Thursday, October 18, 2012
Posted by Tiffan Clark
Whether you’re creating a business around a new product or service, or coming out with a different version of something that already exists, it’s important to determine the overall size of your market. Not only will potential investors be interested in how big or small the market is, but you should always be aware of how many customers you could potentially serve.
What does market size mean? Basically, it’s the number of customers potentially interested in your product or service, and the total possible amount of money that could be spent on that product or service. It sounds easy enough, but how do you measure something intangible?
Businesses trying to determine if they have a profitable idea often approach sizing their market by making a broad estimate. But if you’re a business that is ready to find funding, an educated guess may not be enough.
For instance, say you’ve decided to start a business in the growing pet industry. You’ve created a new chew toy that’s guaranteed to resist chew marks and splits for at least five years. You’ve set a price of $10 per toy. What is your market size?
- Consider the entire U.S. population: Let’s estimate this to be around 300 million people, half of whom are considered to be a part of a household.
- Consider how many could use your product/service: Of those 150 million households, how many own a pet? Let’s say about 50 percent, which would be 75 million households. And of that amount, let’s say a little over a half—35 million households—owns a dog.
- Consider how many of them could afford your product/service: You’ve priced your product to be competitive with others that are currently on the market. You can also estimate that the average dog owner spends $100 a month on things such as food, vet services and grooming. Maybe from there, you can estimate that 75 percent of dog owners could readily afford your product. That takes your market down to about 26 million households.
- Consider any other restrictions: Senior dogs (ages eight and up) tend to be less interested in chew toys. This could potentially reduce your market size to more like 16 million.
Based on this estimate, you predict that somewhere around 16 million households could be interested in this chew toy, based on the fact that they have a dog and can afford your product. At your price point, you’re looking at potential revenues around $160 million.
Would this number look appealing to an investor? Possibly. But during due diligence, they may inquire just how you got this number. That’s where your use of estimations may catch up with you.
The Quantitative Research + Estimate
Let’s use the same product idea, but this time we’ll do a bit more research.
- Consider the entire U.S. population: According to the U.S. Census Bureau, the total U.S. population is around 314 million—only 14 million off from our estimation. Of that number, about 114 million are considered to be a part of a household.
- Consider how many could use your product/service: According to the 2011-2012 American Pet Products Association (APPA) National Pet Owners Survey, about 46 million households own dogs, with a grand total of around 78 million owned dogs in the U.S.
- Consider how many of them could afford your product/service: You’ve priced your product to be competitive with similar products. According again to APPA, the average dog owner spends only $43 a year on toys. Keeping in mind the current state of the economy, you could still assume that the majority of dog owners could readily afford your product.
- Consider any other restrictions: You still want to consider aging pets who are no longer interested in chew toys. The public statistics here are limited so some estimating will be required, but with 46 million households owning dogs, you can probably assume that at least 80 percent, or around 36 million, would remain potential buyers.
By doing a little bit of research, and just a small amount of estimating, we’ve estimated the market size to be 36 million households, with potential revenues of $360 million dollars.
As you can see, a little bit of research can make a big impact on sizing your market.
But where do you start? First, research your industry. Use Google to find the statistics that are readily available. Are there any trends that suggest the industry is growing or declining? Perhaps there are industry organizations that have specific statistics on competitors and consumer spending habits. Then, take a look at the SBA market research guide, which can connect you to public databases such as the U.S. Census Bureau. If you are entering a pre-existing market, firms such as Gartner or Forrester might have market research reports available for purchase. You might even want to check with your local library, since they often buy into research database systems you can utilize at no charge.
In the end, conducting research will not only give you a more accurate number, but it will also show investors your knowledge of the industry and your company’s potential for revenues.
And while knowing your market size is important, investors will also want to know your Total Addressable Market (TAM) – the total revenues you could generate assuming that everyone who could buy your product or service actually did. How does this differ? Take the example above. Though the market size is $360 million, if the product was to be sold exclusively online, perhaps the TAM is 50 percent of that total market size, and therefore the highest potential revenues would be $180 million.
Once you have determined both your market size and your TAM, you can begin to focus on your target market. It’s important to note that your market size will generally be much, much larger than your target market. In fact, you should determine the size of your market before ever trying to pin down to which customers you specifically, and consciously, hope to appeal.
Tiffan Clark is the Vice President of IdeaCrossing, a free online community created by JumpStart, which connects entrepreneurs with the capital, mentors and technical resources necessary to grow their businesses. Tiffan has worked at several venture-backed startup technology companies and strategic marketing agencies in both Boston and Cleveland.