Market sizing is the estimation of the potential of a market. Incorporating market research, market sizing is useful for businesses looking to introduce a new product or service to evaluate the business opportunity. Market sizing also helps investors to understand the value of the potential opportunity within the target company’s business plan.
- Understanding market sizing
- The five basic steps to market sizing
- Market sizing example
- Key takeaways:
- Connected Marketing Concepts
Understanding market sizing
For businesses wishing to enter a new market, the research that goes into market analysis is daunting in its complexity.
Market sizing seeks to remove that complexity by breaking the analysis into smaller sets of assumptions. These assumptions can then be extrapolated to form an overall market size estimate.
Once a business has successfully undertaken market sizing, it can determine the level of investment required and also potential growth strategies. It can also gauge the value of a market and its profitability – factors that ultimately determine whether the business enters said market.
The five basic steps to market sizing
To be effective, market sizing should be a bottom-up approach. Although time-consuming, this approach to market research gives more realistic and accurate market potential. Using the bottom-up approach, market size can be calculated by multiplying the number of units sold by the price of each unit.
In other words, businesses using this approach start with the smallest known pieces of data and then use these data to build up a realistic representation of their market.
This approach differs from the top-down approach, which is based on generalized and trend-inflated market valuation whose data accuracy is often questionable.
Here is how the bottom-up approach works.
1. Define the target market
The first step is perhaps the most important, and it involves understanding a target audience. In other words, who is the type of person a product or service is best suited to? A buyer persona can help because it allows businesses to be ultra-specific on the type of people they want to attract.
Then, the business must determine the size of their target market. This can be done in several ways and may involve contacting business organizations or governmental and commerce agencies. For example, a high-end baby food company may contact its local commerce board to determine that there are 550 high-end supermarkets in their state.
2. Assess product interest
Then, the business should determine the number of consumers who may be interested in buying their product. This can be done by looking at competitors and their annual sales data.
However, sometimes this information is hard to obtain. If competitor data cannot be found, then focus groups and surveys can be used to gauge the likely level of interest in a new product. While the baby-food company may have identified 550 stores, they find that only 250 are interested in stocking the product on their shelves.
3. Calculate the potential sales
Calculating potential sales can be tricky, but an accurate approximation can be obtained by competitor analysis or by referring to cash flow forecasting or other finance based models.
In the case of the baby-food company, it estimates a roll-out cost of $20 million across 250 stores compared to potential annual revenue of $60 million. Although the investment is 33% of forecasted annual revenue, profits in the second year sans roll-out costs are significantly higher. Therefore, the company decides to enter the market.
Market sizing example
Now that we’ve provided an overview of market sizing and how it works, let’s take a look at the hypothetical example of a LED manufacturer.
The manufacturer wants to know the size of the residential LED market size in the United States.
Step 1 – Defining the target market
In first defining a target market, the manufacturer may find there are several audiences worth quantifying. These include:
- Environmentally-conscious consumers who want to switch out their incandescent bulbs for LEDs.
- First-home owners who want to incorporate LED lighting as part of a new build.
- Existing homeowners who want to upgrade or improve the lighting in older homes that are dimly lit.
- Homeowners living in states where incandescent bulbs have been banned by authorities.
The company can then perform detailed research and determine how many LED units are sold in each market and add them together to determine the total market size.
Alternatively and upon further research, it is found that the total US LED market was valued at $9.89 billion in 2020 and is expected to be worth $17.22 billion by 2028.
However, these data account for LED sales across the residential, commercial, industrial, retail, hospitality, and healthcare sectors.
Step 2 – Assess product interest
To determine what percentage of total LED sales are residential, the company learns that 47% of all United States households use LEDs for all or most of their lighting.
If there are approximately 142.2 million houses in the United States, this equates to around 66.8 million potential customers.
Step 3 – Calculate the potential sales
As we noted earlier, calculating the potential sales for any product or service can be one of the most difficult parts of market sizing.
Below we have listed some assumptions for both existing and new homes in the United States.
- Approximately 66.8 million homes use LED illumination.
- The average US home has seven rooms with three LED units in each. Hence, the total number of LED units in all American homes is approximately 66.8 million x 7 x 3 = 1.4028 billion units.
- Considering the average LED unit lasts 14 years, we can assume that 1.4028 billion units are purchased/replaced every 14 years. As a result, the company calculates that around 100 million units are purchased every year in existing homes.
- According to the US Census Bureau, 912,000 family homes were built in 2021.
- For the sake of this article, let’s assume that every one of these new builds incorporates LED units with none using incandescent bulbs. Let’s also assume that these homes have an average of 7 rooms and 4 LED units in each.
- The market size for LED units in new homes in the United States is therefore 912,000 x 7 x 4 = 25.536 million.
The company then adds the number of LED units sold in existing homes and new homes on an annual basis and arrives at a number of 125.53 million.
If we assume that the average cost of an LED unit (including standard bulbs and more expensive downlights) is $15, the residential market for LED lighting as it stands today is worth around $1.88 billion annually.
- Market sizing is the estimate of the size of a market using insights gleaned from a target audience and existing or potential sales volume.
- Market sizing is a bottom-up approach that utilizes known data to give a representative view of the larger market. It is more accurate than the top-down approach that relies on generalized or assumption based market data from competitors.
- At its core, market sizing is an iterative process that is based on an accurate and detailed view of the target audience a business hopes to serve.
Connected Marketing Concepts