Zoho offers a suite of 14 online office software tools covering word processing, spreadsheets, presentations and more. Sridhar Vembu (co-founder and CEO) noticed this quote from the founder of a new competitor, Live Documents:

[Sabeer Bhatia of Hotmail fame] said "If Live Documents makes 1 per cent of Microsoft Office revenues, then we would earn USD 200 million a year. If Live Documents makes 10 per cent of Microsoft Office revenues then our revenues would be USD 2 billion a year in the next three to four years."

Except that's rarely a good way to look at it. The Zoho blog points to a Jan. 2006 post from Guy Kawasaki:

it's also not that easy to get 1% of any market, so you look silly pretending that it is

It's actually an old complaint among investors.

Someone once told me that a rule of thumb used by venture capitalists was to steer well clear of any business plan based on capturing a small share of a large market.

(An aside to VC bloggers: I couldn't find much coverage on this topic; it's probably worth a post or two.)

Back to Zoho:

Finally, there is what I call the "tail problem" - it is the old 80-20 problem. It is quite likely that 80% of MS Office revenue comes from 20% of their user base.

And that's not the 20% that's likely to switch.

In April 2006, Startup VC (and former entrepreneur) Josh Kopelman of First Round Capital discussed an investment thesis that is counter-intuitive, but plays out repeatedly in new markets:

We love investing in technologies and business models that are able to shrink existing markets. If your company can take $5 of revenue from a competitor for every $1 you earn – let's talk!

(An aside: 80:20 is 4:1; i.e. both rules of thumb are pretty close.)

Ironically, one of his examples was Microsoft shrinking someone else's market:

By 1996 Britannica's sales had dropped to $325 million - about half their 1991 levels – and Britannica had laid off its famed door-to-door sales staff. And by 1996 the encyclopedia market had shrunk to less than $600M. In that year, [Microsoft] Encarta's US sales were estimated at $100M.
...
So in just three years ... the encyclopedia market was cut in half.  More than half a billion dollars disappeared from the market.  ... While Microsoft made $100M it shrunk the market by over $600M. ... Every dollar of Microsoft's gain caused an asymmetrical amount of pain in the marketplace. They made money by shrinking the market.

Conclusion: Live Documents, Zoho and others in this space may end up sharing 10% of Microsoft's current office revenue -- by cutting it in half.

How does this model relate to the blogging market? Stay tuned. (Or add your view in the comments.)

Company links: Live Documents, Zoho.