Estimating Market Size for Your Startup
When looking to raise funding for your startup, investors will want to know how big the market is for your product or service. They’ll also want to know if there are enough potential customers out there to warrant their investment. As the founder, it’s your job to give them a realistic estimate of the market size.
Estimating Market Size
First, let’s start with the basics: what is market size? Market size is the total potential annual revenue you would achieve if you were to sell your product or service to every potential customer. Estimating the size of a market for your product or service can be challenging, especially if you’re still in the early stages of creating and developing your startup. However, it’s important to have at least a rough idea of the potential size of your market, as this will give investors an indication of the potential return on their investment. There are two main approaches that you can use to estimate market size: the top-down approach and the bottom-up approach.
The top-down approach typically involves looking at industry trends and statistics and then scales down to a more specific level. For example, if you were trying to estimate the size of the pet food market, you might start by looking at global food sales and then break that down into the portion that is pet food. From there, you could further break it down by looking at the types of pet food and finally by estimating the number of pet households in your target market.
The bottom-up approach to market sizing relies on understanding how many potential customers there are in the market and estimating how much each of those customers might spend. So, using the same example, you would start by estimating the number of pet households in your target market and then multiply that by the average number of transactions per year and the average transaction amount.
So, which method should you use? It really depends on the data that’s available and the level of accuracy that you need. In general, the bottom-up approach is more accurate than the top-down approach, as it’s based on actual data rather than estimates. However, if you don’t have reliable figures for your target market, the top-down approach may be more appropriate. If using top-down, you can also find a reputable source to back up your data (e.g. Forbes states “that the Specialty Pet Food is a $2B market”).
Once you’ve estimated the size of the market, you’ll need to further break it down into three subsets:
- Total Addressable Market (TAM): the entire market opportunity for a product or service.
- Serviceable Available Market (SAM): the portion of the TAM that you can realistically reach with your product or service.
- Serviceable Obtainable Market (SOM): the portion of the SAM that you can realistically capture with your product or service.
Other terms to be familiar with:
- Beachhead Market: Your initial target market where you can establish a foothold and start to generate revenue.
- Compound annual growth rate (CAGR). This is the rate at which a market is expected to grow over time, and it can be useful for predicting future sales.
Understanding Market Growth
In addition to estimating the size of the market, you’ll also need to give investors an indication of the potential growth of the market. This will help them understand the opportunity that your startup is going after and whether it is a high-growth market.
To do this, you’ll need to research the industry and understand the drivers of growth. This could include things like the number of people entering the market each year, the economic conditions in the market, or any major technological or regulatory changes that could impact growth.
When estimating market growth, it’s important to be realistic. Investors will be able to spot overly optimistic predictions, so it’s better to err on the side of caution. It’s also important to be as specific as possible. Estimating that the market will grow by “a lot” or “somewhat” isn’t helpful, so try to come up with a more precise figure.
Finally, remember that market growth is just one piece of the puzzle. Even if the market is growing rapidly, your startup might not be able to capitalize on that growth if it doesn’t have a strong value proposition or execution plan. So, while market growth is important, it’s not the only thing that investors will be looking at.
Estimating the size and growth of your target market is a critical part of any startup’s business plan. Doing this research will allow you to give investors a better understanding of the market that your startup is targeting and will show that you are prepared and have considered all possible outcomes. And, if your market is large enough and growing quickly enough, you might just be able to convince them to invest in your business.