Market Size: The 2 Best Methods for Market Sizing
Imagine this: You've spent months developing your product only to learn that 100 people in the U.S. might purchase it. It may be worth the manufacturing, production, and distribution costs for your product to reach that population size - or it may not.
To understand whether there is a viable market, you must go deeper in your market sizing, even if you have 10,000 potential customers.
Our guide below explains how to calculate your market size and determine your business's potential revenue. We'll also share insights from founders, CEOs, entrepreneurs, and more about their market sizing journeys.
What is market sizing?
Market sizing is the process of estimating the potential audience or revenue for your product. The market size refers to the number of potential buyers and the potential revenue reach based on that number.
When market sizing, you're calculating customer numbers to measure the growth potential of your business.
Why is market size important?
Every business should spend time sizing its market for several reasons:
By sizing the market, you can determine whether your product is worth investing in. The latest data from the U.S. Bureau of Labor Statistics (BLS) finds that 23.2% of private sector businesses in the U.S. fail within the first year. A business may fail for many reasons - but miscalculating product demand (or not calculating it at all) is one of them.
You can estimate profit and growth potential by sizing the market. You can estimate how much revenue your business can generate if you know how many people it can reach. Investors and business owners both benefit from this.
Market size defines who you’re marketing to and what their needs are:Marketing is essential to the success of any business. Understanding your target market's needs begins with knowing its size.
Market sizing helps your business make better decisions: You will be able to make better decisions if you understand your market landscape, gaps, and opportunities. Assigning resources, refining strategies, and setting realistic goals can also be accomplished with this tool.
Real-life example:
“Skipping market sizing can lead to costly mistakes,” says Logan Mallory, vice president of marketing at Motivosity, an employee recognition and rewards platform.
“Early in my career, I was a part of a startup that did not prioritize market sizing. Due to our expectation that our product would appeal to a large audience, we overspread our marketing efforts."
Mallory continues, “As a result, we wasted resources on low-conversion areas while passing up more lucrative prospects. If we had done comprehensive market sizing, we could have identified and targeted high-potential sectors from the outset, maximizing our budget and generating faster growth.”
Your business minimizes risk by sizing the market. It is inherently risky to start or expand a business. Predicting and preparing for challenges can be easier if you understand your market.
Market Size vs. Market Value
Market size refers to the total potential demand for a product or service. A number like this is usually used to calculate the number of potential customers, the number of units sold, or the amount of revenue generated. In other words, market size refers to the total reach of the market.
A company's market value refers to its financial worth or estimated market capitalization. In other words, it measures the perceived value of something. You can use it to estimate how much a company could sell for in a given market.
As a result, market size refers to the potential market opportunities, while market value refers to the financial value of an individual company or market.
Terms to Know About Market Sizing
You should familiarize yourself with a few helpful terms before estimating your market size.
Total Addressable Market (TAM)
Total Addressable Market is referred to as TAM. A company can achieve this number if it captures 100% of its market share and generates maximum revenue or customer base.
Serviceable Addressable Market (SAM)
The term SAM refers to the Serviceable Addressable Market. As part of TAM, SAM aligns with the company's resources, capabilities, and target customers.
Serviceable Obtainable Market (SOM)
A SOM is an acronym for Serviceable Obtainable Market. An organization's current scale determines how much SOM it can get. In this figure, marketing and sales strategies, competitive positioning, and product demand may be taken into account.
Target Market
Market segmentation refers to focusing a company's efforts on a specific group of customers, industries, or segments. The segment of customers most likely to show interest in, purchase, and appreciate a company's products and services is this group.
Penetration Rate
An organization's penetration rate is the percentage of its target market it has successfully penetrated. Based on the level of market share a company reaches in a specific market segment or overall market.
Market Segmentation
The concept of market segmentation refers to dividing the total market into distinct groups or segments. There is usually a common characteristic, need, or behavior shared by people in these segments.
Understanding your target customers better can be achieved by segmenting the market. You can also tailor business strategies, such as marketing, to meet the needs of specific segments.
Value Proposition
A value proposition is what a company offers its target customers. In addition to creating value for customers, it differentiates a company's product or service from that of its competitors.
It is crucial to understand the value proposition when sizing a market. You can use it to identify the customer segments that will find your offer most valuable.
How to Calculate Market Size
1. Consider your total addressable market first
2. Within that target market, identify a group of customers to focus on
3. Calculate the likelihood of your product being purchased by those customers
4. Multiply that number by the estimated penetration rate
In spite of the fact that calculating market size requires only a few steps, it is an essential step. Understand your business's potential demand and revenue opportunities by following the steps below.
1. Consider your total addressable market first
Don't be intimidated by the technical jargon. By multiplying the total customers in a market by the annual value per customer, you can calculate your TAM.
Before calculating, take a look at the steps below:
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Define your product or service. Growth of a business around a product can be more challenging than developing a product. Because of this, you need to really understand what your product or service does and how it solves a problem.
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Find your market category. It is possible for a product to be classified under more than one market or industry category. Narrowing your TAM begins here. Think carefully about what you want customers to compare your offer with.
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Conduct market research. Collect relevant data and information about your potential customers. Check out this free market research kit with research and planning templates if you're new to market research.
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Analyze the competition. You should conduct a competitive analysis to find out who your top competitors are and what their unique value is.
2. Within that target market, identify a group of customers to focus on
Do you want to know who your top customers are? Here are some tips to try:
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Create your ideal buyer persona: Outline your ideal customers' characteristics, demographics, and behaviors using the Make My Persona tool.
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Segment your target market: Divide your target market into distinct segments. Segments can be based on age, location, interests, or buying habits.
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Continue market research: Continue to collect data and insights about each segment. You will be able to gain a better understanding of each segment's size, needs, preferences, pain points, and purchasing habits. As part of your ongoing market research, you may conduct surveys, interviews, focus groups, or analyze existing market research.
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Set pricing for your product or service: Pricing can play a significant role in the purchase decision of some products. Decide on a price range or pricing for your products if you haven't already.
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Assess segments of your market and prioritize: The size of each segment, its growth potential, and its competition should all be considered. Consider how each segment aligns with your company's capabilities and resources as well.
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Refine your buyer personas: Take a second look at your ideal customer profile based on your prioritized segments. Your marketing and sales strategies will be more effective if you have a better understanding of your buyer persona.
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Confirm your SAM with market testing: Assess the responses and feedback of your target segments with a product or service pilot group.
3. Calculate the likelihood of your product being purchased by those customers
This step will allow you to focus more intensely on the customers who need what you have to offer. They are looking for you or a clear alternative to your competitors. This group can be quantified as follows:
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Create a customer journey map: Using this process, you can map out the ideal customer journey from awareness to purchase. From how customers will discover your products to what might stop them from purchasing, this step is helpful for market sizing and beyond. Are you new to the process? These customer journey templates can be used.
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Estimate conversion rates: Estimate conversion rates using historical data, industry benchmarks, or industry research. Using this method, you can estimate the number of leads, prospects, and customers in each segment.
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Figure out buyer intent: Determine the likelihood of each segment purchasing your product by creating a ranking or score. You can use this information to prioritize segments that are most likely to convert.
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Create a SOM estimate with your data: Your market size estimate will be more credible if you use the research above. Your growth strategies can also be guided by it.
4. Multiply that number by the estimated penetration rate
Divide your SOM by your TAM, then multiply by 100 to calculate penetration rate.
If you have calculated your market size, make sure you can trust it. Here are some tips to keep your market sizing up-to-date:
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Confirm your data is accurate and reliable: For your research, use reliable sources such as industry reports, market studies, and government databases. Make sure the data you're referencing is current as well.
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Keep up with market growth, seasonality, industry trends, tech advancements, regulatory changes, and economic conditions: Both market size and customer demand can be affected by these factors.
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Review and update your market size estimates regularly: Over time, market conditions change. Update your calculations with new or relevant data on a regular basis.
How to Apply Market Sizing Information Once You Have It
What do you do now that you've estimated the size of the market? Your business can answer the following questions based on market size:
- What is the potential revenue from this market? Is it even worth our time and effort?
- Would we be interested in the market if it were large enough?
- Does the market seem to be growing? In the U.S., 36.2% of businesses fail after three years, 48.0% after five years, and 65.3% after ten years. Three, five, or ten years from now, will this market still offer revenue opportunities?
Create a strategic plan
According to Vinay Kevadiya, once Upmetrics had done its market sizing, it helped the team create a clear strategic plan.
“Lots of customer insights are gained. It involves understanding customer demographics, behavior, and preferences, which are essential for tailoring products and services to meet the market demands more effectively,” says Kevadiya.
Building marketing and sales strategies was part of the strategic planning process. “Based on the groups, it is now easy to target the customers, and it helped us to plan content marketing and SEO strategies,” Kevadiya says.
Leverage unique positioning
Reviewflowz founder Axel Lavergne used competitor analysis data to gain valuable insights into his business.
“We studied our competitors to determine market saturation and gaps,” says Lavergne. “For instance, we discovered that, while many companies provided review management tools, few expressly addressed the needs of small to medium-sized SaaS businesses.”
Reviewflowz was able to position itself uniquely by targeting an "underserved niche" based on this analysis.
“As a result, we avoided overcrowded niches and focused on unmet demands, resulting in a strong market launch and rapid growth. Market sizing was more than just a formality; it helped us link our vision with market reality, ensuring we focused on the correct audience and possibilities,” emphasizes Lavergne.
Adapt product features
“Detailed market sizing was central to our winning FinlyWealth pitch,” says Kevin Shahnazar, co-founder and CEO of FinlyWealth.com, a credit card comparison platform in Canada
Shahnazar's team began by estimating the total number of credit card holders in Canada - approximately 30 million. Those looking for new cards or better rewards - a subset already existing - were then considered. Annually, 20% of cardholders are estimated to be affected.
FinlyWealth's approach combines top-down and bottom-up thinking. Analysis of industry reports and government data was part of the top-down approach. In the bottom-up approach, they surveyed potential users and analyzed search volume for credit card comparison terms.
Shahnazar adds: “From this process, it was evident that an obtainable market of SOM around 1.5 million users annually exists. As a result of this data, we refined our platform based on the needs of the targeted markets."
Thus, they were able to "adapt product features to the most challenging market needs, increasing engagement by 40%."
Market Sizing Methods
There are two simple methods for market sizing your business. These processes can help you use data to gauge market size.
Top Down Approach
The first is a top-down approach, in which you start by looking at the market as a whole and then refine it to get an accurate market size. That would look like starting from your total addressable market and filtering from there.
Let's say you want to start a wine company. In order to determine the total market for your product, you need to determine how many liquor stores there are in the United States.
According to your research, there are 50,000 liquor stores in the United States. Among that total list, only the New England area - including Massachusetts, Maine, and Rhode Island - should be on your sales list.
Your target market includes the 1,000 liquor stores in New England. As a result, you conduct research and speak with alcohol distributors to discover that wine distribution has a success rate of roughly 40%.
In this example, we would use the following formula to calculate the market size:
1,000 liquor stores x 40% = 400 liquor stores
Then, if you assume each liquor store will result in $20,000, you can figure out potential revenue using the following formula:
400 liquor stores x $20,000 = $8,000,000
This means you stand to make $8 million if you penetrate 40% of the total market in the New England area.
Bottom-Up Approach
Starting small and working your way outward is a bottom-up approach.
The first step is to determine the number of units you anticipate selling, followed by the number of sales you anticipate from each buyer, and finally, the average price per unit.
Using the same wine example – say you found recent data showing that the average cost of a wine bottle in New England is $10. A survey shows that the average consumer buys one bottle of wine a week, or 48 bottles a year. This means that the average consumer spends $480 per year on wine.
Next, you discover that the number of consumers (or households) you can expect to reach in the New England area is 16,000.
As a result, your market size is 480 x 16,000 = $8,000,000.
I have to emphasize that both methods ignore the existence of competitors, customer churn rate, and other factors that impact sales. With this in mind, I recommend staying conservative when estimating how much of the market size you'll win and using this as a starting point.
Market Size: FAQs
What is the first step in calculating market size?
The first step in calculating market size is to start with your Total Addressable Market (TAM.) To calculate your TAM, multiply the total customers in a market by the annual value per customer.
What is considered a large market size?
It depends on your business and goals. However, if you’re looking to attract VC funding, a $1 billion market size is said to be large enough. But this is a symbolic target. In reality, VCs are more interested in exit size because when a company is sold or publicly listed, they’ll get a return on investment.
What is considered a small market size?
Once again, it depends on your business and your goals. However, a small market size typically means a projection of under $15 million in annual revenue.
What is a good market size for a startup?
A good market size for a startup depends on each business.
For example, a competitive market estimate for a tech startup could be between $5 billion to $500 million. However, a competitive market estimate for a local small to mid-sized business startup could be $60,000 to $500,000.
That said, the potential demand for your product or service should always be large enough to sustain growth in the first few years.