Fred Wilson recently posted on his blog his presentation about Disruptive business models that he gave to Google staffers. The slide I like the most was the one he talks about Shrinking a Market. He discusses how the Internet continues to get more and more capital efficient. The costs for things like software, hardware, bandwidth and storage are 1/10th what they were 10 years ago. I think that this is an underestimation. Bandwidth for example, used to cost $1200 per Mbps. Now you can easily get a rate of less than $30 per Mbps. Anyway, things are a lot cheaper. Well, combine this capital efficiency and target a market where you can win not only by providing a more effective service but also by undercutting the price and you may become the market leader by shrinking the market. Fred Wilson quotes another VC who uses this thesis as part of his investment criteria who said “If you have a business that will shrink an existing market, allowing you take $5 of revenue from a competitor for every $1 you earn, let’s talk!”
The example that Fred Wilson discusses is Craigslist and the classifieds business. The classifieds business was a multibillion business for newspapers and Craigslist completely dismantled that business with a basic online classifieds system that is almost all free. They charge a minimum amount for certain categories such as job postings that if you talk to any HR person, they will tell you is the most efficient buy in terms of a cost per applicant. Craigslist is the dominant player in classifieds and has shrunk the market to probably no more than $100 million. However, by completely owning the market Craig Newmark is basically running a monopoly because no one can touch him in both price and scale.
Shrinking the market isn’t limited to a Web service business that targets a market dominated by an offline business. It happens in markets dominated by online businesses as well. An example of this is what PlentyofFish.com is doing. I was always puzzled on how much money online personal sites could charge and how it really is a capital efficient business if you didn’t have to pay a lot in marketing costs. Well, Markus Frind figured that out and applied some basic rules including:
1. Pick a Market where competitors charge money and do it for free!
2. Keep your cost low. Really Low.
He is disrupting a billion dollar online personals market by attempting to shrink the market. And he is making some incredible traction. Look how he is quickly catching up with market leader Match with just a small fraction of the resources and advertising budget.
So what does this mean for Internet Entrepreneurs? Well, in a recession economy, running a capital efficient business in not only a necessity but actually can be the main advantage. Target markets in which you can shrink the market and be the disruptor.
Ah-ha 2.0 
Good post, Ben. I remember you’ve always liked this idea. The Bezos quote: “I’ve always believed that high-volume, low-margin businesses are more defensible because they don’t have a [soft] underbelly.” is a good corollary.
Thanks Arul. I always liked that Bezos quote. The cool thing about shrinking the market is that it doesn’t necessarily mean your margins are thin. Look at both Craigslist and PlentyofFish. Since they are so capital efficient, they still have extremely high operating margins and are very defensible. I ultimately think what happens is that the market becomes too small and that deters new entrants. If online dating becomes less than $100 million in market size, there aren’t going to be too many players that really want to get in the space and dethrone the existing leaders.