In a recent email newsletter, CB Insights published the graph below outlining the similar growth trends in micro VC tech deals and microbreweries in the US beer industry. And although the comparison was mainly for show, there’s a deeper truth hidden behind it in which I’ve firmly believed for a long time: If you want to win in a maturing industry, you need to be either a Budweiser or a laser-focused craft brewer.
I’m far from the first to espouse this belief. Michael Porter, arguably the father of business strategy consulting, first described a set of business strategies which firms can employ to achieve a sustainable competitive advantage. These divide into two sets. The first is differentiation & cost leadership strategy for those firms with a broad market scope, and the second is a segmentation strategy for those with a narrower market scope.
In the case of the first strategy, a company can differentiate through aspects like features, design, or brand, or they can win on price through production efficiencies. Bud Light wins using its brand marketing and cost strategy, for instance.
As for that second approach, those that win using segmentation strategy employ a much more narrow focus. Essentially, this is about specialization. The scope of a company’s offering must be such that it only appeals to a subsegment of consumers.
Now, it’s easy to assume that the most profitable approach would be to build the biggest or broadest businesses and claim the largest share of the total market. However, in reality, that’s only partially true. Yes, some of those companies are very successful, but empirical research shows that firms with lower market share and greater specialization also have the potential for outsized industry profits.
So what does this mean for venture capital? Many of the larger firms with broader strategies investing across multiple sectors, geographies, and stages can profitably succeed. But so can the many smaller firms that have narrower and much more focused strategies in one or more of those areas.
In light of that reality, all the hand-wringing around whether too many new VCs are entering the market is a bit overblown. Some are exclusively seed-stage specialists, like us at NextView Ventures; some are sector-specific, like OpenView (no relation to NextView) with B2B SaaS; others are geography-specific, like Frontline, which is finding success by being a rare early-stage firm in Europe, in addition to focusing on startups trying to enter the US market from abroad. Not all those pursuing a segmentation strategy fit the micro VC moniker, but many do because of the lower barriers to entry in starting with a smaller fund size.
As for the increased number of VC firms entering the market, while it’s certainly getting harder for entrepreneurs to navigate the various brands, it’s by no means oversaturation when it comes to the success of those firms. Through more focused strategies targeting a specific subset of entrepreneurs, many of these VCs will build enduring businesses. The firms who deliberately embrace a unique strategy which fits into their place in the landscape will have a structural advantage.
It’s not all good news, however, as there still remains one very dangerous place to be in a mature market. If you can win by being the Budweisers or Andreessen-Horowitzes of the world or you can win by being the local craft brewers or hyper-focused VCs, the danger zone thus becomes the middle.
Porter’s research supports this notion too, pointing to the issues in having moderate market share and being neither a dominant, far-reaching leader nor a focused player. These firms lack both the resources to compete with the Budweisers and the refined skills and ravenous “fans” to compete with the specialists. Large firms win on scope or cost, small ones win on focus, and those stuck in the middle are just that — stuck.
The beer market in the ‘90s is a salient example of this theory playing out in action. The top brewers with meaningful brands and resources could command market share and profitability. Despite an average product, they relied on a widely known, heavily marketed name as their differentiation, along with value-based pricing and large-scale operations to win on cost. This is a classic broad market approach.
But during that same decade, the microbrewery phenomenon emerged, and it continues to boom today. All of these breweries compete with a segmentation strategy, focusing in a specific region and/or concentrating on a specific style or type of beer. A Stone Brewery IPA doesn’t taste like an Ommegang Witte or the Belgian-style ale found only in your local brewpub. And all of these taste very different than a Bud Light.
Yet despite that bifurcation, the two segments not only coexist, they thrive.
As the venture capital space continues to mature, we’re witnessing a similar pattern. Elite, top-tier firms have a sustainable competitive advantage with both entrepreneurs and LPs alike, given their brands, their vast networks, and their self-reinforcing success. They also don’t focus their strategies on any particular location, sector, or stage. Instead, they find themselves in a diverse set of broad-market competitors doing whatever it takes to identify and catch the next unicorn. Just to cite two examples from the past year, NEA recently raised a $2.6 billion fund and Andreessen Horowitz raised $1.5 billion.
All the while, so-called micro VCs continue to thrive and play an increasing role in the ecosystem, many of which are yielding tangible results despite the alleged “saturation” of the market.
Ultimately, all of this is a great thing for entrepreneurs. Just like beer drinkers, top entrepreneurs now have an increasing amount of choice. More VCs mean more sources of capital, especially at the seed stage. And with the increased competition, more and more firms are turning to founder-focused initiatives like platform and other in-house services to compete. These are only positives for the entrepreneur.
Whether you’re running a venture firm or a brewery, the most profitable approaches are to go big & broad or narrow & specialized. As the VC market continues to mature, the results of these strategies will become much clearer.
So, cheers to your VC.
David Beisel is a Co-Founder & Partner at NextView Ventures, a seed-stage venture capital firm which helps Internet founders get their companies off to the best possible start and also creates online resources for seed stage companies at ViewFromSeed.com. David was previously a Vice President at Venrock and a Principal at Masthead Venture Partners. He also co-founded Sombasa Media, an e-mail marketing company successfully acquired by About.com where David served as VP Marketing. David has an AB in Economics from Duke University and an MBA from the Stanford Graduate School of Business.