So You Want to Measure Market Size
The art of accurately measuring market size is a critical component of strategic business planning. It provides invaluable insights for decision-making, from identifying market opportunities to resource allocation. In this comprehensive exploration, we delve into four primary approaches to market sizing:
- Bottom-Up Marketing Sizing Analysis
- Top-Down Market Sizing Analysis
- Value Theory Approach
- Market Share Approach
These methodologies, each with unique focus and techniques, offer businesses varied lenses through which to view their market potential.
In this post, you’ll learn how to assess when it’s right for your organization to conduct a market sizing analysis and which kind is most appropriate based on your budget and the data you have available.
What market are we referring to when we say market size?
Before we dive in, it’s important to know what we mean when we say market size. Most brand managers conceptualize market size in three ways: Total Addressable Market (TAM), Serviceable Addressable Market (SAM), and Serviceable Obtainable Market (SOM).
- TAM (Total Addressable Market) refers to the total market demand for a product or service, assuming there are no competitive barriers. In other words, TAM represents the maximum potential revenue a business can generate if it captures the entire market. If this were true, everyone who purchases the product category would be doing so from one business.
- SAM (Serviceable Available Market) represents the portion of the TAM that a business can realistically target with its products or services. SAM takes into account factors such as geography, customer demographics, and market saturation.
- SOM (Serviceable Obtainable Market) refers to the portion of the SAM that a business can realistically capture or serve. SOM takes into account factors such as market share, competition, and product differentiation.
You may have noticed that TAM, SAM, and SOM are a funnel. Depending on your reason for sizing a market, you may be more interested in sizing one part of the funnel over another.
When is it important to size a market?
A market sizing analysis may be the right choice for your brand if you need any of the following:
Market sizing analyses are valuable for organizations that need to evaluate a new market. This need may arise from launching a new product within their existing market or entering a new market.
For example, a market sizing analysis would help a company understand whether they should start selling higher-end dresses or stick to more affordable, everyday wear. Sizing the market would help the organization understand whether the revenue it could possibly generate is worth the production cost of creating dresses made from nicer materials.
If your company is looking to understand which segments of their customers they should focus on, a market sizing analysis would provide the most helpful output. By understanding the size of each customer segment in their larger market and their spending habits, a brand can gameplan which customers are most lucrative. The same information could also help them decide which segments to focus on to maximize their market share versus revenue.
Market sizing analyses are also helpful if your brand needs to understand its market position relative to competitors better. This is most helpful to ask when assessing a brand’s SAM. Sizing SAMs allows for additional questions to gauge which brands consumers are spending most of their money on.
This information can be used to project the market distribution by the company and is mostly useful if current revenue data is not publicly available.
If your brand needs to make an informed decision about how to allocate resources, a market analysis may be the way to go.
For instance, let’s say your brand currently sells shoes, dresses, and jewelry, but rising production costs force you to ask whether you should continue to produce all three. A market sizing analysis could help your brand assess which of the three markets has the highest revenue potential. Weighing this data with your production costs would help your brand make the most cost-effective decision.
Finally, a market sizing analysis may be the right method for your brand if you’re in need of creating realistic and achievable revenue goals for a period of time.
Market sizes change over time based on a variety of social factors. This is why revenue projections for one year may not hold for the next year. Therefore, periodic market sizing analyses can help your brand set realistic revenue projections and growth-oriented goals.
Methods for Measuring Market Size
Now that you have some insights into when to use a market sizing analysis, it’s time to explore the different methods of market sizing. There are four broad methods of measuring market size that all range in cost, accuracy, and, relatedly, the type of data used.
The top-down method estimates market size by using industry reports and studies to calculate the total market size. The total market size is then adjusted based on the target market segment and other relevant factors. For example, if the industry report estimates the total market size for smartphones to be $460 billion, and the target market is limited to the United States, the market size would be adjusted based on the smartphone penetration rate in the United States.
- Relatively easy and quick to perform.
- Useful when industry reports and studies are available.
- Can provide a broad understanding of the market potential.
- Can help identify potential market opportunities beyond the company's current target market by identifying the size of adjacent markets.
- Industry reports may not be up-to-date or relevant to the client’s specific situation.
- May not capture nuances or differences within the target market. For example, it may not provide estimated revenue by demographic information.
- Typically assumes a uniform market potential across all regions or does not break down the market size by region.
Estimating market sizing by using the bottom-up method calculates the potential market size based on the number of potential customers and the average revenue per customer. For example, if a business is targeting the enterprise software market, the bottom-up approach would estimate market size by multiplying the number of potential enterprise customers by the average revenue per customer. Typically, the bottom-up approach relies on survey data for its calculations. This makes it a great method when you need the most up-to-date information about your customers.
- Typically provides a more accurate estimate of market size.
- Helps to identify specific customer segments and their needs.
- Takes into account variations in revenue potential by customer segment. In other words, the interlocking quotas that are used to extrapolate the sample estimate to the population can also serve as segments to look at sales potential for certain demographics.
- Can help identify opportunities for market segmentation.
- Requires significant time and resources to gather data on potential customers and their buying behavior.
- Not based on actual sales/purchase data.
Value Theory Approach
The value theory approach estimates market size by calculating the value that customers place on the product or service. The approach takes into account the benefits that the product or service provides to the customer, as well as the customer’s willingness to pay.
For example, if a business is offering a new software that streamlines workflow, the value theory approach would estimate market size by calculating the potential time and cost savings for the customer and the willingness to pay for those savings. The willingness to pay would then be extrapolated for the existing customers in the market.
- Takes into account the unique value proposition of the product or service.
- Can provide a more accurate estimate of market size if the value of a new product or feature is easy to calculate and associated with a willingness to pay.
- Helps to identify the maximum price customers are willing to pay.
- Can be difficult to quantify the specific benefits provided by the product or service.
- Typically, it assumes that customers are willing to pay the maximum price for the product or service, which may not be the case.
- May not take into account variations in willingness to pay based on customer segment or region.
Market Share Approach
The market share approach typically starts with an estimation of the total market size or a specific market segment's size, which can be obtained from industry reports, market research, or other sources. A company's market share is calculated as a percentage of the total market or segment size. Finally, the market size can be estimated by dividing the company's revenue by its market share percentage.
For example, if a company has a revenue of $50 million in the smartphone industry, and its market share is 5%, the market size for the smartphone industry would be estimated as follows: market size = (Revenue / Market share percentage) → market size = ($50,000,000 / 5%) →market size = $1 billion
- Provides a more accurate estimate of market size based on the company's current market share.
- Can help identify the size of the opportunity for the company to increase its market share.
- Assumes that the company's market share will remain constant, which may not be the case.
- Doesn't take into account potential changes in the market landscape.
- May not capture potential market opportunities beyond the company's current market share.
In this journey, we've untangled the complexities of market sizing analysis, showcasing its indispensable role in guiding strategic decisions. The top-down approach offers a macro view, leveraging industry data for broad market estimations, suitable for businesses with limited access to granular data. In contrast, bottom-up analysis provides precision by delving into detailed data from specific segments, ideal for organizations aiming for depth in their market understanding.
Beyond these, we differentiated between market size and value analyses—where the former estimates potential reach and the latter quantifies segments in financial terms. These distinctions are vital for businesses to align their strategies with market realities, whether the aim is to capture market breadth or evaluate revenue potentials.
Armed with these insights, we hope you feel better positioned to select the analysis most aligned with your organization’s strategic objectives, data accessibility, and budget. From there you’ll be able to drive informed decision-making and foster sustainable growth.
If you’re looking for an expert to help you choose and carry out the right market sizing analysis for your business, Gradient is here to help!