A market’s size should always be framed in the context of its attractiveness: its growth potential, how well-developed other players in the space are, how ready customers are for a solution. Both will be considered in an investment decision.
A market exists when there are a group of customers with a problem, willing to pay money for a solution. Investors want to see a large, growing market opportunity where a startup could do one of two things. Create, or significantly grow, a new market niche like Amazon went onto with their third-party ecommerce platform, or devour the incumbents in a large market with a strategy they can’t pivot to.
Further, a VC-attractive market must be an industry whose economics do not have high “capital expenditure” (CapEx) or cost-of-entry, have a high gross margin (profit over and above expenses), and where technology can provide the competitive advantage that enables scalability.
While the market itself is expected to be large and growing, to offer the potential for a significant return, a smaller but faster-growing market may offer investors a similar opportunity for a smaller investment. On the contrary, a small market that’s growing slowly offers nothing for venture capital firms who, as we’ll discuss, have limited time to return profits to their partners. To make the case for your market size in your pitch deck, let us consider the following premise.
Market Size Slide
Calculating the market size is not easy, but it is necessary as it helps to get a basic understanding of how big your customer base is and whether the overall market is big enough to allow for an outsized return. Ensure that you draw on numbers from reliable and up-to-date sources, and keep your estimates conservative as far as you can. Understanding the following approaches will help to achieve a realistic breakdown of your relevant market.
How to estimate your market size
There are two ways to estimate market size:
Top-Down Market Sizing: Involves drawing data from market research and estimating a market’s value. This is a generic approach that relies on a bird’s-eye view from established experts; reliable, but perhaps too restrictive for some high-risk startup opportunities.
Bottom-Up Market Sizing: Involves sizing up your market by customers: defining the product’s price, estimating the prospective customers. Your numbers might not have been checked by experts, but this “user-centred” approach might discover pain points and opportunities known only to people on the ground.
In this hypothetical example, we take two approaches by the same company looking to operate in the same markets over the long-term.
The top-down market sizing may sound like this:
“Africa’s healthcare market was worth $180B in 2020, and we think that we can reach 1% of this market in 2023, meaning we’re targeting a $1.8B market opportunity.”
While it may sound impressive, the above will fail to convince an investor, who’ll ask you to drill down into your specific plans for winning that 1% of the market. On the other hand, bottom-up market sizing enables you to say:
“We’re going to sell our product to health professionals who are held back by poor patient case management systems, starting in Kenya. There are 5,000 health clinics in Kenya, each of which has around 25 medical staff currently using this kind of software. The average revenue/selling price will be $120 per customer per year over three years ($360). That gives us a $45M total addressable market to begin with, including the opportunity to expand regionally.”
The second example is a much smaller market size overall, but it shows a real customer demand and a clear path to gaining a foothold in one market very quickly. From that foundation, the startup could prove their business to future investors and raise funds to expand to other countries.
While it does not represent the total potential for your business, the “total addressable market” is the market revenue opportunity (at 100% market share) of your first market. Founders should focus on a minimum-viable product in a profitable niche of the existing market in order to build up the critical mass, growth momentum, and investor confidence needed to scale further and eventually dominate a market.
The “bottom up” approach adds this credibility to your investment case.
Bottom-up market sizing involves asking:
- Who is your specific customer?
- How many customers are there?
- How many of those customers can you realistically reach? When?
- At what price will they buy?
- Then, perhaps the most importantly: how many will buy from you?
Bottom-up market sizing shows investors:
- You know who is in your minimum viable segment: the smallest market you need to win to survive.
- You understand what each of those customers is worth, and you’re ready to build a strategy around different customer personas with different values to the bottom line.
- You can estimate how many of those customers are out there.
- You’ve thought about how you will realistically reach them.
- You have an idea of how you will expand to drive growth.
TAM, SAM, and SOM Defined
TAM, SAM, and SOM are abbreviations for the three metrics to describe the market that your startup operates in. These metrics are key components of a pitch deck, as well as the success of your venture.
Furthermore, they are core to framing your sales and marketing strategy, setting realistic revenue goals, and choosing to enter the markets worth your time and resources, not to mention the investor’s cheque.
Total Addressable Market (TAM)
Refers to the total size of the relevant market that you are seeking to address with your product. It represents the maximum amount of revenue that a business could possibly generate by selling their product or service in a specific market; it’s what you could win if you took 100% market share. The calculation should be based on total sales or total sales for a year. TAM is often a global number but can be calculated for a country or region.
An ideal way to calculate TAM is by running a bottom-up analysis of an industry. As stated above, the bottom-up analysis involves counting the total number of customers in a market and multiplying that number by the average annual revenue from each customer in this market.
Serviceable Addressable Market (SAM)
Due to the limits of your business model (such as specialization or geography), you will not likely be able to service your total addressable market. SAM is most useful number for businesses to accurately estimate the portion of the market they can acquire, and they should use that to determine their short- and medium-term growth targets.
SAM captures those subsets of the market relevant to your venture, as defined by the types of users, price points, sub-geographies, etc. For this reason, product development and distribution strategy is most relevant to SAM.
To calculate your SAM, count the potential customers that would be in scope for your early-stage business and multiply that number by the average annual revenue of those types of customer in your market.
A firm with a high share of the overall market may be able to increase its TAM to grow. (Think of Amazon opening up to third-party retailers, increasing the size of the ecommerce market overall.) In another example, a small firm with a large SAM may be able to reach its revenue targets with less than 1% market share.
Serviceable Obtainable Market (SOM)
Even with only one competitor, it would be unrealistic to convince an entire market to only buy your product or service. For this reason, it’s crucial to measure your SOM to determine how many customers would “realistically” benefit from buying your product or service.
SOM is the portion of the SAM you aim to capture in the short-medium term with the resources available to you, informing a startup’s targets across this timeline.
The measurement should be based on your strength against the competition in areas such as promotion, sales, distribution, pricing, and brand awareness. Your strategy might be built around a technological advantage, which unlocks defensive moats like network effects, economies of scale, or counter-positioning against incumbents.
Divide your revenue from last year by your industry’s serviceable addressable market from last year. This percentage is your market share from last year. Then, multiply your market share from last year by your industry’s serviceable addressable market from this year.
Although these figures will largely be estimates to inform your strategy, the more market research and historical data you build up, the more precise your understanding of the market will be. This will give you a foundation on which you can start building a strategy, which you’ll need to stand up to investor scrutiny.