How to Estimate a Market

The goal of a market analysis is to determine the attractiveness of a market and to understand its evolving opportunities and threats as they relate to the strengths and weaknesses of the firm. Venture capitalists look for a large market, so this is the first hurdle that an entrepreneur has to do to convince the VC

Instructions

Difficulty: Moderate

Things You’ll Need:
* A sharp mind
* a good knowledge of the industry

Step1

Startups raising VC should be in industries over $1 billion in market size

By “large” I mean an industry that can pretty easily have $1 billion plus in revenues. The rational behind this is pretty simple - in order to generate 10x returns on their investment the VC’s startups need to have a real chance to hit several hundred million in size. Larger industries also have more outcomes that can be generated by trade sales to larger companies within that industry or in adjacent industries. Note that the market can be growing to be this size in the next couple of years.

Step2

Top down: Citing overall market research, and then claiming an arbitrary percentage of that market as a target.

In general, the top-down method uses a broad market size figure (often provided by an analyst, industry participant or other) and whittles it down to the target market segment. For example, an ecard company targeting kids, might start with the total revenue generated in the card market, multiply it by the percentage of revenue generated from ecards and then by the percentage of ecard revenue generated by kids.

To do each of these steps there might be a bit of behind the scenes analysis - figuring out the percentage of ecard revenue generated by kids might take some additional estimating leg work. Make assumptions that need to be made and have the details of that analysis available on a backup slide when you present. While you should be prepared to explain your entire approach, first present just the highest level drivers and the resulting estimate. If VCs want more detail about your methodology they'll ask for it.

Step3

Bottom up: Detailed research within a small part of the market.

The bottom-up method builds up the total addressable market by using the main variables of the revenue model. For example, expected price times the total number of potential customers will yield a bottom-up addressable market. Using the ecard example, multiply the total potential page views from the kids market by the average revenue generated per pageview. If you have several revenuve streams, you will likely need to calculate the bottom-up estimate for each of them independently and add them together.

The bottom-up method is generally considered more robust. There's a good reason for this - the broad market size figure used as the starting point in the top-down analysis often includes a slew of different market segments. It's easy to forget to take some of these out of the estimate. In contrast, a bottom-up method the estimate is less likely to include non-addressable revenue.

Bottom up approaches show greater understanding and depth, however top down can still be used to validate bottom up.

Step4

That means do more than just read some analyst reports that suggest that a market is a particular size - actually talk to a number of potential customers. Choose representative customers that are similar to the average potential customer for your startup. Get a feel for their potential desire to purchase and their willingness to pay. With that information, you can then multiply their projected price point against the number of potential customers who look like the ones you have spoken with. Viola, your market size!

Tips & Warnings

* In addition to being more reliable, the bottom-up analysis can be used as a starting point for financial projections and operational planning. With this model in place annual revenues can usually be created by varying a key driver, such as the number of customers. With a projection of the key drivers of the model in place you will be able to begin making operational plans. For example, with the number of new customers already projected you can back into how many sales people you will need to acquire them, enabling you to determine costs, profitability and cash burn. With either approach you will often find that one or two assumptions in the estimate are less reliable numbers - you may not trust the sources. If you're not comfortable with an assumption do a low and a high version of the estimate. For the low version, use the lowest reasonable value for the unreliable variable; for the high, use the highest. Highlighting discomfort with an assumption and offering a range for the size of the addressable market can demonstrate your thoroughness to an investor. To really impress VCs with the rigor of you analysis, you should consider estimating the market size in more than one way (if you can). You might do two different bottom-up estimates or one bottom-up and one top-down. If you can show that you can get to a big number no matter the approach, you mitigate some perceptions that your methodology might be wrong. Be sure that the two approaches yield a somewhat similar number. If they don't this tactic can backfire and create questions about the validity of your approach.

* David A. Aaker outlined the following dimensions of a market analysis:

1. Market size (current and future)
2. Market growth rate
3. Market profitability
4. Industry cost structure
5. Distribution channels
6. Market trends

* Key success factors Market Size The size of the market can be evaluated based on present sales and on potential sales if the use of the product were expanded. The following are some information sources for determining market size:

1. government data
2. trade associations
3. financial data from major players
4. customer surveys

0 comments:

Post a Comment

 

© Copyright WISE MAN AREA . All Rights Reserved.

Designed by TemplateWorld and sponsored by SmashingMagazine

Blogger Template created by Deluxe Templates