Market sizing provides analysis on how large a market is in terms of revenue, number of customers, and target segment.
Why Do Market Sizing?
Market sizing is an important step on the way to product market fit to make sure there actually is a pot of gold at the end of that rainbow.
Most quality venture capital firms expect to see a thoughtful market sizing estimate in a startup pitch. For most corporate ventures, it’s considered pro forma too.
However, too many new product ventures skip this process or do it wrong. The most common excuses are:
- People with experience from the early 2000s saw too many failed startups with wild projections, so they figure it’s better not to do it at all
- Entrepreneurs with an engineering background have no training in market sizing and share a general disdain for things they don’t understand
- Teams subscribing to an agile, lean, or customer development framework figure they just have to follow the crowd and they will luck into a large market, which is not exactly what those frameworks recommend
- Great entrepreneurs and sales people won’t take no for an answer. It’s in their DNA. It’s why we all love them. If they didn’t believe in their plan, they couldn’t sell it. Sometimes they have to find out for themselves. But that doesn’t mean you have to go along for the ride.
Today, larger companies in mature markets have the resources, data, and analysts to model out a market opportunity.
For startups, market sizing is an important gut check before you commit your team and precious resources to a venture. As we have said, knowing if you have a product market fit is not always obvious. However, knowing you at least have a market is not rocket science. There are plenty of tools for guerilla market sizing, so there really isn’t an excuse for not at least running a quick check.
Market Sizing Concepts
Let’s start with three basic terms:
- Total Available Market – Total revenue the product would earn in a year if every available customer bought the product.
- Segment Available Market – Total revenue for the segment targeted
- Share of Market – Total share of revenue the product would earn in the target timeframe, usually 3-5 years.
To make it real, here are some examples:
|Grocery List App||Web Analytics||Enterprise Domain Registration|
|TAM||# Consumers with a smart phone||1 Billion Websites in the world x average revenue||Enterprises with over $250 MM in revenue|
|SAM||US households with two working spouses, smartphones, and under 50||Small to medium size SaaS companies with Product Managers who need product analytics||Enterprises with over 1,000 domains and $25k+ to spend|
|SOM||5-10% X SAM based on current customer acquisition rate and the fact 10-20 way split among competitors||10-20% X SAM based on current customer acquisition rate and a 5-10 way split among segment competitors||30-50% X SAM based on current customer acquisition rate and a 2-3 way split among competitors|
SAM is where you enable Sales and Marketing target the market segment where there really is a fit.
SOM is where the rubber hits the road. It’s where you decide with marketing and sales how much is realistic for your targeted timeframe.
Too many business plans focus on the TAM number. We’re going after the X BILLION Dollar Mobile Apps market. The X BILLION Dollar SaaS Market. etc. SAM and SOM is where vision meets execution.
Top-Down vs. Bottom-Up
There are two basic approaches to estimating your market.
Top Down looks at the total number of potential buyers, so:
Total # Buyers X Revenue per Buyer
Bottom Up looks at total existing sales, so:
Total Sales Channels (or Competitors) x Revenue per Channel-Competitor
Top-down tends to estimate the market potential, whereas bottom-up gives you the state of the market today.
Both numbers have their value.
A disruptive product in a new market segment needs to look at the top-down numbers starting with TAM. Disruptors can’t let the naysayers of existing markets set the benchmark hold them back.
On the other hand, a mature product in an existing market segment needs to look at the bottom-up estimate all the way down to a realistic SOM. If you’re a market follower or your product is just a better mousetrap, this is where to start. Bottoms-up methods are also well suited to niche markets where the competitors and distribution channels are well known and easy to size up.
Not Sizing Your Market. There are plenty of stories of startups with a revolutionary product that defied any market sizing exercise. Google, YouTube, Facebook, and Apple all started without business plans. Are you feeling lucky? Then go ahead. However, many entrepreneurs are not as original as they think. Before you skip this exercise, ask yourself:
- Is my product truly original?
- Are there no competitors?
- Will it make a market instead of entering an existing one?
- Am I rich, crazy, or capable of creating a “reality distortion field” like Steve Jobs?
If the answer is yes to these questions, then by all means, skip market sizing.
Not Targeting Your Market. i.e., looking at the TAM, not the SAM or SOM. Beware of business plans that target generic segments like “Digital Consumers” or “The Fortune 500”. Ask yourself:
- Is my SAM specific enough? Can marketing generate a list of target prospects? How will I reach them?
- Is my market base large enough? Afterall, if I go after the Fortune 500, what is 500xAvgPricexMarketShare?
The China Fallacy. Named after all the failed business plans that assumed that “if we can just get 1% of China…” Assuming that just because a market is big, you’ll reach even a small percentage of it, is naive. Most often, you see this in business cases that the startup will achieve X% of the X billion XYZ Market (insert Gartner/Forrester Estimate here). Again, defining a specific SAM is critical.
Mistaking velocity for market size. Don’t assume the market is huge because the product is selling fast. You see this often in B2B startups where Enterprise sales people string together a few quick deals and report that the market is “huge”.
Chasing Butterflies. The counter to chasing fast growth is ignoring slow growth in huge markets. In the race to show growth, many new ventures launch a series of products and pivot from one strategy to the other. Sustainable market advantage often takes time to develop. There are plenty of tech firms today that dominate their space after 10-15 year trajectories.
Ignoring market forces. Look at your fundamentals like Porter’s Five Forces. In the effort to be lean, too many startups build a product that is easily imitated, or enter a crowded, unattractive market. For example, the online book retailer market is huge, but good luck selling to that one customer that owns 80% of the market. Look for a market that is large, diverse, and emergent with few competitors.
Confusing Lack of a Fit for a Lack of a Market. Just because somebody tried a market with a bad product doesn’t mean there isn’t a market at all. There are plenty of bad products out there that never made their market. The Newton sold poorly, but the iPhone did great. Today, web grocery services are launching all over again. If you have a better product or the timing is new, don’t assume there’s not a market.
Friends don’t let friends do a startup without checking the market first. Basic market sizing is not rocket science. There’s no reason not to at least do a gut check in the early stages of any new venture. Whether you’re in a startup or an enterprise, there are plenty of guerilla marketing tools to size your market with progressively more accurate estimates. Start with a basic hypothesis and go from there. Entrepreneurs know all too well the uncertainty of these estimates, but without a method, you’re flying blind.
Market Sizing Tools