can either change behavior or dominate a niche. This results in lower expectations at each stage, making it easier to meet them, leading to better growth, and more effectively involving founders over time.

In contrast, an early-stage company targeting a giant initial market—let’s say, insurance—usually needs to raise a large sum of money compared to a progressing company to compete with well-funded employees who will inevitably notice them and attempt to crush them. This leads to higher expectations at each stage and reduces equity participation in the distribution of net income along the way. This is worse for both founders and maximizing chances of success.

# The Ideal Balance

It would be nice if there were a standardized basis for evaluating the “optimal” market for a startup. This would allow every player in the system to easily outline the path from a toy market to a mass-adapted market. It would also be somewhat dull, as creating a startup no longer required the use of imagination.

Imagination turns out to be an essential trait that allows founders to see how something small can become something big. It’s what investors need to believe in a founder who is figuring out how to build something that doesn’t exist.

The best founders present their own frameworks for their companies’ success and convince everyone around them that they are right. They use some combination of adjacency and ways to change behavior to achieve success. They adapt to both the market changes they catalyze and those introduced by competitors. These scenarios never look the same twice and are never obvious from the start.

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