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Due-Diligence: How to Evaluate Competition

Jun 12, 2020 | 00:13:27 | E9

Andy Reed, Swati Chaturvedi

In Episode 4 we had put out a framework for ‘How to Evaluate a Startup’. Episodes 6 and 7 discussed ‘How to Evaluate the Market’ and ‘How to Evaluate the Team’, respectively. In this episode, we continue the discussion on how to evaluate a startup. Today we discuss how to evaluate competition.

Highlights of this episode:
– Status quo, or how customers currently solve their problem, is always a competitor (often the main competitor)
– Good competitors improve one of three things for their customers: 1) they are lower cost 2) they are higher performance or 3) they are more convenient.
– Talking to customers or industry experts is one of the best ways to learn about competition.

Disclaimer: Propel(x) is a funding platform, not a Broker-Dealer. Securities are offered through Hubble Investments, member FINRA/SIPC and an affiliate of Propel(x). Private investments are highly illiquid and risky and are not suitable for all investors. Past performance is not indicative of future results. You should speak with your financial advisor, accountant, and/or attorney when evaluating private offerings. Neither Propel(x) nor Hubble Investments makes any recommendations or provides advice about investments.

This is Propel(x) podcast, discussion on investing in all things startups. Startup investing is highly risky. Please listen carefully to the disclosures at the end of this podcast.

Andy Reed: Hi everyone, this is Andy and this is the Propel(x) podcast. We’ll be continuing our series on diligence. This far we’ve presented a framework on how to evaluate startups. The framework has eight risk factors. The first of which was market, which we previously addressed. We also had a discussion on team and today we’re going to dive into a discussion on competition. So I’m joined as always by Swati Chaturvedi, CEO of Propel(x). Hi Swati

Swati Chaturvedi: Hi Andy.

Andy Reed: Thanks for having me on your podcast again. I’m excited to get into competition. Competition is one of the major factors that I think people look at when they’re talking about the success or potential success of an investment in a startup. Let’s start at the top. How should we think about competition?

Swati Chaturvedi: Yeah, it’s very important and we should start with the status quo, which is, what’s going on right now? The status quo is always our competitor, if not the main competitor because it’s hard to get people to move from the status quo. The status quo is always one competitor. And then you have to look at other companies that are solving the same problem by different methods potentially. There’ll be companies using similar technology, but there’ll be companies using different technologies. So in general, if we were to think of competitors, real competitors are those that offer a better solution to the status quo in one of three ways: They’re either lower cost, or better performance, or more convenient or any combination of the three. But there’s really three benefits that competitors offer. There’s this concept of the Pareto curve where you reach a point where you can’t improve on one without getting worse on the other. For example, you can continue to lower cost to an extent until you start compromising on performance and so on. But in general, one characteristic is often kind of tradable against the other.

Andy Reed: Just to clarify what you’re saying, so you’re saying the status quo thing is what’s in the market today? What are customers buying? What out there that’s being sold? There’s this product that is going to compete directly against, that’s what you mean by the status quo, right?

Swati Chaturvedi: Yes. How are they currently solving the problem?

Andy Reed: And then just to go through an example of the curve, you could think of something like super light race cars that you can get lighter and lighter and lighter by adding you know..more composite materials, but the cost will skyrocket. So that’s like an example of a trade-off with an industry that’s probably pretty efficient because they’re pretty mature.

Swati Chaturvedi: Yep. Very good. But the key point is there are these three characteristics that can be improved upon; cost, performance, and convenience.

Andy Reed: Is there another example that you would think of? Just a good
example from maybe more of the deep tech startup world?

Swati Chaturvedi: Yeah, absolutely. I mean the automotive examples are really good example. Another one that we can think of is a wearable blood pressure monitor. So you may know there’s a lot which are currently in development. Nothing where the performance is perfect currently on market. But a wearable blood pressure monitor is definitely more convenient. It’s giving you real-time readings and a lot of data, right? So you’re actually monitoring your blood pressure consistently and continuously, as opposed to the one time that you go to the doctor. So it’s more convenient. Is it lower cost? Well, when you go to the doctor, it’s a free monitoring exam that you pay for the copay, right? But these devices are likely going to cost more than the one-time copay. Is it better performance as of today? That is not the case. In fact, that is what various startups are working on getting performance up to par if not better than the status quo. So here we are trading convenience against performance and cost. But convenience may trump over other things. So in any event, blood pressure monitors something that needs to be approved by the FDA, especially if it has to meet the medical standards. In that case, it will have to meet the baseline of blood pressure monitoring performance, accuracy, that is to say and then everything else will be tradable against the other. So that’s another issue.

Andy Reed: Yeah. That’s an interesting example. And I think it actually goes into an aspect of competition that’s really important, which is what is the actual market that they’re competing in? So you gave the example of a continuous or a wearable blood pressure monitor. And then I think you mentioned that it could be continuous so that there are wearable pressure monitors, and then continuous wearable blood pressure monitors. Essentially, these are devices that are wireless, that are hooked up and do non-invasive blood pressure monitoring. That in contrast to something where you’re stationary, you’re sitting in the chair, or going into the doctor’s office. And I would imagine for a wearable blood pressure monitor to actually hit the market like you said, they are probably not going to have a cost advantage relative to the cost that you wear that’s really cheap. But there must be essentially a market application or use case that would justify the higher pricing. So one of those three pillars that you mentioned; likely better performance or providing more data over time: if there’s actually a customer need for that, then they’re not exactly directly competing with the costs that you get at the doctor’s office. They’re in the same general market, but they’re not competing head to head.

Swati Chaturvedi: Yes, absolutely. I mean, someone who would spend that kind of money on a wearable blood pressure monitor are the people who actually need it, who need to be monitored continuously, possibly people who have chronic problems related to blood pressure, and so on. Those are the people who would most benefit and who would be willing to spend for it. So, yes, the market is then smaller than the whole general population which gets its blood pressure monitored every once in a while.

Andy Reed: That seems like an easier-said-than-done distinction to make in diligence. I kind of get that, but you know..if we were to take another example of a company and try to understand who really is the competition, what advice do you have for people who are going through due diligence to understand who exactly the competitors are?

Swati Chaturvedi: Yeah, absolutely. So that’s good. Find out who else, other than the status quo, who else..is solving the problem? Well, so first and foremost, startups present typically a competitor chart in their pitch decks which we should not rely upon. But this is a starting point. Typically it’s a two by two where you have two axes and somehow the said startup will be on the top right corner, which is their best on all axes, on both axes. But the advantage of that or the benefit of that chart is at least it gives you the names of the key competitors. And you can start from there. You can start researching from there. So that’s one place to start at but the most important is talking to people, talk to the customer. What I have found to be most useful is talk to the customer, and sometimes the startup themselves will refer you to the customer and ask them, “Hey, Who else have you considered in the past? Why did you pick this instead of the others? And once you talk to two or three, you will start to get a sense of who is in the market. Talk to customers and industry experts. Ask them about the status quo, what it takes to shake that and who else have they considered? Who else have they seen offering a similar solution?

Andy Reed: Yeah, I think that’s a great point. Another thing you might find is the decision-making on a purchase, which is ultimately, how money is transferred. maybe more nuanced than just you know..what is the technology or what is the, where are they located or different factors that might appear to be important at first, but really kind of talking to customers, you kind of get an understand of understanding of, why they made that decision. There’s also a ton of industry materials that are kind of..available on the internet for a low cost or sometimes free. So there’s industry reports, particularly for startups; Crunchbase comes to mind, its one that is pretty available. Even something like AngelList where you’re digging around and looking at the competition, the National Science Foundation has a directory of all the different companies that they’ve given grants to. So it can get a little bit thick in terms of the amount of things that you’re digging through. But what are your thoughts on equity research reports trying to report the kind of high level where these markets are headed and who’s participating in them?

Swati Chaturvedi: Yeah, absolutely. Those are great sources. The only thing that I would say is that typically equity research reports cover more mature companies, right? But they’ll give you trends and sector trends and so on. But if you really want to find names of competitors, I think what you mentioned AngelList, for example, is a good source platform. Crunchbase, which tells you which other similar companies. Absolutely. Those are very relevant. Then there’s always the Google search.

Andy Reed: I’ll just share a little bit of my experience with those, which is that they can be a good starting place, but you might find companies that are in fact no longer in existence, or again, getting back to the customer example, they may not be actually directly competing with the company. So it’s a good thing for market overview, but it doesn’t really replace… or I’d say it’s more of a supplement to boots-on-the-ground type research. Well, this has been, I think, pretty informative. I don’t actually have many other questions. I think this is a good starting point for engaging in diligence. Are there any kind of parting thoughts that you want to make sure that investors walk away with?

Swati Chaturvedi: No. I mean, I think the only thing that I want to reiterate is these are high-risk companies. There is no exact science to diligence, but if you follow a process, then you can be more exhaustive than if you don’t. And the process is something that we have put out there in the form of that evaluation framework and if you follow that framework or any other frames, then it’s a great way to do your diligence. Have a process, use our framework if you want to, use your own, develop others; you know..however works for you, but have a process. We’ll be covering other, other risk factors and how to evaluate those in later episodes of course.

Andy Reed: Yeah, thanks so much for your insights. This is very informative and I’m glad that we’re getting through the overall framework for how to evaluate a startup in due diligence.

Swati Chaturvedi: Thank you, Andy. Nice to discuss this with you.

Andy Reed: All right. Until next time, this is the Propel(x) podcast.

Disclaimer: Propel(x) is a funding platform, not a Broker-Dealer. Securities are offered through Hubble Investments, member FINRA/SIPC, and an affiliate of Propel(x). Private investments are highly illiquid and risky and are not suitable for all investors. Past performance is not indicative of future results. You should speak with your financial advisor, accountant, and/or attorney when evaluating private offerings. Neither Propel(x) nor Hubble Investments makes any recommendations or provides advice about investments.

Content Disclaimer: Past performance is not a guarantee of future performance. The investments mentioned in this podcast (if any) are illiquid and there is no guarantee that an exit strategy will come to pass.