Market Sizing

If you are a CEO, you probably have a pitch deck slide with a single giant number with the words, “market size” near it. For me, these “Market” slides usually set off a blaring BS alarm. If the dollar amount is too big, I feel like they are trying to pull one over on me. If the dollar amount is too low, I think that the founder doesn’t know their market. Neither case is good for fundraising. The problem is founders are confused about which “Market Size” to report. There are three primary terms that are reported at different times.

Total Available Market (TAM):

The total demand for products or services in a market is called the Total Available Market (TAM). If you sell a new type of high-end sports tire, your TAM may include all tires. Alternatively, if you sell aged pistachios, you might try to report global food sales as your TAM. In both of these cases, the TAM is for a much larger market than the product could ever hope to address.

Serviceable Available Market (SAM):

The portion of the market for which your product fills a need is the Serviceable Available Market (SAM). In the first example above, the SAM is the total sales of high-end sports tires that your product fits. In the second example, the SAM is the total annual pistachio sales for your distribution region. The SAM is much smaller than the TAM — roughly 1–10%.

Serviceable Obtainable Market (SOM):

The portion of the serviceable market that your company can capture. For most successful startups, the SOM is a small percentage of the SAM (1–10%). SOM is basically the long-term annual revenue of your startup. Typically, SOM for a great startup is less than 1% of the TAM. If you have a bomb-proof plan for taking on more than 10% of SAM, great — just back it up.

Pitch Deck:

So, what should a CEO put on her pitch deck’s “Market” slide? In theory, Serviceable Available Market (SAM) is the best number to report. Having said that, most entrepreneurs pitch the TOM, which is often 10x larger than SAM and 100x larger than SOM. The problem is that if you report SAM or SOM, you’ll look like small business next to a CEO that pitches TAM. So, what is a CEO to do? My suggestion is to know your audience. If you’re talking to an inexperienced investor, report TAM in large numbers with SAM in small font in the notes. If you’re talking to an experienced investor, report SAM. Instead of reporting TAM of all foods when you sell pistachios, report TAM for nuts in your country.

Conversation:

Hopefully, your pitch deck is only the start of your conversation. If you report too low or too high in the deck, you’ll decrease your odds of a further conversation. You also don’t want to surprise your investor by saying one thing and then switching to something different. A consistent message is needed, not a changing one.

In this conversation, the important thing is that you are coming from an informed position and not doubling down on your estimate. This is probably just some number that you pulled out of one place or another. There are probably five other numbers that would have been just as wrong.

If an investor claims that your chosen number is too high, don’t BS the investor or get upset. Look her in the eye tell her you estimated the market size in five different ways and this is the middle estimate. Don’t get bogged down in this discussion, just state the range and move on.

Marketplace:

For a product or service play, your SAM is more easily understood than for a marketplace play. In a marketplace, you should indicate how large the total market of sold goods and services is currently (TOM). Markets only extract transaction fees for transactions. The services that marketplaces provide are associated with making the deal happen. They are a conduit, not a traditional supplier of goods or services. Therefore, the serviceable market should be the cost that the buyers and sellers pay for the service of making sales happen — not the total sales that happen in the market. In other words, a real estate play should list the total realtor fees as SAM, not total home sales (the TAM).

Yet, most of the marketplace decks seem to report the total market size (TAM) — even in places where they specifically state “Serviceable Available Market”. This is not to say these CEOs are dishonest. On the contrary, these CEOs are providing relevant data in a way that most investors understand.

Market Size Estimation:

Most of the time, you won’t have perfect data on the size of your market. If someone has already researched and published your market size, you should expect that others have that same information and are planning to act on it. Therefore, the challenge is to estimate the TAM, SAM, and SOM from what data you can find. There are a bunch of ways to estimate TAM. Here are a few:

• Search for reports of your market size and use those.
• Estimate how many people buy what type of service. This requires doing customer research into what types of people buy how much of what type of product or service.
• Find out the annual revenue of your largest competitor, and estimate their revenue share. Estimating revenue share may require customer interviews as well.
• Find the TAM for the broader market and take out other parts of the market based on reports and unit sales.
• Engage a consulting firm like McKinsey to collect more data.

Disruption:

If your startup is really disruptive, it will bring new revenue into the market. As Jakub Kostecki pointed out to me, Uber and Lyft are a prime example of this. Uber and Lyft have increased the number of hailed rides by increasing the convenience. Plus, Uber and Lyft have cut into the broader ground transportation market — especially the car rental market. Most startups aren’t as disruptive as this duo, so don’t count on a similar convenience bump.

Market & Valuation:

For me, the serviceable obtainable market (SOM) is most important. SOM is basically the long-term forecast revenue of your startup. The SOM indicates the future value of your startup, assuming some revenue multiplier (e.g., 5x). Using a 30% IRR, you can estimate the present value of your future labor — disregarding risk. If you assume 1 in 20 odds of success, just multiply your present value by 5% and that is roughly your current valuation — assuming you can pull it off. Of course, the larger your SOM, the greater the odds are that you won’t succeed.

Fun Bits:

• Here’s the true definition of disruption: ‘ “Disruption” describes a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses.’ (Clayton M. Christensen) For further information about disruptive innovation check out the HBR article.
• Above I mentioned ways to estimate your TAM, one of which was to research reports on market size. Here’s a great list of resources to find these reports and more useful information for market research.
• For an easy guide on how to build your pitch deck, check out Guy Kawasaki’s blog: The only 10 slides you need in your pitch.

Originally published on February 9th, 2017 on our previous blog.