How to Calculate Market Size — Market Viability

I’ve been working for the past 15 years to provide business planning services to companies like First Republic Bank, Goldman Sachs, and the Nelson Mandela Foundation. Frequently, I see them try to assess a potential new market. Here’s the step-by-step guide I use to help them determine the financial viability of their ideas.

Even great business ideas can fail if your target market is too small. Ensuring that your organization is focused on a large enough market will make it easier to generate sustained revenues over time and help your business thrive. Here’s how to calculate market size and whether it’s big enough to be viable:

Top-Down: How Big Is The Market?

In the Top-Down approach, the goal is to find the largest market size of the universe surrounding your product by using industry research and reports.

For example: Your organization is developing a new furniture product “ACME Chair”, made from a special sustainable material that’s stronger and lower cost than competitors.

Step 1: Find “Total Addressable Market (TAM)”, which measures the total revenue opportunity available for your product. To do so, use online and publicly available data such as The Bureau of Economic Analysis for national Gross Domestic Product (GDP) spending, The U.S. Small Business Administration, customer market research like Nielsen and Statista, censuses, or government data.

  • Total Addressable Market (TAM) = Total Revenue Opportunity
  • Total Addressable Market (TAM) = $80.9BN = (US national spend on Furniture in 2017 based on GDP)
    (Source: www.bea.gov)

Total Addressable Market is the first basic Top-Down indicator of your maximum market revenue. Although organizations will never capture all of their TAM, it is useful for our next step, finding a more narrow approximation of market revenue called “Serviceable Addressable Market”.

Step 2: Next find “Serviceable Addressable Market (SAM)”, which measures the percentage of TAM that can actually be reached through your business model.

Continuing Our Example: ACME Chair can only be distributed in California due to shipping constraints, and is best suited for office environments rather than the home.

  • Serviceable Addressable Market (SAM) = (TAM) x (% Opportunities as Part of Business Model #1) x (% Opportunities as Part of Business Model #2) x (“…” Business Model #3, etc.)
  • Serviceable Addressable Market (SAM) = $267M = ($80.9BN as TAM) x (13% as California’s percentage of US GDP) x (55% as percentage of furniture spend in commercial vs. residential) x (4.7% as percentage of chairs vs. other furniture)
    (Source: www.bea.gov; www.statista.com; Note: when calculating SAM you can include more than three “Opportunities as Part of Business Model” to narrow accuracy even further).

In summary, use TAM to calculate SAM to find basic Top-Down market size. Although inflated to a best-case-scenario figure, it reveals potential revenues given your organization’s current business model and constraints.

Bottoms-Up: What Are Potential Sales In The Target Market?

In the Bottoms-Up approach, the goal is to determine specifics of your potential market revenue by using data or surveys from actual references including customer or competitor usage.

Step 1: Survey potential customers on their willingness to pay for your product at your desired price.

Continuing Our Example: ACME Chair conducted a survey where 5 out of 20 Californian corporations say they are willing to pay the price of $300 per unit for 2 units. (Assume that $300 per unit is the average unit price in this industry and 2 units per company is a standard purchase order).

Step 2: Find Target Market Potential Sales. Use your internal surveys and public research to project revenues.

  • Target Market Potential Sales = (% Customers With Interest From Survey) x (Price Customers Will Pay) x (# Units Customers Will Buy) x (# of Opportunities as Part of Business Model)
  • Target Market Potential Sales = $109M = (25% = 5 Customers With Interest From Survey ÷ 20 Customers Surveyed) x ($300 as Price Customers Will Pay) x (2 as Units Customers Will Buy) x (728K = 5.6 million Commercial Offices in the US x 13% as California’s percentage of US GDP)
    (Source: ACME Chair’s internal survey; www.bea.gov; www.eia.gov)

Target Market Potential Sales is a more accurate portrayal of possible revenues — it is an actual depiction of what’s valuable to customers and what they are willing to pay right now.

Market Viability: Is The Market Big Enough?

In the Market Viability test, the goal is to determine a realistic estimate of future revenues and whether it’s big enough. Since it’s unlikely that your organization is operating a monopoly, you would realistically win less than 100% of all customer business.

Step 1: Find the Market Viability Size. Though it varies per industry, start with an estimated 2% revenue capture for market penetration. In general, 2–5% revenue capture is aspirational but realistic in a 5-year period. This is because you are starting at 0% customers, and even ambitious distribution takes time to build.

Continuing Our Example: ACME Chair has aspirations of becoming a public company within 5 years.

  • Market Viability Size = (2% as Estimated Revenue Capture) x (Price Customers Will Pay) x (# of Opportunities as Part of Business Model)
  • Market Viability Size = $4.3M = (2% as Estimated Revenue Capture) x ($300 as Price Customers Will Pay) x (728K as Commercial Offices in California)
    (Source: ACME Chair’s internal survey; www.eia.gov)

As a reference point, generally companies go public with $100M+ revenue per year. In our example, ACME’s realistic best case would not take it to IPO ($4.3M is much less than $100M as an IPO minimum). However, going public does not have to be the goal; $4.3M in revenue would still be an incredible feat for a small to medium-sized organization, thus, continuing to penetrate the target market to reach that number is a viable option.

Knowing your target market’s size, potential revenues, and likelihood of viability is critical in understanding the limits of your organization’s scale and future profits. If the market is too small, capturing new customer revenue in the future may be challenging, so make time to assess your target market in advance.


More Articles:

Business Planning
The 10-Point Checklist to Launch Your Business
12 Steps to Scale a Business
How to Calculate Market Size
7 Steps To Assess Your Competition
Competitive Advantages That Last
Finding The Right Customer Profile
How To Measure Results
Know Your Niche & Costs
Developing a Go-to-Market Plan (GTM)
4 Steps of Customer Discovery Before You Launch

Pitch Decks & Messaging
How to Make a Pitch Deck for Your Fund
How to Write an Investor Update (With Example)
How to Write a One Pager
9 Easy Steps to Build Your Company’s Messaging
How to Make a Great Pitch Deck

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Operations
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The First Service Providers To Hire For Your Business
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Customer Service Basics
Save Your Business in 60 Days: Cutting Costs — Part 1
Helpful Tips for Better Operations
5 Ways to Productize Your Business

Sales
How Your Sales and Operations Can Thrive Post-COVID-19
Save Your Business in 60 Days: Increasing Sales — Part 2

Civic Engagement
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Kaego Rust is CEO at KHOR Consulting. If you’re looking for help, contact kaego@khorconsulting.com or visit www.khorconsulting.com.

Photo by Adeolu Eletu

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Kaego Ogbechie Rust

Kaego Ogbechie Rust

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CEO at KHOR Consulting, helping companies build business plans, pitch decks, and streamline their operations. Email: kaego@khorconsulting.com