Toy Markets

by Aaron Harris9/5/2018

Many of the largest companies in the world started in markets so small they looked like toys. Over time, each of these companies grew their markets or created new ones to dominate. Despite this, founders spend time attempting to demonstrate that the markets they are targeting are already huge.

It makes sense that founders would focus on how large their markets are. It is easier to argue that a better product will take market share from incumbents in a static market than it is to argue that something truly new will create or change a market. The first argument builds on logic. The second argument requires faith.

Founders often talk themselves out of building new things because they can’t quite figure out the answer to “How big could this get?” Founders who push ahead and build a product without a clear answer will often get stopped by investors.

Investors should know how important it is to bet on toy markets. They’re the ones who have learned, again and again, that the biggest companies start out looking like toys. Amazon was for selling books online when relatively few people used the internet. Google was a search engine in a landscape crowded with search engines that weren’t themselves gigantic businesses. Ebay was for selling beanie babies.

Unfortunately, the investors that rode these successes are tricked by hindsight bias. The markets are so big now, it is hard to remember that at the start they were anything but. It is easier for a senior investor to pretend that they knew, from the start, how big something would be rather than to admit it was a gamble. At the same time, it is difficult for newer investors to believe that markets can actually grow as fast as they have.

Founders also need to overcome an investor’s aversion to peer risk. This is the idea that investors are not punished by their bosses – LPs or senior partners – for doing what everyone else is doing. When no one else wants to fund social networks, funding one is a big risk. If this is a large bet, and it goes badly, the investor will look dumb for doing something crazy. The investor might get fired or be unable to raise another fund.

On the other hand, if the investor funds a social network when no one else will, and that company is later worth tens or hundreds of billions of dollars, the investor is hailed as a brilliant contrarian. Many senior investors are unwilling to risk their reputations in this way. Many newer investors are unwilling to risk their future careers on such speculative bets.

Founders in toy markets who want to raise money need to find the right investors, and tell those investors the right story. Finding the investors is just a matter of talking to lots of them to find out which of them have the optimism and conviction to take bets. Looking at their past investments can help here. Once a founder finds the right investor, there are two different types of stories to tell about how a toy market can become a huge one: Adjacencies and Behavior Change.


Adjacency arguments are the easier pitch. Founders describe how their product will gain dominance over some small but valuable set of customers. Once the company gains dominance in that area, it can use that niche as a base with which to capture another, larger set of users that share characteristics with the initial group. The company can repeat this again and again until the actual market in which it operates is huge.

Uber seems to be a good example of this method. At the start, Uber was a way to order a black car on demand. This is a market, but it isn’t gigantic. Over time, Uber began to expand, and the founders’ real ambitions were revealed – they wanted to handle all versions of non fixed-line transit. They did this by moving through adjacent markets: black cars, idle cars, logistics, international markets, trucks, and self driving vehicles.

Behavior Change

Behavior Change is a more radical pitch. It works in this way: “There is no market for what I’m building. However, by creating my company, I’m going to change the way humans live their lives. By doing that, I’ll create incalculable demand for what I’ve built, and capture a huge amount of the value as a result.”

This is the foundational story of Standard Oil, AT&T, GE, Apple, Google, and Facebook. Telling this type of story as a founder is less a demonstration of evidence than an appeal to faith.

Most behavior change arguments change significantly over time.1 This is fine. What matters is that the founders accurately identify what will change and are flexible enough to ride the change that they create. GE has been about a lot more than light bulbs for most of its existence.

Companies that are now huge have rarely stuck entirely to one narrative or the other. Usually the companies that start as adjacency bets change the behavior of users while the companies that change behavior find new customers in unexpected places. It makes sense to account for both sides of this equation but, at least at the start, it is better to focus on one model or the other.

Capital Markets

While most successful startups that make one of these arguments will eventually raise large sums of money, the fundraising environment at a company’s founding can have a large impact on it’s path. One of the stranger things happening in the startup world right now is the ever-rising amount of capital available to startups at all stages of life. This seems to be reinforcing the dangers of overthinking markets, as founders and investors each try to justify larger amounts of investment and the pricing that goes along with that.

This is hurting founders. An early stage company that targets a toy market doesn’t need much money to start proving that it can either change behavior or dominate a niche. This means a lower set of expectations at each milestone, which are easier to beat, which leads to better growth, which leads to better ownership for the founders over time.

Conversely, an early stage company targeting a gigantic initial market – say, insurance – usually needs to raise a huge amount of money relative to progress in order for the founders to make a case that they can compete with well-funded incumbents who will surely notice them and try to crush them. This leads to higher expectations at each milestone and more dilution along the way. This is worse for founders and for maximizing chances of success.

A Fine Balance

It would be nice if there was a commonly accepted framework for evaluating the “goodness” of a market for a startup. This would allow every player in the system to easily chart the path from toy to mass adopted market. It would also be somewhat boring since it would take the imagination out of building a startup.

Imagination ends up being the necessary trait that allows founders to see how something small can become large. It is also what investors need in order to believe in a founder who figures out how to build something that doesn’t exist.

The best founders imagine their own frameworks for the success of their companies and convince everyone around them that they’re right. They use some mix of adjacencies and the ways in which they’ll change behavior to make the case that they will succeed. They adapt to both the changes in the market that they catalyze and those that are introduced by competitors. These scenarios never look the same twice, and are never obvious from the start.

1. For instance, one of Facebook’s early big bets for the future was Wirehog:

Thanks to Paul Graham, Nabeel Hyatt, and Craig Cannon for your edits.


  • Aaron Harris

    Aaron was a Group Partner at YC and a cofounder of Tutorspree, which was funded by YC in 2011. Before Tutorspree he worked at Bridgewater Associates, where he managed product and operations.