The efficient market hypothesis states that “asset prices fully reflect all available information”. If the efficient market hypothesis is true, then you would expect actively managed funds (where fund managers pick the stocks) to do no better than index funds. That does seem to be the case:
“Numerous studies have shown that index funds, with their low costs and ability to closely mimic the returns of markets both broad and narrow, steadily outperform the returns of most actively managed funds.” Wall Street Journal
Unless you have some sort of insider knowledge (which it might be illegal to exploit), you might as well invest in index funds or get your cat to pick your stocks as pay someone else to do it.
But I am interested in a different sort of market efficiency. If you have to pick a vertical market to start a software business in, does it matter which vertical market you pick? If the market is perfectly efficient for businesses, then each vertical will have a level of competition proportional to the size of the market. In that case you should have an equal chance of success whether you decide to write a game, a developer tool, an anti-virus product or a CRM system.
From lots of reading and talking to other software business owners I have come to the conclusion that the market is highly inefficient for businesses. The market vertical you pick has a big effect on your chances of success. It seems to me that the three worst verticals are: games, developer tools and consumer mobile apps.
Games are fun! Writing a game sounds like a blast. Much more exciting than writing software for boring businesses. It has also been getting easier to write games due to the ever improving tools. Consequently, the market for games is totally saturated. The outlook for independent games developers looks grim. Today on the Steam platform there are 12,971 games listed. Even some of the big and famous games developers only seem to survive by forcing their staff to work vast amounts of unpaid overtime.
Pretty much every software entrepreneur has considered creating a software development tool at some point. I know I have. It is a market that we all understand (or think we do). But consequently it is saturated. Software developers are also pretty horrible customers. They are used to using lots of free software. And that tool you spent years developing? They think they can write something better over a weekend.
“Thousands of people used RethinkDB, often in business contexts, but most were willing to pay less for the lifetime of usage than the price of a single Starbucks coffee (which is to say, they weren’t willing to pay anything at all). … Developers love building developer tools, often for free. So while there is massive demand, the supply vastly outstrips it. This drives the number of alternatives up, and the prices down to zero.” Why RethinkDB failed
I wrote back in 2010 what a horrible market the iPhone app store is for developers. Since then the number of apps has increased tenfold to 2.2 million, the average paid app price is a measly $1.01 ($0.48 for games) and some 90%+ of apps are free or freemium.
You should be wary of markets with no competition. But the really high levels of competition in these three markets drives down prices and makes it very hard to get noticed. Obviously not everyone in these 3 markets is failing. It is possible to create a product in one of these markets and be wildly successful (Indie game developer Notch of Minecraft fame springs to mind). But I think the odds are very much stacked against you.
So what market should you pick to maximize your chances of commercial success? Aside from the obvious factors (e.g. something you are interested in and knowledgeable about, something that solves a real problem etc) I suggest avoiding anything considered ‘sexy’ by other developers.
Here is a radical idea – create a software product aimed at women. The vast majority of software is written by men and consequently it tends to cater for men. 50% of the world’s population are women and they buy software too!
Just because a product is not in a ‘sexy’ market doesn’t mean that it has to be boring to create. I have found plenty of interesting usability, optimization and visualization problems to solve while developing my own seating planning and visual planning software products.
Here is a thought experiment. Imagine you are talking to another software guy at a conference and explaining what you product does. If your imaginary software guy says “that sounds cool”, then it’s probably a tough market to create a commercial product in. But if they look a bit surprised or their eyes glaze over, then you might be on to something.
Successful Software 
Interesting post, Andy.
>From lots of reading and talking to other software business owners
From those sources (reading and owners), do you remember about how many developer tool products heard of, that were at least moderately successful?
I know of a few development tool companies that are successful enough to support at least 1 full-time developer. But I couldn’t put a number on it.
How do you suppose a piece of software will be different for women? Especially when you think about B2B software.
Another way to say what I am trying to say is – Does gender as a demographic matter when you’re attacking a business problem?
>How do you suppose a piece of software will be different for women?
You might make subtle differences in the design. But I was talking here about choosing a market, not the design of the software.
>Does gender as a demographic matter when you’re attacking a business problem?
I think so. I believe there is less competition for software in female dominated professions (e.g. child care, midwifery, beauty salons) and female dominated hobbies (e.g. crafts, dance, yoga) than male dominated markets of the same size. Simply because the vast majority of programmers are male and tend to think about male problems that need solving. But I don’t have any hard data to back that up.
Thanks for your response, Andy. I just saw Patrick McKenzie’s video on Marketing to Minorities which echo the same sentiment as you. https://www.youtube.com/watch?v=ODzMgaVtXLE
Hi Andy, what do you think about the market for database reporting software? I am talking about alternatives for popular tools such as Crystal Report and SSRS?
This has been coming up as far back as 2009, if you intend to stay small find a small nice that would not be of value to larger players in the field and tend to your users. There are different scales and such and how you can treat your potential competitors.
What comes to mind too, Tim Ferris has this advice if you can’t think different – something valuable that no one else does(implying marketing or special knowledge – ie working for a few of the incumbents) then think way out there strange and iterate over a few directions. Surely something is going to comeout of the art. At least it would be original )
> The efficient market hypothesis states that “asset prices fully reflect all available information”. If the efficient market hypothesis is true, then you would expect actively managed funds (where fund managers pick the stocks) to do no better than index funds.
A bit pedantic but… if the efficient market hypothesis was perfectly true you would expect _all_ actively managed funds to do no better than index funds.
In reality, some do better, and a very very small number of them consistently do better (e.g. Berkshire Hathaway)
That’s why both the efficient market hypothesis is bunkum AND you should still invest in index funds – because you cannot predict which minutely small proportion of the active fund market will actually perform well in the long term. Or you could invest in Berkshire Hathaway, but the shares are pretty steep these days!