Estimating Your Market Size

An integral part of determining the attractiveness of a new venture opportunity is looking at your market’s size. Throughout the venture realization process, you will have multiple opportunities to better assess the number of potential customers you have in any given marketplace. You will fine-tune your understanding of who your customer is and how many accessible customers there are. This post outlines three opportunities to quantify your market—Pre-Screen, Segmentation, and Market Strategy phases.

The Pre-Screen Phase

Very early on in the process, as part of your pre-screening efforts, it is worth conducting what is sometimes called a top-down assessment of your market. This assessment derives from accessible secondary research into current customer behavior patterns related to the problem area you are hoping to solve with your venture. It is essential to stay focused on the market as directly associated with the customer’s needs. Think of your market as customers (consumers or organizations) who require solutions (products or services) to solve problems and satisfy needs. Keeping your focus on customer needs is critical to the future success of your venture. Start early and get into the habit of doing this.

During the pre-screening phase, keep your definition of your market open and flexible. If you focus too early on a market definition related to a specific product (solution), you limit your view of the market potential. I see this occurring time and time again. Founders view the market through their specific product idea instead of the customer’s actual need. When this happens, you narrowly view the opportunity, limiting who you see as domain experts, influencers, competitors, and other market-industry stakeholders.

At this stage, you are looking to understand the market’s overall size at the highest level. The current market size and associated trends will give you a 30 thousand-foot view of your potential market in the future. However, entrepreneurs should not see this as their future sales opportunity. You are just viewing current customer activity associated with the problem and any observable trends in market direction.  

There are a few additional questions to answer in this pre-screening effort beyond the question of size.

  1. With a focus on the customer need, can you readily identify your market? This identification is not as easy as it sounds. Founders typically have many assumptions about customers. However, the beliefs are rarely detailed or actionable.
  2. Is the market growing? How fast? It is time to understand where the market and associated products are in terms of the life-cycle. Are the solutions relatively new? Early-late growth phase? Or declining? For startups, there are always opportunities to enter a market. But most would agree that entering a fast-growing market is optimal.
  3. Is the market segmenting? Associated with growth is the understanding of whether the market is segmenting by different customer behaviors or demographics. As will become apparent, understanding which segments already exist may open up opportunities for new market niches.

So what do you want to know about market size during this early opportunity evaluation stage? Before segmentation, any estimates are going to be very high-level.

Your early estimates of your market’s size will focus on the total number of potential customers needing a solution for the problem you hope to solve. The main reason to spend time on this estimate is to give you a sense of whether or not the opportunity is of sufficient size for your efforts and resources. This decision can be very personal for a founder, dependent on your passion for the problem and longer-term venture goals. However, if you plan to seek outside funding at some point, then you need to consider what the investors will see as an attractive size. Investor criteria depend on several factors and beyond the scope of this post. In general, venture capitalists are looking for a minimum of 10X return on their investment, so potential markets valued at $500MM to $1Billion would be attractive. Smaller investors such as angels might see smaller markets as attractive depending on the percentage of the venture they think they would own after future funding rounds and associated dilutions. In this scenario, angels may be willing to invest in ventures who can capture a good percentage of a $100MM to $500MM market.

So, where should you look for market size data at this pre-screen stage? For the most part, secondary sources should provide enough information to support a decision to continue to work on the venture or change directions. Very rarely will founders find a “report” that provides the exact market data required? And if such a report exists, it is rarely at an affordable cost. Start by focusing on available data in the public domain and some well-conceived assumptions to provide what you need at this point of the process. From my experience, some of the most fruitful sources of market data come from government publications and data sites, industry trade journals, press releases associated with the problem to be solved, and analysis of current solution providers—most likely your competitors.

This secondary research information will not go to waste as it will become an essential foundation as you begin to analyze your market in more detail during the segmentation phase.

The Segmentation Phase 

As you move deeper into the venture realization process, you will spend a good deal of time defining your customer profile and thinking about how customer behaviors and demographics might segment the overall market. Understanding each customer segment’s size is an essential criterion for selecting your first market to enter and future follow-on market segments. 

A common approach provides entrepreneurs with a cascading model where you start at the broadest definition of the market and then peel back the layers. You hone in on your market picture until you have identified the customer base you are most likely to reach in your venture’s early period. This model typically includes multiple layers and applies the following four: Total Potential Market (TPM), Total Addressable Market (TAM), Served Addressable Market (SAM), and Share of Market (SOM). If you google this approach, you will find a plethora of definitions, so you should define each level. Here is how I tend to determine each market level. 

Total Potential Market (TPM)
Total Potential Market (TPM) is the total number of customers looking to solve the problem. If they all (100%) purchased your solution, how many customers would that total? I think of this estimate as including customers across all segments. You should calculate this number after you have defined all the customer segments and completed the rest of the market size analysis. You start by defining all potential customer segments. Then prioritize the top 5-6 segments. These prioritized segments will meet several criteria (see Selecting Your Early Customers). However, I think the keyword here is addressable, meaning that there is a clear path on how you will access and acquire the customers within each of these segments. There will be segments within the total potential market that you will not seek in the early stages. 

To understand “your” full potential of the market, you need to determine the Total Addressable Market (TAM) for each segment you consider for early market entry. Similar to the TPM, the TAM represents how many customers you would acquire if you had a 100% market share in a specific segment. You will notice that I focus on the number of customers and not revenues. Many articles on market size discuss TAM in terms of expected market share in revenues. I tend to have founders focus on customer numbers, sometimes referred to as market volume, early on and revenue later. You will be able to extrapolate some potential market revenue estimates through secondary research. For example, you should find any data about how much customers spend on products and solutions already in the market. You won’t determine your potential revenues until you have decided on your revenue and pricing strategies. 

Total Addressable Market (TAM)
To determine the TAM for a specific segment, you will apply a combination of top-down analysis through secondary research resources as well as a bottoms-up analysis from select primary resources. You should conduct a deeper analysis of the potential number of customers in the segment in question, starting with details from your customer profiles, including demographics, behaviors, and reasons for purchasing. During this step, begin with demographic data for each customer segment bounded by the identified geographic area. Then search for market data that provides a portion (percentages) of the population that manifests your target customer’s identified lifestyle or behavior. This analysis will result in the Total Addressable Market for the segment in question. 

Once you complete a thorough analysis of your TAM for each segment, you add all segments together to have a reasonable estimate of your total potential market. This analysis will be a much better estimate than the one you started with during your pre-screening efforts.

Served Available Market (SAM)
The next level of market size analysis looks at customer purchasing behavior with a specific eye towards the number of customers actively looking to solve the problem at stake. These customers are using current solutions to solve the problem, demonstrating how important it is for them to find a solution. Served Addressable Market (SAM) refers to the number of customers actively looking to solve the specific problem addressed by your solution. You identify this market group by customers buying optional product solutions from your competitors or associated products typically purchased by those with a genuine interest in the product category. You accomplish this analysis by integrating market data on similar products’ purchasing behavior or optional solutions, including competitors’ market share data. Then, extrapolate segment size by combining demographic and geographic data with percentages of the population that manifest appropriate behavior and purchasing patterns. 

The analysis you conduct to determine the TAM and SAM for a segment will give you a reasonable estimate of how many customers will be interested in your solution. You will focus on them during future marketing efforts. 

Share of Market (SOM)
The final market size analysis for a specific segment is your Share of Market (SOM). SOM refers to how many actual customer sales can you expect to achieve over a specified period. SOM is usually calculated at a later stage of the venture realization process once you understand customer acquisition strategies and costs and other financial and operational considerations. 

Marketing Strategy Phase

Up to this point, you have focused on quantifying the number of potential customers across segments in your total potential market. As you move towards determining your go-to-market strategy, your understanding of market size becomes all the more critical. A significant part of your marketing strategy is concerned with how you plan to acquire new customers and the promotional channels you will apply in customer acquisition. 

Understanding your priority customer segment size becomes an important determinant of your marketing efforts and dollars. To estimate how many customers will purchase your solution over a specific time, you need to consider how many customers within the segment can gain access to and convert to an actual sale. The market size work conducted up to this point should provide you with an upper limit on how many customers are addressable within your target segment. With this upper limit in mind, you can decide what promotional channels will be most effective. In turn, you have a much stronger basis for estimating how many customers you can acquire and the number of revenues expected. So you can see why such due diligence on market size supports your decisions regarding marketing efforts and subsequent revenue projections. 

By this point in the venture realization process, you can better predict your potential SOM, the number of customers, and the revenues you can realistically achieve once you enter the market. This estimate is typically for a time frame of 1-3 years. After your venture has been in operation for a while, you will be able to refine your estimates of future market share. 

Conclusion

The above process outlines what I call one of those “connecting the dots” activities where entrepreneurs see how their understanding of the market builds and evolves throughout the venture realization process. Understanding the achievable market size will enhance many of your decisions and financial projections, thus increasing your venture model’s credibility.

For more on this subject and other entrepreneurship topics, get a copy of Patterns of Entrepreneurship Management, 6th Edition.

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