How to Effectively Determine the Market Size of a Business
How to effectively estimate market size | RationalStat

A significant and essential task for entrepreneurs and founders is determining their market size and the possible value the target market could bring to their new business. Without this information, it will be challenging to create a credible business plan or consider a potential candidate when the start-up approaches potential investors.

It is essential to consider that the market must reach billions. Even if the start-up or business has the best team and product, the return will be limited to potential investors, making investment less appealing.

Market Size for Start-ups

The size of the market is vital. It informs the team, company, partners, and investors what potential business opportunity is available. It can help in determining the amount of value for a particular venture. It is essential to know that even if the individual or company does not have a plan to raise any money in capital from outside sources.

Market size is vital if the start-up requires funding to expand its business. Market numbers are among the most basic numbers any potential angel and VC investor would be looking for before investing in an idea or product. Even family and friends ought to be asking questions about it in pre-seed and seed financing rounds. Being unprepared will damage the business’s credibility immediately.

This is an aspect that entrepreneurs often overlook when preparing their initial plans before launching the world of a new venture or when pitching to investors. How will start-ups ensure that they are doing it correctly?

Estimating Market Size

This exercise comprises five steps to help assess the potential market for a particular product/service.  To prepare comprehensive market sizing and define target customer characteristics, the company or start-up will need to conduct market research. Market research can be done using two different methods: primary data and secondary data. Each stage will draw a generalized market study;

Step 1. Determine the target customer for the business

At the beginning of their journey and start-up, all entrepreneurs have to determine their ideal clientele. Customer choice is the company or person for which product and service help address their needs and solve the problems. To define the target customer, the start-up must:

  • Find out who is the ideal client.
  • Create a profile of the usual or anticipated prospective customers.
  • Due to the importance of defining the ideal customer, it is essential to allocate enough time to conduct a thorough study of this initial step.

Step 2. Determine the number of potential customers

To estimate the number of customers for a target product or service, the first step is to understand what products/services have to offer to a group of people or businesses. In addition, identify the product or service features and benefits.

Suppose an individual or partner starts a new venture in Ontario or another Canadian province. In that case, a start-up or a new business entity could use industry databases like the ones provided through Statistics Canada, the U.S. Bureau of Economic Analysis, or Hoovers to help in determining the market.

Step 3. Determine the penetration rate for the product

Define the market size by considering a penetration rate for the product/service category. The penetration rate depends on the quality of the product or service. Market penetration provides start-ups and companies with significant insights into how their customers view their products.

Calculation:

To calculate market penetration, the current sales volume for the product or service is divided by the total sales volume of all similar products, including products sold by competitors. The result is multiplied by 100 to create a percentage.

Example: Penetration rates of computers and the business intelligence system:

Computers, word processing, and the Internet: There is barely any way to run any business in the modern world without a laptop computer that can process words and internet connectivity. Although these three technologies have not been at 100%, it's nearly enough to utilize this assumption to boost business growth and planning.

Systems for business intelligence: In theory, most businesses could benefit from having a company intelligence system, a type of software used to analyze and manage information about sales, finance marketing, and other specific purposes.

However, in reality, only a handful of ventures possess the capacity and business skills necessary for making business intelligence tools an investment worth the investment. This means that the penetration rate is limited to giant corporations, which make up less than 1% of the businesses in the world's major cities. While 1% may not sound like much, it is more potential customers than a brand start-up could reach.

Step 4. Determine the potential market size

The market size is based on volume and value

Market volume can be defined as the overall product units sold or total software purchases or a total number of orders booked. To determine the market's overall potential, multiply the number of potential customers by the penetration rate.

Market Volume = Number of Targeted Customers x Permeation Rate

Furthermore, to calculate the monetary value of the market, multiply the market volume by the  average value (pricing) of the product/service, i.e.

Market Value = Market Volume x Average Value (in US$)

Step 5. Use the market size information

The steps mentioned above on how to effectively determine the market size (value & volume) are not a perfect scientific method. There are ways to increase the efficiency of this method:

When making the first estimate, look at every assumption made and the reasons that could make it change. To account for the potential risks of change, consider scenarios for worst-case and best-case scenarios and anticipated scenarios. As time passes, the start-up should be able to monitor whether assumptions are accurate and decide if the company needs to alter its beliefs.

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