Valley of Death – Part III

Marketing is perhaps the rarest skill to find. Your customers rarely know what the market will do or what product they need. You can make all manner of calculated predictions but in the end markets are comprised of humans and competitors (some of them are human too) and they are fickle--it's why any good entrepreneur admits luck as the major factor ;-)

A big market opportunity forgives a multitude of sins because if you can identify a clear, large pain point you only have to worry about making your solution work, and work better than your competitors (who will be many if it's a big enough market).

But if it's all about big markets, where's the fun in being a VC? After all, we are supposed to be brilliant--so in deference to the classic laser markets, I would like to discuss the alternate model because it's more relevant to small markets, which are classic early adopter territory.

Let’s think about a component company (most laser businesses are exactly this). Selling a component (i.e., a laser, a laser system, anything that is not an end-user product in its own right) is fraught with challenges, not the least of which is focus--component plays always want to be all things to all people. The laser business is a mile wide but only an inch deep, so you are invariably going to have to sell into multiple vertical markets--the illusion that OEM is better because S&M cost is so much lower is obviated by the need to understand many different markets, customer bases, and evolve multiple sales approaches, which makes the classic recurring process and revenue really, really hard to achieve.

However, if a component is unique, with strong barriers to entry and compelling differentiated technology, chances are it can start to displace the incumbent technologies. There is a point at which the value proposition crystallizes for all customers, the sales process really starts to work, and revenue begins to ramp--grow the sales team and push the opportunity to sell before competition wakes up. No component can own the market for long, but this phase gives you the opportunity to move into much deeper relationships with your customers, and to start to integrate more of their product into your component so that before long you are selling a sub-system for which they are happy to pay more money because it saves them time and integration. You are designing yourself deeper and deeper into their product, making true barriers to entry beyond mere technology.

Unfortunately for most component (or non end-user) sales, its hard to ever become big (telecom bubble not withstanding, in which the whole value chain got turned on its head). At some point you have to break out to the end-user with a whole product solution, otherwise the next bright and shining technology will do to you what you did to the old technologies. This is a difficult transition, complicated by the fact you will invariably be competing with your immediate customer and thereby risking the lifeblood of your revenue.

Once of the best ways is in an adjacent market, in its early phases, where the customer actually needs your help to create the solution. Another way is when your customer pulls you up the stack, as big telco OEMs did when they wanted to get out of the transponder business and pulled their laser suppliers up to be Tx vendors. That was a bad example (telcos made no money on Tx, and neither did laser suppliers). The one you want is the customer who is making so much money elsewhere that they are happy for you to make money supplying their system--then everyone gets to eat.

My personal two favorite component plays are the disposable, and the small niche you can own for a long time. The former is obvious, but the latter often isn’t--take marine telco. SDL worked on that tiny market for years because it was so demanding and difficult, but their laser diode was the only product that could meet the final (lockout) spec, a lockout that they created, and once installed in submarine environment, nobody was going to change suppliers. Despite many, many cheaper competitive products, that SDL laser still dominated marine telco because it's simply too costly and risky to switch. If you can't find such a niche, or scale up to a system level product, then the other way is to keep selling components into as many verticals as possible until another telecom bubble comes along and components become king again--but I think that could mean a long, thirsty journey through the Valley of Death ...