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
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 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.