Determining your market size is critical for startups, and maybe especially firms that are trying to launch new products. Being able to determine and justify the likely number of possible customers can be critical in gaining resources and developing revenue forecasts.
Why market sizing is important
Gaining resources
One of the primary reasons for market sizing is to help gain necessary resources. Projections by startups, who are often looking to gain support based on future state rather than current sales, are important to investors and partners. Often times investors may only be interested in firms that have a prospect of reaching a particular size, and projections can help convince others that the firm will be of noteworthy size.
Of course, not only are investors likely to be interested in: indeed being able to justify why projections are robust can be as valuable at convincing others than the high-level number themselves.
Determining resource allocation
Beyond gaining resources, market sizing is also critical to appropriately sizing resources. The ultimate market opportunity can radically influence the appropriate level of resources to commit to a particular project.
It is important that the level of staffing and other property decisions are based on a realistic estimate of how large a company can become: it can be just as bad to have too many resources as too little. Oversizing the market opportunity, can and for example result in over-staffing or committing to excessively large property leasing, making it very difficult to be successful on what may have the potential for being a modest market opportunity.
Dangers of market sizing: How it goes wrong
Extrapolating from small scale success
Small success is great – and you should definitely celebrate it. But, it is easy to extrapolate from very small initial success and see very big numbers.
In the early stages of a business you may see quick sales growth: Maybe one month your sales are 20% higher than the previous, and maybe you even see this happening for a couple of months in a row. Quickly you do the math, and realize that if your 20% month-on-month growth continues, you will be about 9 times your current sizes a year from now (i.e., 1.2^12), and an incredible 56,000 times your current sizes in about 5 years (i.e., 1.2^60)!
These hockey-puck, exponential growth projections are not uncommon, but almost never materialize. The key danger is that you are projecting from a very small starting point, and while it is not uncommon to see relatively high growth rates early on, it is a lot less common to see high growth rates continue month after month.
Unfounded assumptions
Another real danger of market sizing is the sometimes huge assumptions that are built-in. Some of the most inaccurate market sizings start by assuming that 1% or 5% or 10% of a particular group of people will buy or use your product – with little basis for the assumption.
Components for determining market size
It can be difficult to determine market size, and maybe especially so for new products where there is not an existing market that you can reference. Estimating the potential market size is as much about drawing from fragments indicating the opportunity, ideally triangulating the sizing from multiple angles to circulate on plausible estimates of the possible market.
Extrapolating from similar markets
Possibly the primary way of sizing a market is to draw from existing, similar markets. How much is for example being spent in similar markets – either customers that can potentially be converted to your offerings, or an approximately similar group of customers that may also be interested in your offerings.
Determining the number of likely users
A complementary approach for determining the size of a market opportunity is to total up the number of potential market customers (e.g., businesses or consumers) who could purchase the product. The closest you are able to get to the actual population of interest the more likely the estimate will be accurate – narrowing down on a specific and defined set of customers is likely to be more accurate than say assuming 0.01% of the overall population will be interested in your product.
Verifying assumptions
Another important component of evaluating a market opportunity is to look to verify assumptions. This may involve limited trials to gauge the extent of interest in the offerings or to verify the actual prices that customers will pay.
Summary
Sizing a market opportunity is not an easy task, with common financial projection mistakes, such as widely optimistic growth rates that are unlikely to actually materialize. It is important to scrutinize your estimations, and, to the extent that you are able, verify or triangulate assumptions in your models.
This can help avoid the danger of overcommitting resources (creating an organization structure that due to inherent costs can never turn a profit), while also potentially making it easier to acquire resources with estimates that can support.
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