People spend years building a business. They invest in cutting edge technology for websites, they work on building an efficient team and they work for the product to match customer needs. But all these efforts are incomplete without the calculation of market size. Determining the market is just important as any of these aspects of any startup. Understanding and calculating market size for any startup is crucial for two categories; the addressable market and the total revenue opportunity. Since, calculating market size is so necessary, let’s figure out how to calculate TAM, SAM and SOM the right way.
What is market size?
Market Size can be defined as the total potential buyers of any service or product in a given market and the revenue generated by sales of these products. Market sizing is an important task for right marketing, planning and budgeting. And if your company needs a third party financing, it is highly essential. And even if your business doesn’t need any external financing it is necessary for strategic decision making areas like:
- Critical employee skill
- Product Development
- Organizational development
TAM or the Total Addressable Market
TAM is the total demand in the market for any product or service or it is the total revenue opportunity available for a product to capture if it achieves 100 percent market share. The Total Addressable Market is helpful in estimating the potential growth of the market. The potential buyers and investors can utilize TAM for providing a feasible value proposition.
The creation of a feasible value proposition needs estimation of overall investment size, growth expected, available market, market size, and competition. And this can be achieved by calculating TAM. TAM accounts the customer segments and products which are untouched by the startup and helps in determining the actual size of obtainable market and the competition prevailing in the market for the product line offered by the startup.
Calculating TAM can be complex if most of the competitors in the market have opaque and privately held sales figures. However, there are three options for calculating TAM:
- Top-down analysis: It determines TAM using industry research.
- Bottom-Up analysis: It uses the previous/early sales data to estimate the market.
- Value theory analysis: It estimates the effect of buyers’ behavior through product value.
Top down analysis
This method follows the elimination process, starting with a large piece of known sized population that comprises the one the marketing business is targeting and then narrowing down to particular market segments. An inverted pyramid can be used to represent top down analysis where the large population is marked at the top and the narrowed segment at the bottom.
This type of research is mostly based on the existing research done by the market research firms, but for a better analysis, the research should be supplemented with some extra assessments like phone, email surveys. This strategy has some negatives as the numbers cannot always be trusted if data is not based on a completely transparent company or if it is self reported data.
Bottom up analysis
The bottom up method is more reliable as it is dependent on primary market research. It utilizes a more reliable data set on present usage and pricing of the product. The plus point about using this approach is that here it is explainable why some segments are selected and why the others are left out.
Bottom up TAM analysis makes researchers think precisely about how the product is market fit, so the TAM figure is built on a more solid sense of what makes the product market. The TAM can also be broken in several geographic areas or industry segments for showcasing your way of approaching aspects of the market.
Value theory analysis
The value theory analysis is dependent more on supposition and guesswork which makes the TAM conclusions to be quite murky, but they are still useful. It estimates the value the product provides to the consumers and how much from that value can be used in the product pricing. Value theory is helpful in calculating TAM when a business is introducing any new product, upgrading any existing product or is cross selling particular products to the pre-existing customers.
For using this approach, the most important is finding what value the customers can find in the product and how much they are willing to pay for the same. Further, it is needed the number of customers who will find that value added in the product and will opt it over competitive products available in the market.
SAM or the Serviceable Addressable Market
You might calculate the TAM of any product but achieving it is kind of a hypothetical concept. Most of the businesses cannot capture the TAM or the total addressable market for their products. Even if the service has a single competitor, it is difficult to convince the whole market to buy just one service. So, here comes in the Serviceable Addressable Market that helps in determining which enterprises will actually gain some benefits with your product.
The SAM is calculated by counting the potential customers who are the right fit for the product offered and multiplying the same by average revenue of such customers in the market.
SAM= Potential Customers right fit for the product X Average revenue of such customers
SOM or the Share of Market
Share of Market is the realistic percentage or the actual customer bases of the SAM that any business can capture. It is used in determining how much revenue the product is capable of generating.
For calculating SOM, the market revenue of products for the previous year is divided by the market’s SAM of the previous year. This percentage depicts the market share of your business from the previous year. The next step is to multiply the market of your business by the SAM of the market this year.
Your market share of last year = Last year’s market revenue of product/market’s SAM of last year
SOM= Your market share of last year X market’s SAM of this year
Why is TAM important?
Total Addressable Market is one of the key metrics used by companies and startups for estimating their potential scaling the market in revenue and sales. TAM breaks down the available market any product aims at capturing into manageable levels. It is important from the investor level as well, because an exaggerated value can take the investment to markets with lesser growth potential.
What to keep in mind while determining market size?
When you are calculating market size, there are few aspects which helps in determining the market size, they are:
The market to which your product belongs
It is very essential for any business to identify the market type in which they are planning to operate. There are four market types:
- New market
- Existing market
- Re-segmentation of any existing market as a low-price product
- Re-segmentation of any existing market by applying a niche strategy
Determining the market size influences many important aspects of any startup like understanding customer needs, customer adoption rate, market size estimation, new product launches and the position of your product in the market.
Applying the market size data
There is no exact science that determines the right way to estimate the market size in value, but there are some ways which can improve the effectiveness of this estimation like:
- While you do the first estimate, examine and ponder every assumption and the changes it makes. It should include the risks involved in changes and calculating the best case situation and the worst one.
- You should also monitor how accurate your initial assumptions are and if you need to modify or change them with time.
Determining the market size is a fundamental part of any startup, and it is essential for every entrepreneur to know how to calculate it. A well thought, calculated and specific TAM calculation is a good way to convince the investors the value and aimed growth of the business. And if you are willing to get a precise picture of the market size you are aiming, you should be realistic about the estimates, projections and figures you are accounting for the research as it can be fruitful in making strategic decisions for your startup.
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