Market size is a very important factor. It's a measure of the potential value of your market. It gives you an idea of how much money there is to be made from your innovation.
This has far-reaching implications. It not only tells you whether your venture is viable, but can also help you to make decisions about how much to spend and whether to target a niche or try to serve the market as a whole.
It is also one of the headline figures investors will want to look at when they decide whether to put money into your business or not. Being able to show potential investors that there is an existing market of considerable size can make a huge difference in gaining their support.
Market size - in terms of both volume and value - can change over time due to supply and demand trends, price inflation and currency exchange rates, so you should periodically update any calculations of your target market size.
How to evaluate market size
There are many different ways to define market size. Some of these are quite easy, while others take a more diverse range of influencing factors into account in an attempt to calculate a more useful or 'realistic' result.
It's rarely as simple as just adding up all the money spent by customers in a given sector. You have to decide which rival suppliers fall within your target market and which revenues to exclude from your calculations.
By calculating your potential market value for each product or category, you can then combine these figures into a single market size. The result is directly relevant to your company, and you can use it to determine your share in a complex, multi-faceted customer base.
Why do we calculate market size?
Working out market size is the first step towards gaining a better understanding of your company's potential scalability.
Market size is a many-layered metric. In any sector, there are likely to be parts that you cannot serve with your current offering of goods and services.
These unreachable parts still contribute to the total market, but it might be more useful to exclude them from your own measurements and calculations.
Equally so, the potential market you serve can be refined further by geographic area.
In the end, it's more important to get numbers that are useful to you and your investors than it is to compile a report that spans the entire global market for a product or service.
What is market size?
In general, market size is simply the total amount of money customers spend on goods and services that fall within the definition of the relevant market.
How to calculate market size?
At its simplest, market size is just all of the money spent within the target market, added together to give an overall figure.
This is called Total Addressable Market, or TAM, which we'll look at in more detail below.
As mentioned above, TAM can give you an idea of how much money there is in your chosen sector, but it doesn't always mean those revenues are available to you.
By adjusting your definition of your target market, you can make sure you only include revenues that you have a chance of earning.
From there, you can go on to calculate the ratio of your revenues to the total possible market size, which gives you a measure of your market share.
Understanding market value
There are two important V-words when calculating market size. These are volume and value.
- Market volume
Market volume is a measure of how many customers you can expect to acquire within the target market.
For example, if there are 2,000 customers in total and you have a market penetration of 50%, then your calculated market volume would be 1,000 companies or individuals.
The market volume formula is very simple: number of customers multiplied by penetration rate.
Remember that this is a measure of volume, i.e. the number of entities within the market, and not an estimate of value.
- Market value
Once you have calculated market volume, it is relatively easy to turn that number into a measure of market value.
To do so, you multiply your volume figure by your average sales or forecasted revenues per customer.
This gives you an expected total sales value that can serve as a likely upper threshold for revenues, assuming you reach all of your targets in terms of average order value, penetration rate and the overall size of the market you serve.
Making more than market value
Because market value depends on certain estimates, it is not necessarily a precise figure for the maximum revenues that you can generate.
Your calculated market value is a 'best guess' based on market research and realistic projections, so that you have the information you need to make informed decisions about the way you run your business.
What is Total Addressable Market (TAM)
The acronym TAM stands for Total Addressable Market or Total Available Market. The two terms mean the same thing and you can use them interchangeably.
Knowing your TAM gives you an idea of how much money is available within your target market.
However, it's important to remember that you’re unlikely to achieve close to the TAM figure, as your competitors will always hold a portion of the market.
How to calculate the total addressable market?
To calculate TAM, you simply add together all the revenues generated by companies that fall within the scope of that calculation.
So that could include companies with headquarters, branch offices or other outlets within a geographic boundary, or all the businesses in a specific market.
TAM should be the largest figure for any given market. Other metrics, like Served Available Market and Market Share, are smaller because it is very rare for a single company to occupy a 100% stake in one sector's revenues.
What about static market size?
It's rare for a market to be completely static. In most cases, TAM will rise and fall continually as new demand comes into the market and old suppliers cease trading.
Much of the change in market share comes from these dynamic forces:
- New customers and fewer competitors drives market share higher
- Fewer customers and new competitors puts market share under threat
Overall, your revenues may increase as you steal more market share during static times. But it's crucial to keep a close eye on the incentives you offer, so that you increase the net value of your business despite any discounting.
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