Market research is an essential component of any new business venture. Market research, just as important as hiring the right people or finding the best location, allows you to learn more about your potential customers and gives your new business the best chance of success.
The calculation of market size is central to any market research you conduct. It is critical to understand how to calculate market size: a small market may indicate that there aren’t enough customers, and your business may not make enough money to be profitable. Calculating market size also allows you to consider how much of that market you might be able to capture – known as market share – and how much of a market your business requires to thrive.
What is the market size?
At its most basic, market size refers to the number of potential customers to whom you could sell your product or service. It could be the number of people who visit a high street and become customers of a new coffee shop, or it could be the number of dog owners in your area who could use a dog grooming service.
There are two types of market size to calculate along with your business’ expected share:
Total addressable market
This is shorthand for determining whether the potential market for your start-up is large enough, and it is typically the first type of market size to calculate. In business, TAM refers to the number of customers or the amount of money you could earn if you were 100 percent successful and managed to sell to every potential customer.
Target or available market
This is the size of the market that your new business can realistically reach. It is a subset of the total addressable market and is also known as the Segmented Addressable Market (SAM).
Expected share of the market
This is a useful addition to the previous two market size calculations. It is an additional stage that assists you in determining what market share you want to pursue and what you expect your business to achieve. This is also known as the Expected Share of the Addressable Market (ESAM) or simply market share.
What to look out for when calculating market size
Before beginning to calculate, it is important to understand that calculating market size entails being objective about the facts: it does not entail interpreting market data to support your business case. If the market size data reveals issues, such as a lack of local customers, it’s a red flag that your business may not be profitable in that location, for example.
Markets do not remain static; they evolve and change, and you must account for market trends such as new technologies or consumer purchasing habits. Calculating market size is based on assumptions, but it will help you consider market trends and their implications for your new venture.
Even after you’ve transitioned from a startup to an established company, keep an eye on market trends and consider how they might affect your business. Taking advantage of new market trends can give your company a competitive advantage.
How to calculate the market size
Calculating market size entails first calculating the addressable market, then the available or target market, and finally determining how much market share your company will generate. Here’s how to figure out the market size for each stage:
1. How to calculate the total addressable market
The total addressable market is simply all of the potential customers who might be interested in the products or services that your start-up provides. It covers a wide range of topics. For example, if your company specialised in online learning and tutoring for school students, your total addressable market would include all UK students with internet access and parents or guardians willing to pay for tutoring.
Define your customer
Conduct desk research using the internet
Carry out some top-down analysis
Calculating the total addressable market allows you to see if there are enough customers for your start-up to be worthwhile.
2. How to calculate the segmented addressable market
While calculating the total addressable market size is useful, you should really focus on the number of customers your company can realistically reach. Customers who might consider using your business, your marketing can reach, and who are influenced by other factors such as competitors are considered target customers.
The bottom-up analysis is one method for calculating the segmented addressable market. This is about calculating the number of potential customers you can reach by speaking with market experts, surveying customers, and refining the information you used to calculate the total addressable market.
It is worthwhile to be ruthless when calculating your target market size. Remove any customers who you will never reach in order to have extra money to spend on your business.
Include any sensitivities. These are straightforward assessments of how well your marketing will perform in practice, how long it will take you to contact customers, and how quickly new customers will respond to your marketing activity. Use this information to fine-tune your market size estimation.
3. How to calculate market share
Unless your startup is completely unique, chances are you’ll have competitors vying for the same customers. The total number of customers who buy from all competitors in the market is also a useful indicator of the target market size when added together.
Examine the target market and then estimate a reasonable market share. This should include researching competitors, their products, and their routes to market. Unless you are the first to market with a new product or have few or no existing competitors in your market, you should aim for 1% to 5% as a realistic goal in your first few years as a start-up.
Investigate competitors – Discover who is supplying the market and how much money they are making. Examine annual returns, trade press, and any press releases about significant customer win at Companies House. Annual reports can also be used to estimate the number of customers and how much money they spend. Create a rough market share for each of your competitors based on this information.
Be realistic – Most start-ups will not have a 1% market share in their first year, and may only have a 2% market share in their second year if they are lucky. Many businesses never achieve more than 10%-20% of their target market share.
Plan your business – What market share do you need to break even and start making money? Do the maths, working out how much revenue you’ll likely make in each year.