Defining the target market for your product is a skill that you’ll hone over time. Nothing is worse than launching a product only to find that the size of the market it can serve isn’t even large enough to keep the lights on. There are a handful of methods that can be used to help you define it, but keep in mind that any target market you initially define is simply a hypothesis that needs to be PROVEN. Many product managers get excited about the problem that they’re formulating, defining the target market as anyone with a resemblance of qualification. Don’t fall into this trap. So how does a PM successfully define a sizable target market?
Target Markets Should Be Large
So you’ve got this great idea for x product that is going to be huge because it utilizes the latest tech trends. You spend countless time and resources developing the product until it’s ready to release only to find that crickets chirp the day of your product launch. Although this is a sad story, I hear it frequently when people pitch new ideas for x startup. When searching for problems to solve for customers with your product, you have to prove that enough people view that the solution is worth the cost — hopefully this happens before you spend all of the budget on designing and building the product. This is a straight forward recommendation but is often skipped as people get starry eyed at the thought of launching a unicorn like in all of the techcrunch articles that they’ve been reading. Ok, thanks for stating the obvious Randy, but how do we get an accurate estimate to ensure a market is large enough?
The Inputs Of Market Size
- # Of Potential Customers (Traffic)
- Predictability Of Converting Potential Customers Into Actual Customers (Conversion)
- Ability To Capture Users From Competitors and Tangential Markets (Conversion)
# Of Potential Customers
The inputs listed above are the major factors that determine the size of the market. Potential customers will be the pool of users that you hope your product will create value for. There are 3 types of potential customers:
- New Customers — These are customers with problems that have not yet found a solution. They are either conscious or unconscious of their problem but your product should aim to create value to capture these new customers.
- Competitor’s Customers — These are customers with problems that found a solution through a competitor’s product. Too often startups believe that they’re entering a “Blue Ocean” market and there is no competition in the space. This is an idiotic mistake as competitors offer a solid data point to benchmark your product against. According to Peter Thiel, to capture these customers sustainably, you should aim for your solution to be 10x better than your competitors.
- Customers In Tangential Markets — These are customers with problems that found partial solutions in tangential products. One great customer acquisition hack was Airbnb’s integration of their platform into Craigslist. Airbnb’s users have a specific problem — the need to rent living spaces in a safe manner — that was being partially solved by Craigslist. Although Craigslist generated leads for renters, it did not solve the problem of safety for customers, which Airbnb solved via it’s reviews and vetting processes. Would you rather list your living space on Craigslist or Airbnb now?
Predictability Of Converting Potential Customers Into Actual Customers (Conversion)
Just because you’ve found a market with a large pool of potential customers does not mean that the opportunity is there. The next step is to understand your ability to convert the potential customers into actual paying customers. In a perfect world, this conversion rate should be predictable, but in reality predictability is rarely the case. The main hypothesis to validate is that your ability to convert new customers should be sustainable as you grow. This goes back to the idea of push / pull metrics — both the metrics of inbound leads and conversion should be monitored to ensure that conversion can be sustained as more potential customers are coming in contact with your product.
Ability To Capture Users From Competitors and Tangential Markets (Conversion)
Ideally, every product launch would be into a “blue ocean” market where people are just waiting for your product as there is nothing else out there that can solve their problem. In reality, this is never the case. Highly competitive markets will increase the risks for your products but markets with low to medium competition can actually decrease your risks as you can gather more data from the existing demand of your competition. In low to medium competitive markets, products are usually not fully developed, customer problems are not fully defined, which offers your product a large gap to deliver value. If you can define and solve your customers’ problems 10x better than your competition, you can quickly grow your market with your competitors’ and tangential market’s users.
TAM / SAM / Target Market / Penetrated Market
TAM = Total Addressable Market
SAM = Served Available Market
Target Market = Segment That Is Hypothesized To Purchase
Penetrated Market = Market That You Have Captured / Existing Customers
The important lesson here is that the TAM, SAM, and Target market is not your actual customer base. They are segments of the whole market that represent the total amount of customers you potentially have access to.
Top Down vs Bottom Up
Having an understanding of your target market requires multiple views of the market. Some marketers start and end with the top down approach — industry-analyst reports, market-research reports, and other analyst driven projections. Although this helps define the big picture of your market, it’s not enough to give you an accurate projection of your penetrable market.
Enter the bottom up model. The bottom up model estimates potential sales by calculating existing demand and distribution in products like yours or proxies if there are no products like yours. This predicts a far better result than trying to chop a multi-trillion/billion dollar industry into your niche.
Calculate Using The Bottom Up Method:
Remember that all of these inputs are hypotheses and need to be constantly validated and revised.
Gather the following inputs:
- Where are products like yours most likely to be sold?
- How many of those channels, physical or digital, are there?
- How many of those channels, physical or digital, can you feasibly convince to sell your product?
- What have been historic sales quantities of products like yours or proxies to products like yours. For example, Facebook can use the sales of Google’s ads as a proxy to determine a base, worst, and best case scenario for selling its ad inventory.
- Use existing competition or proxies to derive an average $ per sale.
Putting it together:
#of Channels x Average sales per channel each year x Average $ per sale = Annual Market Value of Penetrable Market.
Now that you have this number, divide it by the top down TAM number. Does the % look reasonable? If you’re at 50%+ of TAM then you should probably rethink your inputs unless you think your product is good enough to be a monopoly one day. Refine your #’s as you gain more data on your inputs.
Test Your Target Market Hypothesis and Refine
The most important lesson here is that there is no 100% accurate way to calculate a market. Analysts are amazing at predicting past behavior but when you shoot their predictions into the future, they’re often more wrong than right. The target market size for your product will inherently always be a moving target as industries change, competitors enter and exit the market, and many other economic inputs that can affect it. Define your target market hypothesis and constantly validate and update it. As the target market opportunity is one of the main factors in the decision to pivot or proceed, you should refine it with as much real data as possible using the bottom up approach. If you’re going through all the pain of launching a product, make sure the opportunity is large enough and that you have the capability to capture the opportunity!
Originally published at Randall Nguyen.