When a startup is past the stages of bootstrapping, friends-and-family testing, research and development, surveying, and sampling, they have two major next steps: getting the product out into the wider market, and seeking external investment in order to scale.
This can be a chicken-and-egg scenario. It can be difficult for startups to scale and drive engagement without investment. But it can be hard to secure investment without proof of customer engagement. What marries the two is market traction.
‘Market traction’ is exactly what it sounds like - when a new brand, product or service starts gaining traction within the wider market. Traction might be in the form of sales or revenue. It might be in terms of engagement or notoriety. Traction acts as proof of market demand.
One of the most classic and tangible cases of market traction was seen in Facebook’s early popularity explosion. In 2004, overwhelming traffic from new users trying to subscribe led to repeatedly crashing servers.
It was enough to secure Facebook’s first external investment. Angel investor Peter Theil recognised the crashing servers as a demonstration of market traction, and staked $500,000 in for 10% of the company. It was this deal that led Theil to making a ROI of roughly USD $1 billion when he sold his shares at the IPO.
As a new investor, assessing market traction can be tricky. You’ll need to make sure that upwards-trending sales figures are not a fad or a flash-in-the-pan.
How to identify traction
1. Sales. Growing sales figures over a period of at least 6 months may indicate that customers are biting and the company is growing. Depending on the business model, a growing company should be seeing its customers moving past free trials, small or test purchases, and into larger, more regular purchases.
2. Partners & Distributors. It might be that B2C or D2C sales are not a part of a company’s business plan. They might be suppliers to companies who sell their product on. In this case, you’ll need to look at who they’ve partnered with and the potential growth of a partner network.
3. Revenue & Profitability. Sales might be strong, but if profit margins are very slim, the question of the business’ long term sustainability should be raised. Slim profit margins are not necessarily a bad thing, but consider whether customer purchasing habits support the model, and if external investment could allow scaling that expands profit margins. In some cases, it might be that the ‘product’ is free, but used to drive something else like advertising revenue. In this case, you’d look at sign-up and page view numbers.
4. Engagement. What does the brand’s following look like? Do they have a growing number of fans and followers? And are these fans and followers actually committing to purchasing? The word ‘engagement’ is crucial here. Don’t just look at subscriber or follower numbers on social media - look at comments, likes, and interaction. Web traffic can spike and then drop. Many mailing list sign-ups are one offs, never to be seen again. A company must show continual and sustained customer engagement before they can be considered as a sound investment.
5. Customers vs. customer acquisition costs. Analysis of customer data should be offset with the marketing spend required for gaining them. A company with demonstrable market traction will be starting to see their customer acquisition spend drop as the marketing efforts kick in, and the brand becomes more widely accepted. This can signal a good point for investor entry.