Working in Silicon Valley I have met some of the brightest minds in the world. Still, I often observe huge errors of judgment and mistaken beliefs when it comes to evaluating companies and markets. Let's examine four key fallacies that Silicon Valley is guilty of time and time again.
Fallacy #1: Comparing Apples and Oranges
This fallacy involves comparing unlike things and drawing incorrect conclusions. For example, "Uber's model worked in ride-sharing so 'Uber for X' should work for this other industry". It's easy to spot the error here. Uber was successful for a variety of different reasons and simply taking Uber's on-demand mechanism is not enough to guarantee success in another industry. This is not to say that other on-demand companies can't be successful, it's just that the comparison to Uber isn't at all useful. This fallacy also goes beyond just high level company comparisons. It's not uncommon to see incorrect comparisons in regards to unit economics, margins, customer cohorts, and so forth. Basically, avoid over-extrapolation and stretching to "connect the dots".
Fallacy #2: Betting on "Big Markets"
Just because an industry is big on paper does not mean you can attain it. Investors and entrepreneurs commonly cite big markets as justification for business potential. This is a shortsighted view and false in most situations. More important than market size are "market dynamics". Competition, fragmentation, online vs offline spend, key go-to-market channels, and market expansion are all important factors to consider and probably more important than raw market size. In fact, massive industries often come with a lot of baggage such as resilient incumbents, endless competition, less pricing leverage, and so on.
Fallacy #3: Drawing Too Many Parallels
Investors and entrepreneurs are trained to squint and see what is on the horizon. It is a very difficult task. As a result, they tend to form a thesis and attempt to validate it by pointing to any supporting evidence that they can find.
We've seen successful two-sided marketplaces in local (Yelp), real estate (Zillow), and food (GrubHub), so shouldn't we see on-demand businesses make it work equally as well in each of those categories? Online classifieds businesses have been massively successful internationally (Avito, Schibsted, OLX/Naspers), so shouldn't next-gen mobile classifieds startups in the US be even more successful? The answer to these questions is a resounding "not necessarily". The world doesn't work that way and there are usually a multitude of reasons why companies are successful or unsuccessful. Aspects such as management team, market dynamics, competitive landscape, "tipping point" dynamics, go-to-market nuances, fundraising environment and timing (extra emphasis on timing) are all important. It's important to understand the similarities between businesses but it's dangerous to draw too many parallels.
Fallacy #4: Putting Too Much Stock Into Unit Economics
Unit economics are great for understanding the general health and scalability of a business, but they can be tricky and it's easy to read too much into them. Companies can easily play games with their numbers, either intentionally or unintentionally, and it's often hard to distill the proper metrics (i.e. does the LTV fully account for margins of the business?). Further still, no one has any idea what the unit economics will look like at scale. The fabled 3-year or 5-year forecasted LTV is seductive (as Bill Gurley has described), but is wrought with issues. LTV, payback, and CAC are measurement tools that should be taken into consideration along with other aspects of the business, not in a vacuum.
Investors and entrepreneurs have really tough jobs. They need to take a lot of risk and think against the grain, and as a result they are often wrong. That is okay. Let's just not make our jobs any harder than they have to be. Most of the fallacies above can be avoided by keeping a rational mindset and focusing on nuanced thinking.