Verda has received inbound inquiries from partners on how we look at markets. Fundamentally, we believe that for a project to reach maximum positive impact, it must first have a sustainable (profitable) business model. Thus, before measuring the impact of a ReFi project (defined here), we are looking at the attractiveness of the respective markets and industries. We’re not proposing the ideas below are original, but rather sharing our approach.
First, we think of markets differently from industries. Markets consist of buyers whereas industries consist of sellers/competition. A project’s market may be attractive while its industry is not and vice versa.
Secondly, we look at both macro and micro factors within markets and industries. In many cases, we place relatively *more* weight on the micro factors compared to the macro factors.
Below is a summary chart of this breakdown.*
(1)Macro Market:
The high-level metrics used to assess the attractiveness of a market include aggregate money spent, number of customers, and number of units. We also focus on macro-environmental trends (demographic, technological, economic, regulatory, etc.) as headwinds or tailwinds for the project/company.
Example (shortened): The micro-lending market size is currently over USD 200 billion and growing at a CAGR of 12.8% with an expected market size of USD 550 billion by 2030 (Source). Increased opportunities in rapidly growing developing countries continue to drive demand amongst micro-entrepreneurs for loans.
Whereas macro is our aerial reconnaissance, micro is what is happening on the ground to actually know if there’s a strong investment opportunity.
(2)Micro Market:
There need to be differentiated benefits for customers to buy and a pathway to growth for Verda to want to invest. If there is, that can outweigh an unattractive macro market (e.g. stagnant growth), for Verda.
Below are examples of questions we ask when assessing the attractiveness of the micro-market:
- Is this a target market segment where the project offers the customer a clear and compelling benefit that they’re willing to pay for?
- Are the benefits in the customer’s minds different from and superior in some way to what’s currently offered by other solutions.
- How large is the segment and how fast is it growing?
- Will this entry into the segment create a segway platform into other future target segments?
Example (shortened): Based on first-hand interviews with in-market lenders in X country, the average net interest margin is 5% for micro-lenders. Company A’s mobile-first wallet allows for easier usage and loan repayment, its real-time analytics from on-chain transactions further reduce operating costs and enables a more attractive (and profitable) 3% net interest margin to borrowers.
Most successful entrepreneurs target a much smaller segment of customers within the overall market and then expand from there.
(3)Macro Industry:
Michael Porter’s Five Forces** summarize the factors we use to assess an industry’s attractiveness at the macro level:
- Threat of entry
- Buyer power
- Supplier power
- Threat of substitutes
- Competitive rivalry
The more forces that are favorable the more attractive the industry, and vice versa. Critically, we want to know where the industry is headed and make sure it’s here to stay. That’s why we always make sure that a web3 tech stack uniquely solves the problems in ReFi (rather than being a technology in search of a solution).
Example (shortened): While Company A has a first mover advantage in X Country and traditional financial institutions' lending methodologies are prohibitively expensive to address this market segment, there is a relatively low barrier to entry and alternative solutions could offer a lower interest rate, and contracting margins. Furthermore, existing lenders are protected by regulatory monopolies in some markets.
(4) Micro Industry
For this segment to be attractive, the business must be economically viable and able to sustain its advantages in the face of additional (inevitable) competition.
In particular, economic viability means:
- Looking at the current and potential revenue and margins in relation to the capital investment required
- Customer acquisition and retention costs, and the time it will take to obtain customers (“Sales Cycle”). We avoid “build it and they will come” approaches.
- Operating cash cycle (how fast do you get paid relative to cost accrual)
Example (shortened): Company A has very low costs of $X per month and maintains healthy growth margins of 20%+ with the economies of scaling emerging from its streamlined wallet and tracking dashboard. Over X thousand entrepreneurs have been given loans with over 98% of borrowers paying back over the last 12 months. The X month average loan tenure means a very short sale-cycle to mitigate risk.
In short, we avoid businesses that compete based on price and give away products for less than they cost to produce. We’re, of course, also looking for the presence of proprietary elements, like unique technology, that other projects are unable to duplicate or easily imitate.
Thus, when we say there must be a sustainable business model, we mean the benefits for which target customers are willing to pay (micro-market) must be greater than the cost structure that makes the intended product or service economically viable (micro-industry).
Serving a large growing market with attractive industry dynamics does NOT offer assurance of entrepreneurial success, but it is an important starting point for assessing the risk-return attractiveness of an investment opportunity.
Sources:
*The New Business Road Test by John Mullins
**The Five Competitive Forces that Shape Strategies by Michael Porter
