One of the most important tasks an entrepreneur has before turning his idea
into a product is to calculate the size of the market and the potential value
the market has for his start-up business.
What is the size of the market?
Market size represents the number of individuals in a given market who are potential buyers and sellers of products or services and is particularly important when launching new products or services.
Why is it necessary to determine the size of the market?
Knowing the size of the market is one of the most important components of any strategic marketing plan, and without this information, an appropriate business plan cannot be created, and you cannot be taken seriously when you want to reach out to potential investors.
Determining the size of your target market allows you to:
- Accurate assessment of possibilities,
- Budget planning for research and development, marketing,
- Identifying potential customers,
- Determining the share of market potential that can be realized by the competition
- Understanding the level of growth you will need to achieve your business goals,
- Helps determine if there is a real need for your product,
- It is essential to bring and present your idea to the market.
- Indicates how the company can best position itself to take advantage of market opportunities.
Issues to consider when determining market size
What period are you considering? One year is standard, but you may have a time frame that suits your job better.
What geographical area does your market cover? Is it a local, regional, national or global market?
Are there any specific issues you need to take into accounts, such as existing regulations or restrictions?
Has your market changed in the last few years? Markets are rarely static. They are evolving and changing every day, so it is very important to keep up with new technologies and carefully monitor consumer habits.
What are "TAM, SAM, and SOM," and why are they important?
The size of the market itself is seen through the terms:
TAM - Total Available Market,
SAM - Served Available Market,
SOM - Serviceable Obtainable Market.
TAM SAM SOM is a visual and measurable representation of the market. Starting with the widest image, the view is reduced to the target market in which you will present your offer.
TAM (Total Available Market) - This is the widest possible market that
your product/service could cover. In terms of value, it indicates the maximum
potential income that can be realized. By determining TAM, you check whether
the potential market to start your business venture is large enough and is
usually the first type of market size to be calculated.
SAM (Served Available Market) - is part of TAM but is limited by the geographical location of the startup, as well as other restrictions that arise.
SOM (Serviceable Obtainable Market) - the narrowest market, part of SAM. It represents the part of the market that the company is currently targeting or plans to target soon.
How to correctly determine TAM?
To correctly calculate TAM, Bill Aulet advises us in his book Disciplined Entrepreneurship to do the following:
- Estimate the number of end-users in the market using top-down and bottom-up analyzes.
- Estimate the annual revenue that each of your end-users brings to your company.
These steps are about narrowing your focus so that you can get a better idea of what you're looking for.
Methods for determining market size
The top-down approach starts with estimating the total market and then determining the market share. The process itself ranges from general to specific and requires access to broad industry data that can be narrowed down based on your target audience, geographic data, and other characteristics that are critical to your product and business. In general, a top-down approach is usually a faster and more time-efficient approach. It is great for quickly estimating the size of the market, but it can very rarely provide all the details necessary for a true analysis of the possibilities.
Instead of analyzing a large amount of data, this method begins with estimating potential sales and determining where your product can be sold and the stakes you can set aside, taking into account specifics such as the size of your sales force, production capabilities, and distribution.
The bottom-up method is based on the product or service itself,
determining primarily your sales channels and getting data on how much you can
sell in each channel. The bottom-up methodology builds TAM by summing the main
target market variables. This method is usually
considered more accurate but requires significantly more time to
Top-Down VS Bottom-Up? Which method is better?
The choice of method for determining the size of the market depends on many factors. It primarily depends on the specific needs of your business and the information available to you. If you can access all the necessary information about the industry, top-down forecasting is faster and the data you get could give you an insight into whether the market is growing or declining.
Many experts believe that the bottom-up method for determining the size of the market gives more realistic results because the figures are based on actual sales and marketing data for your company. However, no method is necessarily better than another.
What needs to be emphasized is that their combination can give extraordinary
results and that is what you should strive for.
By combining these two methods, it is possible to get the most relevant
data, so if you can find your market size using both methods and find that your
numbers are similar, you are well on your way to realizing your idea.
How to estimate the annual income that each of the end-users gives to your company?
When estimating annual revenue per user, you should consider:
What is it that the customer is currently spending money on? It is very likely that the customer is currently spending money to solve his problems or that he is spending money on a product that causes those problems. Think carefully, because maybe your product can solve all the troubles of customers. It is necessary to get to know your customers.
Therefore, you need to know:
- How much does each product cost?
- How much of each product do customers buy?
- What is the average lifespan of a product before it is replaced by another product?
Available customer budget. Consider the following:
- How much money is spent in total to solve the problem of a typical user?
- How much money does the customer have, taking into account household income, business income, and so on?
- What part of that amount could be set aside to solve their problem?
Comparison. You can compare similar products with yours, or data from different markets to enhance your TAM analysis.
In addition to these, it is necessary to take into account some other important factors such as:
- Profitability: Is it and how profitable is it? In most companies, the goal in the market is to achieve positive cash flow if possible before expanding to neighboring markets.
- Times to conquer the market: How many successes or failures can you have in this market?
- Complex Annual Growth Rate (CAGR) of total revenue: Is this a market just starting up and has great growth potential?
- Expected market share: Is this a market that wins and takes over all the effects of networking?
If the answer to any of these questions is no, think twice before taking the next step.
Knowing the size of your market is an essential part of starting any start-up venture. While much of the market size budget relies on assumptions, it can be very helpful to consider market trends and their impact on your new business.
Taking advantage of new market trends can give your company an advantage over competitors, and without a firm understanding of the size of your market and its importance, you can jeopardize the success of your business not only in the early stages but throughout its life cycle.