Why do investors do market sizing?
Imagine that you have just spent three years building a fantastic business. Your product is excellent, and your website is cutting edge. Your people are well-trained and enthusiastic. Also, your customers love what you do.
You are running at a loss. There are not enough customers in the market to support the business.
This is a heart-breaking and prevalent position. It is why many investors conduct “market sizing” exercises before they invest. This is part of the business planning that they do.
This article will look at how you can analyze your market size. We will see how you can use this data to make informed strategic decisions.
What Is Market Sizing?
The “market size” is the total number of potential buyers and the revenue from a product.
It is essential to calculate and understand market size for several reasons.
First, firms can estimate how much profit they could earn from a new business, product, or service. It helps to decide whether they should invest in it.
You may choose to move forward. Then this analysis will also help you to develop a marketing strategy. It will address the unique needs and potential of your core market.
Market sizing can also help you estimate the number of people you may need to hire before launch. This is rather than “feeling your way” as you test your new market.
If you know this from the start, you can optimize your recruitment approach. You will have the right people in place.
Estimating Market Size
Let us say XYZ Company was contemplating expanding their operations. They currently make widgets.
But they want to explore the possibility of making gizmos. The company needs to calculate the market size for gizmos before commencing production.
To calculate the market size, the XYZ Company looked at sales by its competitors. It analyzed the end-user – the consumer. XYZ Company calculated that the gizmos’ market size was $100 million in 2014 in the US.
They reviewed the sales statistics from their competitors. They found that ABC Company had sales of $40 million in 2013. DEF Company had 2013 sales of $20 million.
The market size of gizmos is $100 million. XYZ Company learned that both competitor’s production lines were behind schedule. The sales were backed up for months.
So, XYZ Company may be making a wise decision in filling in the $40 million gap in market size. Each company’s respective ‘piece of the pie’ in the market size is its market share.
Market Sizing Methods
Two methods are commonly used for market sizing: top-down and bottom-up.
Although the top-down method is simple, it is often unreliable and overly optimistic. It looks at the “relevant” market size. It then calculates how much your organization might earn from it.
E.g., your firm markets learning resources to schools. Your research shows there are 6,000 relevant schools nationwide.
You find out that the average sale per school is around US$50,000. This means that your market size is US$300 million.
Of course, this is a practically unrealistic figure. Not every school needs your products. They are unlikely to buy $50,000 worth of goods each. So, it could be a real challenge to capture even a small percentage of this market.
A top-down approach gives you inflated data, and you often cannot rely on it to make the right decisions.
This is why it is much more effective to use the bottom-up approach. This approach is time-consuming because you do all of your market research.
You do not rely solely on generalized forecasts and trends. But you will get a more realistic and accurate assessment of your market’s potential.
It is better to focus on how you can use a bottom-up approach to market sizing.
How to Calculate Market Size
Follow the steps below to use this approach.
Define Your Target Market
To predict your market size, you need to know your target consumer. Your offering has to fulfill a need. It has to solve a problem uniquely well for a group of people. It would help if you defined who these people are.
Think about how you can access these customers. There is no point considering them if you cannot reach them cost-effectively.
Divide your market into specific groups by using market segmentation. This gives you a greater understanding of each target group. It helps you tailor your offering to the specific needs of that group.
Identify the different possible segments in your market. Then choose what you want to focus on to build your business.
Determine how large this market is. To start, contact business organizations, data providers, and civic organizations. In your chosen segments, source a list of potential clients.
Your firm wants to develop point-of-sale software for mid-sized grocery stores. Find out a few things before you invest the time and money to develop the software.
Make sure that the market is large enough. Also, ensure that people are interested enough in your product to buy it
Research online and contact your region’s business and commerce department. You may determine that there are roughly 10,000 mid-sized grocery stores in your country. Source a list of these stores.
Use Market Research to Assess Interest in Your Product
Not everybody in the target market will want to buy your product. So, your next step is to estimate real interest.
Focus on competitors who target the same group of buyers. What is their market share? What are their sales for similar services or products?
Your competitors may be focused on this market. This can give you a reasonable estimate of the potential market size. But it can be almost impossible to source this information if they focus on other markets.
Another way to assess interest is through surveys, individual interviews, and focus groups. Question a large sample of people or businesses that fall within your target market. Explain what you have to offer.
Keep your sample large. It will make your analysis better. Does this product interest them? What would they feel comfortable paying for it? And how likely are they to buy your product or a similar product within the next two years?
It is essential to draw conservative conclusions. It is done based on the feedback you get from these focus groups or surveys.
Often, people will say one thing. But they do another thing.
People often “think twice” before making a purchase. This is especially applicable as interests, budgets, and market conditions change.
Over three months, you talk to 100 randomly selected mid-sized grocery stores. This represents one percent of your target market. You explain the new software’s idea and the benefits it will provide to the store owners.
After the presentations, 35 stores express a strong interest in the software. To be conservative, you reduce this number to 18.
Thus, 18 percent of stores in your target market will be interested in your product. This means that 1,800 could buy out of 10,000 possible grocery stores.
It will take much time to set up and conduct this research. Carefully think about any other market research information you might require. Where appropriate, gather this at the same time.
Calculate Potential Sales
You now have a more realistic figure. It represents how popular your product or service could be to your target market. Use this info to decide whether your product is worth the investment and risk.
To do this:
- Develop a financial model of your business using the data you have gathered.
- Identify critical assumptions within your model.
- Test these using techniques such as Scenario Analysis and Monte Carlo Analysis.
You have determined that 1,800 grocery stores might invest in your software, which costs US$30,000. If 100 percent of these stores buy the software, this is a return of US$54 million.
Your firm has estimated that it will have to invest at least US$7 million. It will develop, test, and market the new software.
The investment is 13 percent of potential annual revenues. So, the risk is low, even if the response is not as lively as predicted.
Your organization, thus, decides to move forward with the development of new software.
The market size is the total number of likely buyers of your service or product within a given market.
To calculate the market size, you need to understand your target customer. Assess interest in your product.
You can do this by looking at competitor sales and market share. Look at individual interviews, focus groups, or surveys.
Your aim is to find out how many people within your target market are likely to buy your product.
Use this info to decide whether the investment is worth the risk.
You can also take a look at our Venture Capital Pre Screening Assessment to evaluate your business and this will also help you in getting funding for your business in just 5 steps.