The two quickest and most common ways entrepreneurs use to determine the market size are the top-down and the bottom-up approaches.
One of the most important things to know before you even think about turning an idea into a product is the size of the market you’re going to be targeting.
You might have a great product, a cutting edge website, a well-trained and enthusiastic team, and customers who love your product, but your company might still run at a loss if there aren’t enough customers in the market to support the business.
To avoid such a situation, professional entrepreneurs and investors conduct market sizing exercises before investing in a new business.
Understanding Market Size
The market size is the number of potential buyers of a product or service within a given market and the total revenue that sales may generate.
A related concept is market share, which refers to the part of the total market that a business has as its sales or customers.
The Need to Determine Market Size
The key reason for estimating the market size is to know whether we have a big enough opportunity to turn our idea into a profitable business or not. We might have a brilliant solution, but if it solves a problem shared only by a handful of people, the product will not be a commercial success.
Sizing the market is necessary for business and marketing planning and budgeting for all startups, especially those seeking third-party financing such as venture capital (VC). Even though their investment philosophies may differ, most VCs and angel investors would like to know that they are investing in a market with a larger potential size.
Even if you do not seek external financing, understanding your market potential is essential for different strategic decisions in areas such as product development, partnering and distribution, organizational design, and critical employee skills.
Ways to Determine the Market Size of a Product
To calculate your market size, you’ll either be looking for data on the number of potential customers or transactions each year.
There are a variety of ways to acquire this data. Census and labor bureau hold a lot of information, and most industries have formal associations which compile and track this type of data. You can also commission your research or purchase studies.
The two quickest and most common ways entrepreneurs use to determine the market size are the top-down and the bottom-up approach.
The top-down approach uses a central source of data to gather intelligence on the total size of an industry and a mix of additional data, logic, and guesstimation to determine the market size.
The top-down methodology uses a broad market size figure and determines the percentage that the target market represents.
Although the top-down method is quick and easy, it’s often unreliable and overly optimistic. It looks at the relevant market size for your product or service and then calculates how much your organization might earn from it.
For example, imagine your organization markets stationary materials to schools, and research shows that there are 6,000 relevant schools in your country. You know that the average sale per school is around $50,000, which means your market size is $300 million.
However, this is an incredibly optimistic figure. Not every school needs your products, and those who do are unlikely to purchase $50,000 worth of goods each. So it could be a real challenge to capture even a percentage of this market.
A top-down approach gives you inflated data, and you often can’t rely on it to make good decisions.
Finding reliable data on the size of an industry is seldom easy. So we have to resort to using a bottom-up approach where we infer the size of the addressable market based on how many customers we estimate it contains and how much they’re willing to spend on a solution similar to what we’re planning to build.
This approach is often more time-consuming than top-down market sizing because you do all of your market research instead of relying on generalized forecasts and trends. However, you’ll get a more realistic and accurate assessment of your market’s potential.
To do a bottom-up analysis you start with the basic units of your business (your product, price, customers) and estimate how large you can scale those units.
For example, let’s calculate the market size for a company that wishes to sell coffins.
There are 2.8m deaths per year in the US, and 39% of those are burials. Let’s assume loved ones are buying a single coffin for these individuals, so 1,097,000 deaths = 1,097,000 total coffins sold in a year.
The average casket/coffin costs slightly more than $2,000.
1,097,000 coffins X $2,500 = $2.7B USD annually.
So, the bottom-up method estimates a total US market size of $2.7B for coffins.
Once you have market size, you’ll also want to consider how saturated the market already is with your competitors’ products. Ultimately, you can’t capture the total addressable market (TAM) — some of those people will choose competitors’ products over yours. So you’ll need to determine whether you have a shot at earning enough consumers out of the TAM to make this a worthwhile venture.
If you have been struggling to figure out how to take your business to the next level or seek assistance calculating and capturing a sizable market, you must check out the i2MF program. This program is for aspiring entrepreneurs who have already taken the first step of entrepreneurship – the thinking up of an idea – and are now looking to turn it into a sellable product. It will help you know your target market, target customers, and competitors and thus build your business model.