The concept of market sizing is highly relevant in many business scenarios you might come across, and is therefore a fundamental part to consider in every business decision you take. Determining the size of the market can provide significant insights in terms of investments, growth targets, performance evaluation and other strategic questions.
Understanding market size
The first step to calculating the market size is understanding what a market actually is. The market is the aggregate of buying decision makers who have a common need or want, which is fulfilled by your product or service. In order to get a real feel of your market you will need to carefully examine various factors, such as:
- The competitors in the market.
- The Substitute and Replacement Products available
- Your Target Audience (e.g. profile, characteristics, etc.)
- Current and Future Market Trends
How to calculate the Total Addressable Market (TAM)?
Total Addressable Market (TAM) refers to the revenue opportunity available for a particular product or service. According to early stage startup investor at Matrix Partners, Jared Sleeper, there are three ways to calculate TAM:
- Top Down approach is primarily based on industry research and reports and it follows a process of elimination. This method begins by considering a large population with a known size and narrows it down to a particular segment of the market. This method contains little information and neglects to consider the potential change in the market size caused by the company’s disruptive product.
- Bottom Up approach is based on primary market research, and is considered to be more accurate than the Top Down approach. It is compromised by relatable data on the existing pricing and usage of the product, which allows the company to rationally support why it selected particular customer segments and why it left others out.
- Value Theory approach is based on an estimation of the value offered by the product to users, and as a result an estimation of how much of that value can be captured via pricing. This method is usually used when an existing company is introducing new products or when it is cross-selling particular products to existing customers.
Taking into account the market trends
Furthermore, you need to make sure that you are taking into account upcoming changes into your future projections. For example, if a product category within the market in question is expected to experience a severe decline in the next year due to external factors, you will need to account for the change of market size.
Whether you are launching a new startup venture, considering expansion, or pursuing a new product development initiative, it is vital that you know your market size, and how it translates to potential revenue. As a final note, remember that you need to be explicit about the assumptions made and data utilized when estimating a market size.