Market Size

One of the questions you will be asked again and again when financing is, “How large is your market?” Market size is an incredibly important metric for measuring the opportunity of a startup.

In order to identify and calculate market size you need to first identify the customers you cater to. If you are b2b startup, who are you selling to? Who will sign off on the purchase. If you are a consumer focused startup, what does the typical profile of your customer look like? Market sizes can be calculated using a top-down and bottoms-up approach. Both of these methods though are estimates. This is important to keep in mind while pitching.

Calculating Total Addressable Market

The TAM is calculated using a top down approach. This method is used for understanding how many users there are in the world which can use this product.

Let’s say we are selling baby food online. The TAM would be the total number of internet users who have babies. There are 2.2 Billion internet users. Current birth rates sit around 20 per 1,000 people. So out of 2.2 Billion internet users, 2% have had babies in the past year. This makes our total addressable market at 44 Million people.

This calculation used unit market share. Rather than calculating units, you could also calculate dollar market share. Dollar market share is the total amount of money waiting to be captured.

Calculating Serviceable Available Market

The SAM represents how much of the TAM you can actually serve. It is used as the bridge between how many users there are and how many users would actually use your product or service. If you are selling baby food online, how many people would actually purchase baby food online? The result of this calculation will be your SAM.

Calculating Share of Market

The SOM is used to figure out how much of the market isn’t captured. This takes a lot of competitive analysis and hopefully some of the metrics are available to you. You need to understand who the incumbents are and how much market share they control. Take into consideration the countries they serve and their sales and distribution channels.

Once you understand the current market, you take the SAM and subtract the already served market from it. This result is the Share of Market you can capture. The importance of share of market cannot be overstated. In order to have a strong forecast for what you can actually accomplish you need to understand the competitive landscape and how much of it your competition have already captured.

Assumptions, Good Data, and New Markets

Remember, these calculations are estimates. Calculated guesses as to how large the opportunity is. When pitching these numbers realize you will be challenged on your assumptions. The data you use should be rock solid and unquestionable. If you use rock solid data, ney-sayers will only be able to challenge your assumptions and not the data you base your assumptions on.

Don’t pitch investors with the concept of being in a “new” market. Although it seems venture capitalists should be investing in new markets, there is actually too much risk involved. If you were to tell this to a hedge fund manager, he would laugh you out of the room. The purpose of an limited partner putting money into a venture capital fund is to invest in emerging markets. The venture capitalists as investors though are still trying to back there bets and invest in opportunities which are known.

If you think you are in a new market, which hasn’t been defined, it is your responsibility as an entrepreneur to demonstrate how you fit into current markets.

Is Our Market Large Enough to Obtain Capital?

Just because you have a hard problem to solve with paying users, doesn’t mean it can be a venture backed business. Venture capitalists require really large markets in order to make profits. Although you could be sitting on an easy $50mm or $100mm per year opportunity, venture capital will have no problem telling you no.

In order to get venture backing consumer markets should be at least 1B potential users. With the amount of users available to you, you can get a lot of people using your products. A lot of people means a lot of eyes to see ads.

Business markets (B2B), by definition, won’t have the same size of opportunity as consumer-based businesses. Those business however make up for it in average sale price. The cost of having a direct sales or direct marketing team however needs to be cost effective.

Your market size is the most important part of your investor slide deck. Make sure the answer to your market-size question is data backed and rock solid.