This week I published an essay on why Reality Has a Surprising Amount of Detail. It looks at common causes of overconfidence bias and how individuals can counteract them to make better decisions.
One of the most common places where I see this show up is in business decisions. Entrepreneurs, executives, and managers often fall prey to overconfidence. I’d like to tell a story of one time I made that mistake (to the tune of about $75,000) in the hopes of helping you avoid it.
One of my first jobs was as a marketing manager for an e-commerce startup in California. I started there as an SEO specialist and gradually worked my way up to running the marketing department. It was a B2B company selling hospitality products, including a line of parking equipment aimed at valet parking companies.
The e-commerce business was doing well, and so, we asked a very sensible question: “what other products could we develop and market to our existing customer base?”
This was around the time smartphones and tablets were becoming ubiquitous and some valet parking companies were starting to use electronic rather than paper tickets. For a physical products company, we were pretty tech-savvy and had built some software internally. We decided to spin out a SaaS company.
Here was the thesis: mobile was going to be a thing and our customer list was the best in the world for valet parking providers. There were already some companies building software and getting traction. If we could just make something equally as good but get to market faster using our customer list, it seemed likely we would win the market. Proprietary customer lists are a very valuable asset for this reason.
Though SaaS is an attractive business model in general, this was even better because we thought we could ultimately process the payments for our customers and keep a percentage of each transaction.
Looking back on it, this is a reasonable thesis.
I’ll spoil the ending: It didn’t work out, not because the general thesis wasn’t strong, but because reality has a surprising amount of detail.
Because we felt confident that we understood the market, we didn’t do a lot of testing. We spent half a year and just built out the software. We’d been selling to this customer segment for almost a decade, of course we understood what they wanted! (Narrator: they didn’t understand.)
When we finally took the product to market, one of the first things we learned about the market was that software solutions only made sense at high-end locations – hotels, hospitals, malls, and casinos.
Like most markets, valet parking follows a power law. By number, most valet parking locations are restaurants that handle a few dozen cars per night. However, a few locations handle huge volumes – think casinos in Vegas or high-end shopping malls that might park thousands of cars in a single day.
Even though our software wasn’t insanely expensive, valet companies needed to supply smartphones and tablets to their valet attendants to use the software. This hardware cost made it prohibitively expensive at restaurants or smaller locations where margins and volumes were lower. If you only park 20 cars per night, you have a lot less volume to amortize that hardware cost over.
We initially thought that that reason companies would switch is that it would provide a better customer experience. If your smartphone was your ticket, you would never lose your ticket. And, instead of having to take your ticket out to the valet and wait outside if it was cold, hot or rainy, customers could request the car on their phones and be notified when it was curbside.
It turned out that no one cared about that. The only reason people were interested is because somewhere between 5-10% of all revenue in valet is lost to theft. Valet attendants can have sticky fingers and pocket some of the cash customers use to pay.
By switching to software and requiring customers to use credit cards, they could see a 5-10% boost to revenue at that location. This was why it made sense at hotels, casinos and other high volume locations. If you amortized the cost of the devices over a couple of years and it was less than 5% of that location’s revenue, then the savings in reduced stealing was worth the cost of the hardware and software.
What all this effectively meant was that our target market was a small subset of the total valet market. I figure maybe 70% of the TAM (Total Addressable Market) was controlled by a dozen companies managing the largest accounts like casinos and big shopping malls.
This meant our existing customer list wasn’t nearly as useful as we hoped it was. Everyone knew who the customers were, it was a matter of enterprise sales into large companies.
We also thought that it would be a very good business because we could eventually process the credit card transactions and take a cut. However, because we were only dealing with enterprise-level companies, there is a lot of politics in who processes their credit card transactions, and forcing them to go through us was effectively a non-starter.
Parking companies tend to have big mortgages on their real estate and the banks they have those with, use that as leverage to make sure they use those same banks to act as payment processors. So even if you offer better terms on payment processing, they aren’t going to switch because they need that relationship with the bank.
What started with a very logical and reasonable assumption: “let’s develop other higher-margin products for our customers that leverage mobile as a trend” was ultimately a dead end because of the politics of the relationship between valet parking companies and their bank lenders combined with the market microstructure.
The point here is not that this was dumb. It actually still seems totally reasonable. Given none of us had a background in how commercial banking works, there is no reason we would or could have known that when we started. The mistake was overestimating our knowledge and investing a bit too much into the product before we knew the business model would work.
It was one of many reminders I’ve had in my life that reality has a surprising amount of detail!
These mistakes follow a similar pattern:
- We overestimate how much we know and think reality is much simpler than it actually is, causing us to gain overconfidence in a simplified model for how something (in this case the parking industry) works.
- Good early results of using that model lead to increased confidence to use leverage or concentration in that approach to increase efficiency. Having a couple of customers that really liked us say they were interested caused us to invest a significant amount of time and money so we didn’t “waste time talking to customers” which would increase our efficiency of getting to market faster.
- Increased leverage or concentration results in increased risk. In our case, this increased investment meant it was harder to change the product once it had been fully built and we couldn’t get back the time and money we had sunk in. (fortunately, we realized our mistake earlier than most)
The truth that Reality Has a Surprising Amount of Detail is why it is almost always a bad idea to “just do this one project real quick that’s not the most important thing but seems like an easy win.” It is not an easy win. If the thing you are working on is not something you want to spend 3-5 years of your life on, you should probably stop working on it.
It is also why it is important to admit how little you know up front and spend more time talking to customers rather than building product. In the words of Steve Blank, “get out of the building.”
Projects always take longer than planned because of the can opener effect. The map in our heads is almost always simpler than the underlying reality.
The good news is that once you understand this, you can make investments of your time and money in a more sensible way.
Last Updated on July 22, 2020 by Taylor Pearson