Conducting a Market Size Up

If you’ve been following InvestBeta and reading our articles, you should have a solid grasp on how to model a company. But after learning about operating models to predict future fundamental value and how to analyse current events and news, it’s important that you also consider the qualitative assessment of firms.

This article is all about adopting a marketing lens. Before a new product or startup is launched how can you predict its opportunity of growth? The answer is conducting a market size up.

The information from a market size up allows businesses to create a feasible business plan surrounding their product and gives possible investors an idea of the firm’s growth potential and the value of the venture.

The Situation

Let’s say you find a very recent news story on Bloomberg that Proctor & Gamble, a consumer goods conglomerate, is planning a new product line in Canada. You’d be somewhat interested in the potential value of this venture and consider taking this investment opportunity.

Olay, one of P&G’s multibillion-dollar brands, is releasing a new skin cream targeted to Gen-Z females (ages 14–18) in Canada. The product, which will sell for $20, is naturally derived, organic, scent-free, is produced sustainably, and has recyclable packaging. In order to assess the viability of this market and see whether this project is a worthwhile investment that will sustain a strong revenue stream, Olay will conduct a market size up. As an analyst, you will also look into a market size up to research the potential value of this plan and what it means for P&G as a company.

The steps for doing this follow in this order:

1. Define the market segment
2. Market sizing using top-down, bottom-up, and value theory methods
3. Market analysis (Porter’s Five Forces)

Segmenting the Market

What exactly is the market? Before we go anywhere else, we need to have a concrete definition of who is buying this product. After all, a market size is the amount of potential buyers of a product or service.

Market segmentation is the process of dividing a market of potential customers into groups, or segments, based on different characteristics. The characteristics by which we can segment the market are geographic, demographic, psychographic, and behavioural.

Demographic segmentation deals with variables like age, gender, family size, income, occupation, race, religion, nationality, etc. From before, we already know that this product will target females aged 14–18. You can think about each of these variables objectively and in more depth, like how much disposable income this group has to spend on skin cream.

Psychographic segmentation is broken down into social class, lifestyle, or personality. Olay could conceptualize this by developing customer profiles. Customer profiles firmly define a potential customer’s preferences, lifestyle, motivations, and key attributes. For example, your product could target Gen-Z females that are vegan and/or value an eco-friendly lifestyle.

After going through this process, you should have a target market. The marketing team behind this product should know its niche market segments, but should also keep a very general target market in mind for the purposes of market sizing.

Market Sizing

If marketing has one goal, it’s to reach consumers at the moments that most influence their decisions. The main model for these “moments” is the customer decision journey. In this journey, the customer transitions through the total set, awareness set, consideration set, makes a decision, and finalizes it through a purchase.

A total set consists of EVERYONE in your target market. Then, this turns into an awareness set, or the amount of people who have identified a need that corresponds with your solution, know about your product, and are looking for viable options. Finally, we have the consideration set. This set of consumers has identified a need and is seriously considering purchasing your product.

TAM, SAM, and SOM

TAM = Total Addressable Market

SAM = Serviceable Available Market

SOM = Serviceable Obtainable Market

TAM, SAM, and SOM represent the different subsets of a market that we analyse when conducting a market size up. The three stages outlined in the customer journey directly correspond with these terms. The total addressable market (TAM), the total demand for a product, is essentially the same as a total set. Beyond the total set, there is the serviceable available market (SAM), which is the target addressable market that is served by a company’s products or services. An awareness set also has specific needs that are satisfied through a company’s offerings. Finally, the serviceable obtainable market (SOM) is the percentage of the SAM that is realistically achievable.

Total Addressable Market

A total addressable market, or TAM, is the total market demand for a product or service, calculated in annual revenue or unit sales.

Three Ways to Calculate TAM

1. Top-down
2. Bottom-up
3. Value theory

The top-down analysis follows a process of elimination that starts by taking a large population of a known size that comprises the entire industry and narrows that down into the entire target market. This method uses industry reports and proprietary research to get broad estimates.

Ex. Compare the major players in the skin care industry like Unilever. L’oreal, and Johnson & Johnson. Determine their size in the Canadian market and factor in the size of smaller competitors with more a niche focus in skin care. This can be done by viewing financial statements (quarterly and annual), which often divide figures into business segments such as skin care & beauty.

A bottom-up approach relies on primary market research. Rather than breaking down big numbers, you build up a TAM by adding together the main variables of your business model, such as current pricing and product usage. This method is more reliable as you can narrow down specific market segments.

Ex. Find the size of your target market through market research. If ⅔ of Gen-Z females surveyed generally match the characteristics determined by the demographic and psychographic segments, then you can quantify the number of people in your market. You would simply do:

Total number of Gen-Z females in Canada x 2/3 x the product’s price

Value theory is the most difficult method, but is still a very valuable one. It basically asks, how much value are we providing to the market and how is this being captured in our pricing? The higher value a product has, the larger a market it can address. This concept is better described through Uber’s TAM.

Ex. Uber’s users have the alternative options of driving themselves, public transit, walking, biking, taking a cab, etc. Since Uber’s users willingly forego these alternatives and ride with Uber, the company can conduct market research and quantify the value users derive from Uber. What is the max price they’d be willing to pay for Uber? This could indicate the potential demand for Uber’s service versus incumbents in the market.

In P&G’s case, the most accurate TAM calculation would combine all of these approaches. For the sake of simplicity, let’s say the TAM for this new Olay skin cream is about 1 million customers, and the revenue potential is $20 million. This is the entire female Gen-Z population in Canada that aligns with the demographic and psychographic segmentation. Remember, we are still at the total set, and we need to narrow our scope down to the SAM and SOM.

SAM

The serviceable available market is the same as the awareness set. This group has identified a need (ex. wants an eco-friendly skin moisturizer) and is searching the market for the best solution according to a personal criteria. The SAM is the part of the market that you can feasibly service.

This is important because P&G will try to turn the awareness set into the consideration set through its marketing strategies in the future. The feasibility aspect of a SAM makes it a more realistic guess of a product’s long-term potential as P&G will try to tap into the SAM in the near future.

P&G’s core competencies, past performance in the market, and distribution channels would be good indicators of its SAM. P&G has a greater market share in Canada than its competitors, has an efficient and well established supply chain, and sells both through big-box retailers and e-commerce websites set up for each individual brand.

Of the total addressable market, P&G believes they can capture 65% of it as the serviceable available market. This is based on their past performance with Olay products and their current distribution capabilities. This means that the SOM consists of 650 000 people, with a revenue potential of $13 million (650 000 $20).

This type of statistic is hard to accurately quantify as and investor, and it will always be an estimate. P&G has access to proprietary market research and sales figures, so it can make a better guess. However, you can assess the SAM by evaluating P&G’s strong distribution capabilities. But usually, P&G will release this type of information during quarterly updates to investors, newsletters, and press releases talking about where the company is heading.

SOM

Finally, we get to the serviceable obtainable market. This is a company’s short-term target and therefore matters the most. If P&G can deliver on its SOM in time, then it is capable and credible on its market size up, and is on track to penetrate more of the SAM.

Identifying a SOM requires more extensive market research on the consideration set. For instance, P&G could survey a large and unbiased sample of Gen-Z females that make up the SAM, and determine what percentage would be part of this consideration set.

Through preliminary market research, let’s say they found that the SOM is ⅓ of the SAM. As a result, the actual size of the consideration set would be:

1 million 0.65 ⅓ = 217 000

The amount of customers P&G can obtain in the short-term is 217 000. With the skin cream priced at $20, that’s a potential revenue of $4.33 million.

What Does This Mean?

The market size for Olay’s new skin cream is large enough to make it a worthwhile project. While P&G has often struggled with accessing smaller, niche markets, this move is likely to help in diversifying Olay’s target market. But the question of whether P&G should enter this market is still unanswered because we haven’t considered the characteristics of the market and how that plays into the feasibility of this plan. Porter’s Five Forces is the standard method of assessing the difficulty of entering a market.

Porter’s Five Forces

This is a model for analysing five competitive forces that shape every market and help determine the strengths and weaknesses of that market. This is key for developing a corporate strategy and further assessing if P&G’s new venture is lucrative.

The specific industry name for Olay’s new product is skin care and beauty.

Porter’s five forces are:

1. Competition in the industry

2. Potential of new entrants into the industry

3. Power of suppliers

4. Power of customers

5. Threat of substitute products

1. Competition — High

This refers to the number of competitors and their ability to undercut P&G’s success in the skin care space. Some key competitors include L’oreal, Revlon, Unilever, Johnson & Johnson, and Kao Corporation. There is a low to moderate amount of competitors so most players have significant market share, and smaller and niche brands exist on a small-scale. Rivalry within the industry is high and there is a lot of competition in large retail stores for shelving, and for both physical and digital ad. There are several pricing strategies that reflect product quality and brand equity, and products are moderately differentiated. Companies in skin care create competitive advantages through supplier networks, brand association, product differentiation, and quality perception.

However, the Gen-Z market and the niche aspect of “eco-friendliness” has generally lower competition as it is less saturated. Entering this market will provide new room for growth and alleviate the threat of competition.

2. Threat of New Entrants — Moderate to High

Barriers to entry within large retailers is high, but entering very small and niche markets is much easier. Within retailers like Walmart — which is an ideal space for selling based on the customer journeys of much of the target market — securing shelf space is highly competitive and requires strong brand recognition and economies of scale because of low margins. As a result, smaller companies are not considered direct competitors.

P&G is entering a more niche market with a strong ability to undercut small companies, which is a good thing. Despite this, key competitors are likely realizing the same opportunity in the same target market, and may develop their own “all-natural” product for Gen-Z females. Therefore, P&G needs to act fast to secure market share in this space.

3. Supplier Power — Low

There is a large number of suppliers in this industry because many manufacturers are required by brands. There is low differentiation in products, but there is a certain cost to switching suppliers. Forward integration (assuming more direct control of the supply chain) is a threat to suppliers, resulting in a low bargaining power for suppliers. For P&G’s new product, it will require a revamped manufacturing process to maintain its value proposition of an all-natural and sustainable product. P&G would likely outsource its manufacturing, so supplier power will also stay the same.

4. Buyer Power — High

Buyers have high power because of the increased competition and wide selection of products. Buyers influence prices as they can easily switch to other brands, making long-term profitability difficult under this environment. In a more niche market like this one, buyer power would be somewhat higher because of the limited selection of “eco-friendly” skin products in retail stores.

5. Threat of Substitute — Low

The only realistic substitutes for skin care products are home-made remedies made from natural ingredients like herbs and oils. The switching costs and buyer propensity to substitutes are low, but these substitutes are mostly used on a small-scale in rural areas.

Market Analysis

We’ve assessed the market and the numbers. This is a big enough market to go after, considering this is generally a new market. With Porter’s Five Forces, we’ve looked at the pressures of competing and how easily P&G can enter this market. This space will soon see more entrants, but P&G can capture significant market share early on. Competition is also low, which reinforces that its a solid decision.

It’s a good strategy for P&G to diversify its target market and enter spaces where small-scale cosmetic companies have previously operated. Olay’s new skin cream will alleviate the competitive pressures that products in much broader market segments have historically faced.

Forecasting for Operating Models

When making forecasting future fundamental value through operating models, your assumptions are a key part. This means qualitative factors that predict the direction and extent of change in future financial figures on the balance sheet, income statement, and cash flow statement. As mentioned in the Operating Models article, if forecasting is only done through formulas and numbers, you’re projection will be flawed as it won't factor the ever-changing external environment that a business operates in.

For P&G, you have to make assumptions to estimate how each figure on each financial statement is going to change. Consider the startup costs, potential revenue, liabilities, and cash from operating activities, etc. by looking at how previous product introductions affected these figures in the past. For example, to what extent will this product launch need debt financing? What would be the short-term expenses? Most importantly, what would be a realistic revenue forecast in the next 2–3 years?

Ex. Because this one product will affect the figures on P&G’s financial statement very minimally, you have to make educated guesses. To estimate for cost of goods sold, you can assume the variable costs of production would be around $16–$17 if the product is priced at $20 and P&G’s net sales is around 15%. Fixed costs (operating expenses) would be estimated by assessing the need for land, buildings, equipment, wages, research and development, and marketing investments. For revenue, analyse how much of the SOM P&G can realistically capture in tangible sales. (Ex. From a SOM of 217 000, I estimate that P&G can convert 45% into sales of one individual SKU, in the first year. That’s an estimated revenue of about $2 million in 2020)

Conclusion

Overall, one skin cream will not drastically change P&G’s stock price. The revenue potential is high, but it’s insignificant to the big picture. This is just an example of market analysis. But if all of P&G’s business segments are trying to enter more niche markets to diversify product lines, you should definitely research further using this format!

Key Takeaways

1. A market size up looks at the opportunity of launching a new product or startup
2. As an investor, you assess the feasibility of this plan
3. The three steps are: Segmenting the market, Market sizing, Market Analysis

4. There is demographic, geographic, psychographic, and behavioural segmentation

5. Total Addressable Market = Total Set

6. To calculate TAM, there are top-down, bottom-up, and value theory methods

7. Serviceable Available Market = Awareness Set

8. Serviceable Obtainable Market = Consideration Set

9. Porter’s Five Forces consists of: Competition in the industry, Potential of new entrants into the industry, Power of suppliers, Power of customers, Threat of substitute products

9. Use a market size up to make assumptions for forecasting in an operating model

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