Just How Big Is Your Market?

Market Research

August / September 2004 By: Grace Brill Volume 2 Number 4

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One of the most important market research activities is determining the size of your market. Although it is tempting to throw around big, generic market numbers, you will fare better by taking the time to generate a realistic assessment of the size of the actual market you are going after. Not only will this keep you from deluding yourself into wasting energy developing a product for which there isn't really a market, but the process itself will force you to get serious about identifying the segments of the market that you have the best chance of targeting successfully.

The more specific you can be in market sizing, the better. Let's say you make handheld chemical detection monitors. You will no doubt run into published reports on the size of the total market for homeland security products and services. This is a number to dismiss, as it is too large to shed any light on your actual business case. You might also find numbers for the entire market of chemical, biological and nuclear monitoring devices. You will be very tempted to stick this number into your business plan and, merely as a way of providing some very general context, that's fine, but it doesn't really tell you what you want to know. The number you really want to come up with is the market size for handheld chemical detectors.

Although published figures—€”if you can find them—€”are a handy reference point, the best market size estimates are generally those you generate yourself, and this usually involves counting something. To reduce it to its most simple formulation, you want to look at the number of potential instances of sales for your product and multiply this number by the average revenue per sale.

In some cases you will be counting numbers of businesses that would actually purchase your product. Here you will need to assess how many units they would buy (and how frequently) making sure to account for additional revenue streams like service or consulting. Before doing this you might need to do some background research and interviewing to determine specifically what types of customers would purchase the product.

In other cases you will be counting units of a larger product or system into which your product is incorporated. If you make helicopter rotor components you will want to start by finding figures for helicopter production, and, if your part could be sold as a retrofit item, getting a handle on how many existing helicopters out there could potentially incorporate your product. The U.S. Census's Current Industrial Reports provide data that can help answer these questions.

These market size numbers can be considered as an outer limit of what you could possibly sell in the marketplace—€”no one expects any one player to capture the entire market. This is a good start, but doesn't really focus on your targeted segments—€”that subset of customers whom you choose to actually go after. So, to refine this "available market" number into something more tailored, focus on those in your actual target market. If you sell a software product that is aimed specifically at mid-sized financial services firms, don't distort your sizing by counting the behemoths and the smaller players, but try to get the best count you can of those mid-sized firms.

In some cases you will want to refine your "available market" numbers by counting who is more likely to buy based on economic realities. Let's say you have developed a product that could be sold to flight training schools. The U.S. Economic Census would reveal that there were 672 flight training schools in the U.S. at last count. However, your projections will probably be more reasonable if you eliminate those schools with revenues below a certain threshold. When we knock out those with, say, revenues under $250K, we are now left with only 407 schools. Perhaps at this point you might realize that you will never be profitable with this small universe of customers and that you need to find additional markets—€”proving that the market sizing project was valuable if for no other reason than it forced you to confront market realities.

Any number of variables—€”geography, firm size, industry vertical, level of need, innovativeness, etc.—€”can be used as a way to better define the entities you want to include in your "addressable market," that is, that subset of total potential buyers whom you really have a chance of reaching.

This method of counting potential customers or sales is referred to as a "bottom-up" market size calculation. It will generally give you a much more accurate picture of market size than the alternative, "top-down" method in which you rely on someone else's estimation of total market size as a starting point, and then calculate the size of your market as a percentage of this. Although all market measurements have an element of guesswork, top-down numbers are particularly suspect because they are even less rooted in reality. You don't know what went into someone else's market size calculation and you usually don't have enough information to credibly subdivide that larger market to reflect the piece that you are pursuing. So ultimately, one of the best arguments for a bottom-up forecast is that it forces you to move beyond industry generalities to the specifics of your target market and to ask questions like "who are my customers," "what are their attributes", and "why would they buy." You will still need to make many assumptions, but at least your research will be grounded in an understanding of your customers.

It is always a good idea to look at your market sizing problem in a variety of ways. Whenever possible, compare data from different sources. If there are companies selling similar products, try to measure those existing revenues; this won't account for people who aren't buying because existing solutions aren't meeting their needs, but it is a useful data point to compare to numbers you might have derived in other ways.

This raises the question of using market size data from market research vendors, investment analysts or industry associations. These numbers can help establish the outer bound of a market, and can be particularly useful in cases where it is very difficult to establish customer numbers or market growth rates. But in many instances you will find that these estimations just don't provide the level of granularity needed to understand your specific market segments. Even if you use third-party numbers you will still do well to do your own bottom-up assessment in order to really understand your market potential.

Don't look at market size as merely a box that needs to be ticked on a business plan checklist. The process of calculating market size will force you to ask some fairly specific questions about your customers, competing solutions, and where your product really has a competitive advantage. You would do better to answer these questions early on than wait until you've suffered through an unsuccessful product launch to wish that you had asked them.

Grace Brill is director of market research at Technology Ventures Corporation.