Already know the target market segment of your Startup, but not sure how to calculate its size? In this post, we are going to talk about the two main ways to calculate market size and what are the main points of attention for carrying out this task.
After defining the market segmentation that your business will focus on, the next step is to calculate the size of that market, also known as Total Addressable Market. Being clear about size is important to assess the business opportunity and identify if the targeting is too specific, too generic, or a good size.
Market size is the total revenue generated in one year from the sale of products or services to the company's target customer segment. In other words, it is the estimate of how much revenue the company would achieve if it reached 100% market share. To determine this value, we need both the total volume of people that make up the target segment and the average value of the products to be sold:
Market Size = Total volume of people in the market x Average sales price
The average selling price is something that Startup itself defines, obviously based on market research and its production costs. It has autonomy to define the value to be used in the calculation. However, the total volume of people in the market is something that must be discovered by the company and, consequently, requires a lot of dedication and time from the founders to measure it. There are different ways to determine the total volume of people:
Bottom-up: It's the best way to estimate. It's basically counting the people who would use the product or service in a more granular way. For example, a company that sells SaaS Software for managing and controlling activities, such as Trello or Asana. Assuming that the initial market segment (Beachhead Market) chosen is people who work in the IT area of technology companies in the states of California, Nevada and Oregon. To measure the number of users, it is necessary to survey all technology companies in these states and the respective number of people who are part of their IT teams. It is a very operational work, but it brings a much more real number than the Top-Down model.
Top-Down: is the name for measuring market size based on reports or information that aid in estimates. According to Bill Aulet, writer of the book Disciplined Entrepreneurship, this model is less accurate than the Bottom-Up model. It usually estimates a value greater than the actual value and should only be used as a complement. Using the same example of the company that sells SaaS Software, the top-down model could be based on reports from each state that indicate the number of technology companies and the average volume of IT teams according to the size of the company. The breakdown below better illustrates this model:
As much as the Bottom-Up model is the best, in many cases, especially for B2C companies with a target segment with different characteristics, it is quite challenging to carry out the survey of people, so it is often unavoidable to establish premises to measure the market as the model Top-Down is based. The most important thing is to always use the most recent and reliable information when possible to measure it. When presenting the business to investors, the way in which the market was measured may be questioned, making it essential to be solidly consolidated and understood by all founders.