Last Wednesday I was sitting at the Louisville Venture Club listening to a presentation by a software company. The presenter went on and on about how huge the market was for his product, and how they “only needed to get 3% of the market to…” Oh no. Not again. An entrepreneur friend of mine sitting next to me turns and says “nice Chinese math.” I nod. “Why didn’t someone warn him?” I say.
I’ve written about this before, but it is so damn pervasive among entrepreneurs maybe I need to be more thorough. Let’s start by explaining the term (which comes in several forms, but ‘chinese math’ is most common around here). Investors love companies that can a)stand on their own two feet early so that they don’t require much more investment and b)have huge market potential. So entrepreneurs try to convince investors that the market is huge, and in doing so they somehow convince themselves (and in turn try to convince investors) that it will be easy to reach cash flow breakeven because of the market size. After all, they only need a small percentage of the market. The name stems from the idea that there are a billion people in China, so if you sell a $1 widget to just 1% of them that is $10 million in revenue. The assumption that is incorrectly applied here is that 1% is easy to get because it is a small number.
I fell victim to this myself a few years ago. Market demographics told us we had over 5,000 potential clients within a few square miles. Surely we could get 10% a year, and surely we would snag some from outside this small area. It turns out that surely I was doing some Chinese math because we didn’t get 500 clients anytime soon.
Chinese math doesn’t work because small numbers aren’t necessarily related to easy success. Think about it by removing the percentages. If you need 100 clients to break even for the year, does it matter how large the potential market is? Probably not. If your potential market is 10,000,000, does that make it easier to get 100 clients than if your potential market was 200 clients? It depends. Probably not. First of all, you have to have something of value (which many startups don’t) and you have to be able to convince even one person why they need it (which many startups can’t) or your market size is irrelevant. You won’t even get 1 client. Secondly, it may be easier to market in the case where you need 100 out of 200 because it may be easier to identify your target audience if it is only 200 people. In that case you are probably in a niche that is easy to market to and don’t just have to blanket your ads on the general public.
Think about it this way, there are several billion people in the world you could potentially date. And since you only need one to marry, it will be easy right (after all, you only need .000000001% of that market) ? Only if you are willing to take any random partner. Small percentages do not translate to easy results.
You will impress investors soooooooo much more if you can pinpoint who will use your product than if you use Chinese math. Don’t say 18-35 year old males with incomes greater than $35K/year. That’s too general, but often that is where analysis stops. Identify your early adopters and figure out what they do in their free time. What do they read? What do they watch? What do they listen to? Have you spoken to them? What have they said? Would they buy your widget?
As part of my day job I deal with companies that are trying to be super secretive as they develop the next killer product to take the country by storm. They all think that, and honestly, you probably need some of that to be a startup. But Chinese math can lead to marketing and financial complacency because it lets you build these ideas up in your head that say your breakeven point is easy to achieve. It isn’t. Stop thinking that. 98% of you will have to bust your ass to hit breakeven.
Market numbers are important, and so is breakeven analysis. Present these numbers as part of your plan, but don’t act like the low percentages mean they will be easy to reach. If you are counting on easy milestones for your success, you aren’t ready for entrepreneurship.