Chapter 15: Focus to Dominate with Less

Book: Finance Secrets of Billion-Dollar Entrepreneurs: Venture Finance without Venture Capital
Author: Dileep Rao
ISBN: 978-1-64250-199-5

Previous: Post-Finance Controlling Takeoff | Next: Sell Direct to Connect with Your Market

Chapter 15 is about one of the hardest decisions any startup faces: focus or diversify? Rao’s answer is clear. Focus first. Dominate one segment. Then expand.

Why focus matters when resources are thin

At the start, ventures have almost nothing. Capital is scarce. But so is management time, skills, and attention. Getting more of any of these is expensive.

The big question is whether to focus on one market segment and own it, or spread across multiple product-segment combinations to hedge risk. That choice has serious financial and competitive consequences.

Poor management causes most business failures. But another major reason is not focusing on the right product-segment combination. The most successful ventures are usually the dominant players in their competitive group. If you do not dominate, you are at a disadvantage against the leader. New companies cannot be everything to everyone.

Jack Welch’s rule at GE was that each business should lead its market. Even large companies should focus. “You cannot be everything to everybody.”

Diversification works for investors, not operators

Most seasoned venture financiers suggest focusing on one product and one segment at the start. After you succeed there, you can find cheaper money to expand. That feels counterintuitive because finance classes teach diversification to reduce risk.

The difference is that financiers manage portfolios passively. They spread risk across many investments because some will fail.

Entrepreneurship is hands-on. You are an active manager with limited resources. If you operate in two market segments, a focused competitor can beat you in each one. You might win in multiple segments if you are Elon Musk-level talented. But what are the odds? You might diversify yourself right out of business.

Herb Kelleher built Southwest Airlines into one of the most profitable carriers by focusing on one thing. As he put it, airlines move in for the kill when they sense weakness. “We don’t know everything about everything. We know about one thing.”

Nearly all of Minnesota’s high-performance entrepreneurs focused on one product and one segment until they dominated. Then they expanded into new segments or added products to serve their existing customers better. Unrelated diversification is riskier. Igor Ansoff noted this decades ago in management theory.

Focus gets you the best customers

Trying to sell a new product to many segments at once spreads your efforts thin. Entrepreneurs who try to sell to anyone without a focused plan rarely impress professional investors. Reaching and convincing large numbers of people to buy from a new company is brutally hard.

Group customers into segments. Then aim your product, marketing, sales, pricing, operations, and financing at the right one. A fast-growing segment helps you grow fast too.

What if customers outside your target segment want to buy from you? Ask yourself:

• Will serving them cost more?
• Will you take on more risk?
• Do you need to change your business?
• Does this pull you away from your central focus?
• Is this new segment more attractive than the one you picked?

You may not succeed if you do not dominate your chosen segment. And you will not have resources to dominate more than one at the start.

Craig Swanson and his partner built Definity Health by focusing on large, self-insured employers. They developed Health Reimbursement Accounts as an employee benefit to cut health costs. They did not want to carry insurance risk. Large self-insured employers had strong incentives to keep employees happy and save money.

Focus stretches limited money and time

Your cost of money is brutal at the start. Early equity can cost 80% to 100% per year from professional investors. As the venture grows and risk drops, VC might cost around 30% at later stages.

That high early cost means you should dominate one market before diversifying. Running two product-market combinations at once forces you to raise more expensive money and split scarce resources. You are paying a high price for two businesses at once.

Leadership time is scarce too. Management may be inexperienced. It is smarter to dominate your target market first, then expand when money is cheaper and you can attract better managers.

Focus can beat being first

Only 11% of first movers end up dominating their segment. To win as first mover, you need an insurmountable lead or near-perfect execution. Followers can study your strategy, improve on your product, and win, often with more money once the opportunity is proven.

Sam Walton made his rural Arkansas stores dominant first. Then he used that strength to dominate rural America and eventually the whole country. Kmart tried to enter rural markets after Walmart was established but could not break Walmart’s grip.

How focus builds dominance

Settling for mediocrity never made anyone great. To win, you need to dominate. That means understanding the specific needs of your key customer segment and serving them better than anyone else.

Horst Rechelbacher and Aveda built dominance through a unique distribution system. He trained beauticians in his schools, then helped his best salespeople become exclusive distributors. He learned vertical integration from a business in India that made products in its own factories and sold through its own stores.

Rechelbacher controlled the entire sales and distribution function. He sold to top-tier consumers willing to pay more. He worried about customer experience, not growth speed. He opened stores on Madison Avenue and in Soho. When distributors saw his success, they wanted in. He helped them open beauty schools and stores in high-visibility locations. When he sold to Estee Lauder for $300 million, Aveda had 15 beauty schools and about 250 stores.

Steve Shank and Capella focused on graduate degrees online when no one had mastered internet education. The University of Phoenix was strong in undergraduate programs but weak in graduate. Capella offered high-quality, university-like education with business efficiency. Shank built a leader in long-distance education.

The bottom line

Focus your business on your competitive advantage. You have limited resources and limited management capacity. Diversification is for later.

By focusing, you dominate your initial market. You design products, services, marketing, and resources to make customers in that segment happier and keep them long term. Pick the segment that offers the fastest revenues and cash flow and the best long-term advantage.

Dominating one segment gives you a strong base and cash flow to expand. Entrepreneurs who diversify before dominating leave themselves vulnerable everywhere.

Walton focused on rural America before expanding. Zuckerberg started with top-ranked universities before going global. Jobs focused on the iPod before the iPhone and iPad. Gates made his operating system the PC standard before expanding to other products.

Entrepreneurs focus. Corporations diversify. That line stuck with me.