How Should Founders Think When Calculating Market Size

When founders calculate market size, they should adopt a systematic approach combining top-down and bottom-up methods. Here’s how they can think about it:

1. Understand Market Segments

- Total Addressable Market (TAM): This is the total revenue opportunity if the product or service has 100% market share. Founders should identify the broadest potential market for using their product.

- Serviceable Available Market (SAM): This is the segment of the TAM that fits within the product’s business model and where the company can compete. Founders should narrow down to the most relevant market segments.

- Serviceable Obtainable Market (SOM): This is the portion of the SAM that the company can realistically capture in the near term. It’s a more conservative estimate that considers the company’s current reach, competition, and market conditions.

2. Top-Down Approach

- Begin with broad industry data from market research reports or industry publications.

- Break down the TAM into SAM and SOM by analyzing factors like geography, customer demographics, and product type.

- This approach gives a high-level overview but can be less accurate if not adjusted for specific market conditions.

3. Bottom-Up Approach

- Start with detailed data from your specific market, such as the number of potential customers, average revenue per user (ARPU), and market penetration rates.

- Use this data to estimate the SOM by multiplying the number of potential customers by the ARPU.

- This method is usually more accurate as it is based on direct data related to the business, though it requires more granular information.

4. Consider Market Trends and Growth Potential

- Evaluate how the market is expected to grow over time. Consider factors like technological advancements, regulatory changes, and consumer behaviour shifts.

- Adjust your market size calculations based on these trends to ensure they reflect future opportunities.

5. Competition Analysis

- Understand who the competitors are and how much market share they currently hold.

- Factor in how your unique value proposition might allow you to capture market share from competitors.

6. Validation

- Use pilot programs, surveys, and early sales data to validate your assumptions.

- Adjust your market size estimates based on real-world feedback and data.

7. Risk and Sensitivity Analysis

- Consider different scenarios, including best-case, worst-case, and most likely outcomes.

- Analyze how sensitive your estimates are to changes in key assumptions, like market growth rates or customer acquisition costs.

8. Communicate Clearly

- Be transparent about the assumptions behind your calculations when presenting to investors or stakeholders.

- Provide both optimistic and conservative estimates to show a realistic range of market sizes.

Conclusion

By adopting these strategies, founders can create a more nuanced and reliable understanding of their market size, helping them make informed decisions about scaling, fundraising, and product development.