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 three 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.
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.
Existing homes
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.
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.
Key takeaways:
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.
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The CATWOE analysis is a problem-solving strategy that asks businesses to look at an issue from six different perspectives. The CATWOE analysis is an in-depth and holistic approach to problem-solving because it enables businesses to consider all perspectives. This often forces management out of habitual ways of thinking that would otherwise hinder growth and profitability. Most importantly, the CATWOE analysis allows businesses to combine multiple perspectives into a single, unifying solution.
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The PESTEL analysis is a framework that can help marketers assess whether macro-economic factors are affecting an organization. This is a critical step that helps organizations identify potential threats and weaknesses that can be used in other frameworks such as SWOT or to gain a broader and better understanding of the overall marketing environment.
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The STEEP analysis is a tool used to map the external factors that impact an organization. STEEP stands for the five key areas on which the analysis focuses: socio-cultural, technological, economic, environmental/ecological, and political. Usually, the STEEP analysis is complementary or alternative to other methods such as SWOT or PESTEL analyses.
The STEEPLE analysis is a variation of the STEEP analysis. Where the step analysis comprises socio-cultural, technological, economic, environmental/ecological, and political factors as the base of the analysis. The STEEPLE analysis adds other two factors such as Legal and Ethical.
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The SPACE (Strategic Position and Action Evaluation) analysis was developed by strategy academics Alan Rowe, Richard Mason, Karl Dickel, Richard Mann, and Robert Mockler. The particular focus of this framework is strategy formation as it relates to the competitive position of an organization. The SPACE analysis is a technique used in strategic management and planning.
A lotus diagram is a creative tool for ideation and brainstorming. The diagram identifies the key concepts from a broad topic for simple analysis or prioritization.
Functional decomposition is an analysis method where complex processes are examined by dividing them into their constituent parts. According to the Business Analysis Body of Knowledge (BABOK), functional decomposition “helps manage complexity and reduce uncertainty by breaking down processes, systems, functional areas, or deliverables into their simpler constituent parts and allowing each part to be analyzed independently.”
The multi-criteria analysis provides a systematic approach for ranking adaptation options against multiple decision criteria. These criteria are weighted to reflect their importance relative to other criteria. A multi-criteria analysis (MCA) is a decision-making framework suited to solving problems with many alternative courses of action.
A stakeholder analysis is a process where the participation, interest, and influence level of key project stakeholders is identified. A stakeholder analysis is used to leverage the support of key personnel and purposefully align project teams with wider organizational goals. The analysis can also be used to resolve potential sources of conflict before project commencement.
Strategic analysis is a process to understand the organization’s environment and competitive landscape to formulate informed business decisions, to plan for the organizational structure and long-term direction. Strategic planning is also useful to experiment with business model design and assess the fit with the long-term vision of the business.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
