What factors should you consider when choosing a market sizing method?

I tend to ignore any market sizing done top down. I always want to see someone estimate from the bottom up, which means they need to more clearly identify their customer segment(s). Every pitch deck I see has a TAM in the billions, so it’s important to have credibility to the estimates. Having some real data and at least some of the estimates validated can make a big difference in how believable the estimate is.

Ideally the market sizing method should comprise of a couple of different approaches. The Top down approach helps establish that the market is large enough if the entire vision plays out and the bottom up approach showcases that you have a good understanding of the immediate segment that you are attacking. For the top down approach , it's helpful to have it backed by verifiable data (research reports / validated assumptions etc) and for the bottom up approach , it's important to be clear on target customers / approximate ACVs etc.

When considering the method for market sizing, it's crucial to weigh several factors to ensure accurate insights. Firstly, assessing the nature of the market itself is key - is it established or emerging? Next, understanding the availability and reliability of data sources plays a significant role. Additionally, considering the level of detail required and the complexity of the product or service being sized is essential. Moreover, taking into account the resources and expertise available within your team for analysis can influence the choice of method. Ultimately, opting for a method that aligns with your specific goals and constraints will lead to more informed decision-making.

Data availability is usually not an issue, but having high-quality and accurate data is challenging. Our process typically begins by examining the sales pipeline and analyzing current conversion rates. We also look at how a startup generates demand, converting it into paying customers. Following this, we take a top-down approach to assess the business's growth potential. It involves understanding the number of potential clients and their willingness to pay. We create a model of an ideal customer pipeline and forecast its growth over five years, considering evolving market trends.

I always advise my startup founders to things about two strategies. Top Down Approach: Think about the industry trends and extract the spends from Gartner, Forrester or whatever reports are available. Bottom Up Approach: Based on your ICP, understand the number of potential customers available for your to serve. You can get this data from the likes of LinkedIn, Apollo or ZoomInfo. Founders should be transparent with both the approaches with VCs so we understand the min max of the market potential.

For a VC, it's a binary question of whether or not the market is big enough. It's either a massive, billion-touchpoint problem, or it's not. If it's not a big market, you have to gain conviction that the market is rapidly growing to be able to hit that scale where you can reasonably assume there's a $100m+ revenue business to be built in it. At the earliest stage, it's better to analyze a market from a bottom-up approach because it requires you to focus on the unit user or end customer. Top-down approaches take big, broad slices of markets and though they can be effective, very few founders take the time to tell the right narrative vs. pulling a CAGR figure and assuming they can take 10% of a broadly defined market.

An analysis does not become better by multiplying two factors that hold uncertainty with each other (quote from Aswath Damodaran during a class in corporate finance). Hence don't try to breakdown market size estimates into further drivers than what you have solid data / assumptions for.

Top-down and bottom-up approaches tell different narratives. Top-down market sizing requires understanding of the broader market landscape to pinpoint & prioritise segments. VCs typically seek market sizes in the billions, preferably tens of billions. The bottom-up approach holds greater merit in my view. Founders should show understanding of their unit sales, sales targets & customer behaviour. Lastly, I strongly advise founders against employing assumptions like "capturing 5% of a $10 billion market." Such simplistic projections are commonplace but often lack justification.

Part of estimating market size, and the addressable market comes from following the consumer journey. Behaviors of people ultimately can impact the number of potential buyers a product or service can have. For instance, when Home Depot entered the China market, it was forced to withdraw within a few years because instead of the “do it yourself” model, consumers had more of a “do it for me“ preference. So, despite the boom in construction which would suggest a large opportunity, the outlet failed. If using a top-down approach, then it can be helpful to add in cliffs for diffusion based on behavioral traits to ensure that you have the “right” business model and don’t overestimate market size.

While the devil is in the details, depending at how narrow/ wide your business opportunity is targeted, you can arrive at estimates based on data metrics belonging to that particular region. Uber or AirBnB as an example, when they started, did not possibly imagine these to become worldwide phenomenons however with time, as product and business evolved, the market sizing became more accurate.

Uncertainty informs a number of the other factors such as how much data to gather, what kind of detail is necessary to achieve the desired outcome and finally what kind of validation is required to make the results meaningful.

Managing uncertainty in market and data analysis is essential when conducting market sizing, especially in emerging market adjacencies where secondary data can be sparse or unreliable. First, gather data from multiple sources to triangulate market sizing estimates. In addition to reviewing multiple secondary research sources and industry reports, conduct your own primary research and expert interviews. Using multiple data sources can mitigate the risk of relying on incomplete or biased data. Next, conduct a sensitivity analysis to assess the impact of varying inputs on your market sizing analysis. Test scenarios such as optimistic, pessimistic, and base-case to understand the range of potential outcomes and impact of key variables.

Normally, most firms tend to look after TAM-SAM-SOM ideology. In practical terms, TAM helps businesses understand the full market potential, guiding long-term strategic planning and investment decisions. SAM provides a more realistic view of the market opportunity, helping companies identify their target audience and allocate resources effectively. SOM indicates a company's performance relative to its competitors and its success in capturing market share. By analyzing these metrics, businesses can assess their growth potential, refine their strategies, and maximize their market impact. TAM: SAM: SOM is usually lesser than 1: 3 to 5: 10 to 25. Again, these are extremely high level numbers to keep in mind!

As a founder venturing into uncharted territories, I've learned that the level of uncertainty in your market is a critical factor when choosing a market sizing method. While more conservative approaches like TAM-SAM-SOM provide a grounded reality check, they may fail to capture the full potential of disruptive ideas. Conversely, aspirational methods like blue ocean strategy can unveil untapped opportunities, but carry higher risks. The key lies in striking a balance that aligns with your vision and risk appetite. Embrace uncertainty as an opportunity, not a barrier, and let your market sizing methodology reflect the audacity of your ambitions

When calculating market size on different target segments you need to make at least top-level validation on each of them. For example, you may have 4-5 hypotheses of target segments, which combined give you a huge market, but if 2-3 of them won't work, your residual market would be small. In that case try to have at least 3-5 interviews with customers in each segment to validate/invalidate segment and get more precise estimation of market size

Innovative Edge Calls for Custom Tailoring — For groundbreaking products or services, steer clear of cookie-cutter market sizing. As I have done many times in various industries opt for the "value obsession." Embrace a value-based approach, estimating market size based on your unique value proposition and potential customer willingness to pay. This method shines when traditional metrics falter, offering a tailored perspective on markets you're poised to create or disrupt.

In most cases (including when an innovation is disruptive, creating a new market category or influence new customer behaviour) there tends to be to be multiple approaches to derive at market sizing. Best way to know you are directionally headed in the right direction is when multiple approaches provide you a range or validate the size of the opportunity using diverse data sources and approaches. For example, market size from a trusted market research resource alongside analysis of universe of potential customers x $ they spend or would spend could set a realistic range. Having a thought through, fact based, validated and well articulated market size sets the stage for the due diligence ahead.

As a founder breaking new ground, I've realized that the level of innovation inherent in your product or service is a critical factor in choosing the right market sizing method. If you're dealing with direct competitors, the comparative approach might serve you well, benchmarking your market against established alternatives. However, for those of us daring to disrupt and create entirely new categories, the value-based method shines – capturing the true worth of our novel offerings through the lens of customer willingness to pay. The market sizing technique you employ should mirror the audacity of your innovation, enabling you to accurately quantify the untapped potential you're unleashing

For a well established market, all the above is easya d getting to a 'market size' is relatively easy. What do we do for high-innovation categories? - Use Value-Based Market Sizing: Employ methods like the value-based approach to estimate market size based on the perceived value proposition of your innovation and the willingness of customers to pay for it. Try to understand how big is the problem you are solving for and adjudge the market size accordingly - Conduct Market Research: Conduct surveys or focus groups to gauge customer interest, pain points, and willingness to adopt. - Consider Indirect Competitors: Since disruptive innovations may not have direct competitors, consider indirect substitutes or alternatives

“Possible innovations” would be too much to discuss or too irresponsible in this context. If it discusses a topic with one bottleneck to solve, then it is fair to expect some innovation can enable the entire chain. On the other hand, like other experts already wrote, it is hard to expect a completely new market rise, or it is unreasonable complex problems could be solved by “a magic happens”.

As a founder, I've realized the level of validation is pivotal when choosing a market sizing method. Theoretical approaches like analogy offer perspective but may miss nuances. I advocate the lean method – iterative, empirical, harnessing customer feedback & real-world experiments. By continuously testing & refining estimates, you enhance accuracy & gain invaluable audience insights. The method you choose should balance analytical rigor with practical ground-truthing. Theoretical can inspire, but validated approaches grounded in reality are essential for sustainable growth.

Once you have an initial estimate, consider using a different method to validate your findings. This helps to improve the overall confidence in your market size calculation.

Market sizing is a delicate matter. Many startups just get a bunch of research done and believe the numbers. The truth is, your market size is never accurate. But by using validated sources, you can at least know your limit in how much you can grow and be reasonable on this matter.

Success or failure of many a startups is closely related to identifying the customer, knowing the customer well to obtain a clear market fit. To identify the best market fit, one must validate certain assumptions in order to ascertain that the product or service being developed has a clear path to target customers and market.

- Analog Method: For example, a VC assessing a startup in the electric scooter market might use data from similar transportation sectors to estimate market size. - Empirical (Lean): A VC may observe a startup in health-tech through user interviews and prototypes to validate market demand and willingness to pay - Analytical Approach: Relies on rigorous data modeling: For instance, a VC might use demographic data and consumer surveys to quantify market segments for a SaaS startup targeting SMBs. Suitable for scenarios with well-defined data and assumptions - Experimental Approach: Emphasizes real-world validation: For consumer goods startup, the founders launch a pilot in select markets to gauge consumer interest and demand and extrapolate

I prefer bottoms-up sizing vs. tops-down. It's best practice to build products with a specific user/customer in mind, and when you use bottoms-up sizing you end up empathizing for the user/customer you're actually building for and asking questions that bring clarity to your product's goals. I find myself tricking my brain into thinking a market is massive every time I use tops-down.

It's important to both do a bottom up and top down analysis to challenge the assumptions. Bottom up can be as simple as multipliying potential clients with the ACVs. Top down requires more data availability and a realistic understanding of the market. Many founders assume that they can win 10%+ of the market when in reality it's a big achievement to get to 1%. Understanding the potential is very important to see what future growth can be possible.

Our fund's view is different from most. We don't care about a big TAM. Instead, we want to see a niche group that is absolutely in love with your product. Is there a $50-$100M market that you can dominate? That's what we want to see. Why? Because if you can dominate that niche, you can expand to bigger markets with a kick-ass offering.

In my experience, most market-sizing exercises for early stage companies is entirely experimental. What is more useful for investors is seeing the founder's go-to-market strategy alongside a list of potential first customers. I like to see a founder's customer pipeline broken down by time-to-close (e.g., near-term, mid-term, long-term). I also want to determine if the founder can develop a repeatable process for acquiring customers. The perfunctory task of determining market size can is usually less challenging and, as such, is less important in my mind.

Neben der Marktgr??e ist auch die Marktdynamik entscheidend. Was heute noch ein zero billion dollar Markt ist kann mit der entsprechenden Dynamik innerhalb weniger Jahre mit entsprechenden Wachstum ein multi Milliarden Markt sein. Andererseits k?nnen sehr gro?e M?rkte weniger interessant sein wenn sie schrumpfen.