Finding the Sweet Spot: How to Identify Prime Industries for Search Funds

February 28, 2024
Kevin Oxendine & Julian Dickenson
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We get asked all the time by aspiring and active search fund entrepreneurs about the ideal characteristics for an industry to search in. While there's a standard set of industry attributes widely recognized and sought after within the search fund community, an essential question is often overlooked. What “inning” is this industry in?
We get asked all the time by aspiring and active search fund entrepreneurs about the ideal characteristics for an industry to search in. While there's a standard set of industry attributes widely recognized and sought after within the search fund community, an essential question is often overlooked. What “inning” is this industry in?

We have many baseball enthusiasts at Pacific Lake, and the concept of innings comes from a standard professional baseball game divided into nine segments called innings. Based on what inning it is, you can get a decent approximation of how much longer a baseball game has left. For example, if the game is in its first or second inning, it's just beginning, offering a perfect opportunity to grab hot dogs, nachos, and peanuts from the concession stands. Conversely, the game is nearing its end if we're in the eighth or ninth inning.

Applying this innings analogy to industries, the most searchable industries for a searcher fall within innings 3-5. Let's delve into the characteristics of industries during this pivotal stage of the game.

Characteristics of Innings 3-5

Potential for Growth: Industries within innings 3-5 are often characterized by significant growth potential. The growth rate, reflecting how swiftly an industry expands, highlights companies' opportunities to grow enterprise value by capturing whitespace, strategic initiatives, and operational improvements. For search fund entrepreneurs, this represents fruitful ground, as companies benefit from a rising tide.

Market Penetration: In this critical phase, market penetration usually ranges from 20-40%, signaling ample opportunities for expansion and market capture. Market penetration measures the degree to which a product, service, or company has been embraced by its intended audience, underlining the potential for further growth.

Mitigation of Early-Stage Risks: By this stage, industries are often less volatile, and the product-market-customer fit may be more apparent. Businesses have been through renewal cycles and begun establishing a track record that can be examined and learned from. This maturity level reduces the inherent risks typically associated with businesses in their infancy (innings 1-2), providing a more stable foundation for sustained growth.

Comparison with Other Innings

Innings 1-2: Characterized by heightened uncertainty and risk, this initial phase involves companies validating their business models and beginning to educate potential customers. While the potential rewards can be significant, the risks are commensurately high.

Innings 6-9: As industries approach these later innings, the risk of market saturation grows, alongside an intensification of competition that can make it challenging to uncover new opportunities. Competitors will often turn to stealing share, which can result in downward pressure on prices and margins. Growth rates slow as markets mature, and consolidation has left fewer players in the field, limiting the upside for new entrants and increasing barriers to entry for searchers. 

Determining the Current Inning of an Industry

You might ask, "That's insightful, but how can I accurately determine the current inning of the industry I'm investigating?" Unraveling this is equal parts art and science. Here, we'll explore a mix of quantitative and qualitative indicators to help you triangulate the stage your industry of interest occupies.

Qualitative Factors

As discussed, market penetration is a strong indicator of an industry's stage.

Further insights can be gleaned from analyzing the industry's growth rate and the level of consolidation within the sector.

On the qualitative front, deep understanding often involves developing an intuitive sense of the industry's phase. A key strategy for achieving this is immersing yourself in the industry to become an insider.

Become an Insider: An insider is someone deeply integrated into the industry, fluent in its language, and engaged in relationships with key players who are deeply involved in that sector. While desktop research can be a helpful starting point, it pales compared to the insights gained from interacting with individuals with firsthand experience and expertise. These industry veterans, including heads of associations and seasoned sales professionals, can provide invaluable perspectives on the industry’s trajectory, its challenges, opportunities, and the implicit rules that dictate success or failure.

Sensing the Industry's Stage: Quantitative analyses reveal essential trends, although qualitative insights add meaningful context to these figures. Being an insider or closely attuned to the industry unveils the effects of regulatory shifts, technological breakthroughs, cultural changes, and the competitive landscape. What is the mood of your conversations? Are insiders talking about how hard it is to continue hiring to keep up with demand? Or are they concerned about intensifying competition? Do your discussions revolve around a growing or shrinking end market? Getting a feel for factors like these can shape your industry picture while highlighting opportunities or helping you decide to move to greener pastures.

Case Study – Clariti

To underscore the value of deep industry immersion, consider the example of Clariti, a cloud-based software provider for permits and licenses targeting state and local governments, acquired by Cyrus Symoom and Jake Dancyger in 2019. From a quantitative standpoint, the permits and licenses sector appeared fully saturated, with existing systems across state and local governments and a static end market (how many new cities or states have you seen pop up lately?). However, by deeply engaging with the market, Cyrus and Jake discovered that many governmental entities were operating outdated, on-premise solutions and planning to transition to cloud-based systems soon. 

While legacy software for the permits and licenses market may be in the 8th or 9th inning, cloud-based software was in the 3rd. This insight, which could only be gleaned through becoming insiders, revealed a significant unmet need in an industry that, on the surface, seemed to have limited growth prospects.

Target Industries in Prime Innings

Industries in innings 3-5 place searchers in the best possible place to succeed. You'll find a zone where companies have mitigated early-stage risk while offering growth potential for the future. 

To identify the industry inning, immerse yourself in it and triangulate it using quantitative measures, such as calculating the market penetration and more "feel" based qualitative means. The best way to do this is to get close enough to the industry and become an insider. 

As you evaluate potential industries for your search, ask yourself, "Which inning is this industry in?" Keeping this question at the forefront of your strategy ensures you're always in the right place at the right time. Ready yourself to step into the prime innings 3-5, where you're perfectly positioned to hit a home run.

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