Business Strategy

What is your market size - part 1

The benefits of market analysis are: faster fundraising, better messaging and overall focus.

Laura Benson

August 24, 2020

Many first time entrepreneurs and CEOs disregard analyzing their market in the early days. This tendency is natural since market analysis is never easy, and you want to push forward on more important things, such as answering the question, “am I solving read pain?”. But once you are serious about your startup, a thorough market analysis is a precious step. It will help you:

  • Focus your product, offering and messaging
  • Identify what size and type of company you can build around your idea or if it’s better to look for a better opportunity.
  • Fundraise much more quickly and deliberately.

What defines a market?

A market is defined by the number of customers who share a problem, and how much they are willing to pay to solve it.

Notice this definition lacks any requirements from the selles. If they exist or not is beside the point. Also, there is no discussion about HOW the problem is solved, so very different solutions may compete in the same market. All solutions that can satisfy the customer need regardless of its business model or how it is delivered, compete in the same market and define it. 

Let’s look at a startup that automatically generates logos using AI based on the customers’ limited input. What is the relevant market for this kind of business, and what is its size?

  • The company might define itself as an “AI company” and base its claim about the relevant market size using an external authority that references “its” market. E.g., “The global Artificial Intelligence Market Size is expected to reach USD 169411.8 Million in 2025, from USD 4065 Million in 2016, growing at a CAGR of 55.6% from 2018 to 2025.”
    Source.
  • Customers may see the solution as an alternative to online designers’ marketplaces like this one or this one (no affiliation), or online freelancers marketplaces such as Fiverr or Upwork, and then depending on the reference point, we might look at the “total addressable market within the U.S. of $100 billion.”
  • But since a local graphics design studio can satisfy the customer needs just as well, it’s probably best to look at the market from the problem statement. The customer who would engage with the company needs a logo. The most aligned market with this problem would probably be “corporate identity design services,” and the size would be 10 billion dollars spent on logo design services.”

To recap this part, when you are trying to identify your market, never ask yourself: “How the product is defined?” or even “who are my main competitors?” Focus on the customer problem, who can satisfy it, and how much is spent on this problem every year.

Avoid an analysis that puts your company as “part of the X market...” For example, while it is hard to analyze the market for a company that automates the placement of sesame on buns.’ do not dismiss it with “we are part of a $600Bn fast food market”.

Top-Down vs Bottom-up approach

Both approaches are valid, and it’s best to run and maintain both analysis in parallel.

Bottom-up market size analysis

In this approach, you list assumptions and build a model to bind them together into one market. Let’s use the logo creation example:

Assumptions:

  • Logo creation is a service needed by either new business or business,, which are rebranding. Rebranding efforts are few and rare and we’ll ignore them. 
  • We’ll assume the number of businesses that don’t have a logo or design it by themselves is negligible..
  • Logo pricing needs to be scrutinized when evaluating the total market..
  • Prices quoted on online logo.

Number of new businesses per year: 800K
Source: SMB administration report: Figure 3 shows 180-240K new business per quarter. We’ll use 200K per Q as a base number

% that buy the base - 85% - Guestimation = 680K businesses
% that buy premium - 15% - Guestimation = 120K businesses
% that buy enterprise <1% - Guestimation = negligible

Base logo price - $100 - Source - 680K*$100 = $68M
Premium logo price $1000 - Source - 120K*$1000 = $120M 

TAM* - $186M (*this is just in the USA.)

Our bottom-up market analysis got us a market size of $186M.

  • Avoid the instinct of inflating the market size by adjusting the assumptions to fit your market perception. For example, you might increase the percentage of customers who buy premium service
  • In most cases, market size that was produced by bottom-up market analysis will be smaller compared with one produced by top-down market analysis. This is expected and you should not be concerned with this. As long as the bottom-up is at least 50% of the top-down, you shouldn’t worry about it. If the difference is 90%, you either chose the wrong market in the top-down analysis (too broad scoped), you’re used too conservative of an assumption int he bottom-up or simply there is a data problem in one of the reports.
  • You should keep clear references to any number you are quoting.
    When you’ll be fundraising and will be challenged on why you assume there are 800K new businesses a year, its best to show a link to an external authority with explanation of what part of that report you relied on to set your assumptions (as done in the above for the number of customers).

Top-Down market size analysis

Top-down market analysis will mostly rely on secondary research (research done by others) and analysts report. Each industry has it’s own analyst firms leading the market as well as new entrants or niche players. For example for IT you have: Gartner; Forrester Research; IDC; 451 Research; Ovum; HFS Research; Everest Group; IHS Markit; NelsonHall, Global Data and others.

When quoting an analyst report keep track of the following:

  • The brand of the analysts firm.
    Some brands are more reputable than others which are perceived more as a publishers for vendors.
  • The relevance of the report and it’s scope. In other words, how fitting is the report scope with your market.
  • When the report was published and what happened since.
    Assuming you have a quote from 2015 that your market has a growth (CAGR) of 30%, can you assume the market quadrupled itself since?
  • Difference between reports providing different estimates by different analysts firms.
  • Keep a link to the report and highlight the relevant numbers in it.
  • It’s better to use an external authority than no authority at all - but if it is not reputable - highlight it at least to yourself.

Be careful of:

  • Quoting the wrong report because you misidentified the market.
  • Quoting the wrong number from the relevant report, e.g. encapsulating HW/SW/Services in a company that only provides one of them.
  • Quoting a “stale” report and missing “fresh” reports - always keep yourself updated on new reports in your industry.
  • Quoting an analysts firm which is totally irreputable.
  • Never buy an analysts report.
    These reports cost thousands of dollars and In a startup, it is considered a waste of capital. You won’t impress any VC with your spending abilities if you did buy it - rather, you’ll make yourself seem irrelevant.
    Rather, rely on excerpts of the report that were bought by vendors for republishing and build the puzzle. You might find access to the reports via universities and local SMB agencies. You might even get a free copy if you ask the vendor nicely.

Let take a step by step example:

  1. The latest crunchbase news talked about a company in the field of “Logistics Platform”. Since I know nothing of it my first search on Google was: “logistics platform market analysis”.
  2. The first result was this report which looked very professional and relevant.
    As I don’t know the analysts firm I need to vet it somehow.
  3. I used https://www.alexa.com/ and entered the analysts firm domain to get a list of competitors.

    https://www.marketsandmarkets.com/
    Grandviewresearch.com
    Transparencymarketresearch.com
    Alliedmarketresearch.com
    Mordorintelligence.com
  4. I than went back to google images, and searched each of the firms followed by “logistics platform” like this. This gave me a very quick way to skim through many graphs and identify the relevant graph before I jump into the report.
  5. In addition, using graphs from reputable analyst is always prefered to graphs you draw on your own (in spite of the graphical “price” you pay for having “ugly” graph in your deck.

You have to keep track of the reports you are quoting:

Grand View Research: The global transportation management systems market size was valued at USD 61.27 billion in 2018 and is expected to expand at a CAGR of 16.2% over the forecast period.
https://www.grandviewresearch.com/industry-analysis/transportation-management-systems-market
2019 - High credibility
Need more granular report
Markets & markets: "The connected logistics market is estimated to grow from USD 10.04 billion in 2016 to USD 41.30 million by 2021, at a Compound Annual Growth Rate (CAGR) of 32.7% during 2016–2021"
https://www.marketsandmarkets.com/Market-Reports/connected-logistics-market-81941108.html
2017 - High credibility
Comments: Need more granular report
PWC: According to one estimate, a 10% to 30% increase in efficiency in the EU logistics sector would translate into €100-300 billion in cost savings for European industry
https://www.hollingsworthllc.com/wp-content/uploads/2017/10/future-of-the-logistics-industry.pdf
2017 - High credibility
Comments: Quote is great but cost savings don’t define a market well

TAM vs. SAM vs. SOM

Classic market analysis would encourage you to further analyze your market into 3 classes:

  • TAM Total Available Market
    is the total market demand for a product or service.
  • SAM Serviceable Available Market
    is the segment of the TAM targeted by your products and services which is within your geographical reach.
  • SOM Serviceable Obtainable Market
    is the portion of SAM that you can capture.

Traditionally people would think about TAM as a global thing and than SAM is the geographical portion you will be targeting. In real life you would usually start with one and extrapolating to the other will be either hard or impossible.

Let’s take my bottom-up market analysis from the above. I used the number of new businesses as anchor in that model, and got a quote on this number from a US government agency. Assuming my solution is served online, this is my TAM and my SAM.

Lets explore two alternatives ways to look at.

First we can claim the analysis provides a SAM of $186M, but our TAM (which is always bigger) is all the English speaking world since we can serve Canada, Australia, UK, South Africa etc.

Another alternative is to assume out TAm is larger than the English countries. In anycase, the extrapolation from SAM to TAM is not trivial. How many new businesses are created worldwide? Do they all have logos? What do I know about small business in Bangladesh? Better not to assume and simply state that “based on our bottom up analysis, the SAM is $186M and we can only guess the TAM is 3-5x that.

What about the SOM? Traditional business can talk about what their business model can serve - for example if you install air conditioner, and installation takes 8 hours and you have 2 installers, you can server max of 480 customers a month, so your SOM is that number in USD number. But what about software and SaaS? What is their SOM? I would assume it is very close to the SAM.

If you are building a VC backed company - focus on the SAM, and be ready to have an intelligent conversation about the TAM and SOM. In most cases you won’t get a chance to have it.

End of part 1

To be honest I'm cutting this here just because I think it is too much to digest at one go. But you will need to read part 2 which will give you some thoughts into the VC brain as well as some gotchas.

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