How to estimate market size—
What is Market Size?
The ‘Using Numbers to Make Money’ is a series of blog posts to help entrepreneurs understand key business metrics in plain English and use them to make money.
Market Size
Also-Known-As: Total Addressable Market (TAM)
Also mentioned in this blog: Addressable Market, Serviceable Addressable Market, Beachhead, Obtainable Market, Market Capture
Common question from investors: What is your market size?
In plain English:
How much money are people spending right now to solve the problem you are trying to solve?
Why is it important?
It is required for presentations, applications, and business plans, but more importantly, calculating the market size pushes the team to think through important details, define their problem, and clarify who the target customer is and who is not.
Example:
Let’s say the team comes up with the MouthScan, the next generation magic mouth scanner that cleans your teeth instantly! The problem being solved is ‘people have dirty teeth’. To calculate the market size, the team needs to think about how much are people spending currently to clean their teeth.
If the product is intended to replace ‘the toothbrush’, the team would calculate the number of toothbrushes in their primary country or region of focus. Usually you calculate the total amount spent over the course of a year.
For the calculation, let’s say the focus is the United States. The team could look up how much was spent on toothbrushes in the U.S. last year or do the calculation themselves.
Market Size — Sample Calculation: (based off the assumptions below)
300 million people in the US X
$2-3 per toothbrush X
3–4 toothbrushes used per year =
Market Size: $1.2–3.6 billion (B)
The approach above is called a ‘bottom-up’ calculation as it estimates the cost per unit and number of users to get the ‘market size’. Another way is to do a ‘top-down’ calculation where you take the total amount spent in the industry and take a percentage of the total. Example of a top-down cost would be taking the total amount spent in the US on dental care (let’s say its $5B) and estimating that 20–25% is spent on toothbrushes ($5B X 20–25% = $1–1.25B).
When calculating your market size, make sure each assumption and source for each assumption is documented. If estimates are made for numbers without a source, make sure the team captures and states the ‘educated guesses’ used to estimate those variables. You can also use a range if you are not confident in the estimate that the team made.
Addressable Market
Investors may also ask for the Addressable Market, also-known-as the Serviceable Addressable Market. This is the portion of the Total Addressable Market that you can actually serve.
Example:
Let’s say you are only targeting people with manual toothbrushes (not including electronic toothbrushes) and only serve people in the New York City (NYC) area.
Addressable Market — Sample Calculation:
10 million people in NYC X
95% of people have manual toothbrushes X
$2–3 per toothbrush X
3–4 toothbrushes used per year =
Market Size: $57–114 million
The team can use different assumptions and calculate the market size in different ways. This is ONE way and as the team is estimating market size, try calculating it in different ways. Compare the results and choose the one that the team believes makes the most sense.
Also you may have choices of who your initial ‘customer’ will be. As an example, the team may start in New York City or they may consider Atlanta. Or they may forget about humans all together and apply the technology to the pet market. It is a useful exercise to calculate multiple ‘addressable markets’ and compare them prior to investing more time and money in development and customer research. This practice is called selecting your beachhead market, which I will cover in another post.
Obtainable Market
The last step is to predict how much of the ‘Addressable Market’ the team believes the company can capture. This is called Obtainable Market or Market Capture. Realistically, the team would not do this until they have decided on an addressable market and in my opinion, obtained a paying customer in the team’s intended addressable market.
Obtainable Market in NYC — Sample Calculation:
2% of the total manual toothbrush market =
Market Size: $1.1–2.2 million
Make sure the team documents the rationale for the assumptions. An example of rationale that can be used for justifying ‘2% of the total manual toothbrush market’ is as follows: Our team has a partnership and advertising campaign planned with the Duane Reade pharmacy chain and 10% of the total NYC toothbrush sales are through them so you expect to capture 20% of those sales.
Where are these metrics used?
It is found in business plans and for presentations to investors, incubators, and accelerators. It is one of the basics that the business lead on the team needs to be able to answer (and explain the details of) in a heart beat.
—
Like any early stage start-up, the customer and use of the product may change, which means the market size will change. For the MouthScan, who will the target customer be? People who use manual toothbrushes? Electronic brushes? Dentists?
Yes, the team may have an earth shaking idea that may cater to everyone, but the team initially should be FOCUSED. Knowing the ‘market size’ and the slice of the market that is relevant to your team helps maintain this focus. The exercise helps the founders review all the details, consider other potential customers, communicate who the customer is, and how large (how much money) the opportunity really is.
