Estimating the size of a market segment is one of the fundamental activities of software company strategic planning and product marketing. Depending upon the company stage, this task can fall to a company founder in a startup, a product manager in a slightly more mature company, or a strategic planner in a large software company. It’s important for many reasons, including providing a baseline to estimate your market share progress as well as understanding what the upper bounds of your current business prospects are.
But first and foremost it’s important for FUNDING. Whether you are in a large software company looking to get a new product development funded or a startup looking for your first angel investor, funding from SOMEONE is the lifeblood of any new business activity. This is true whether you are a part of a large tech business or a startup looking for your first outside investor. To justify funding your product, understanding the market size is essential.
Let me say early on that I am using the terms “market size” and “market segment size” in a very generic manner. More precisely, I really mean your “total addressable market (TAM)”. “Market size” just rolls off the tongue a little easier 🙂
Reasons to Examine Market Size
Go-or no Go startup decision
This is probably the most commonly thought of reason to do an early market sizing analysis. Before putting your heart, soul, and hard-earned cash into starting up a new company, it’s a good idea to get a sense of whether or not the market segment you’re considering will support your end goals.
New product/market analysis
Similar to the startup decision support reason above. In a more mature company you would do a similar analysis, when considering launching a new product into a market that you’re not currently serving.
After making that “Go” decision with support from your early market sizing, oftentimes the next step is raising funds! To present to outside investors you’ll probably need to extend and sharpen your market size analysis, so it will hold up under their scrutiny.
Even after you’ve formed a company, launched a product and so on, market sizing is usually not a “done deal”. Is the market growing? Shrinking? Shapeshifting? To market software products effectively as well as understand what kind of ROI you’re getting from your marketing, intimate market knowledge is essential. And market size is fundamental to building any market segment expertise.
Types of outside investment that are possible/required
Different software target market segment sizes require different levels of investment. And these different required investment levels translate to different types of investors, ranging from friends & family to angels to large software VCs. Without intimate knowledge of market segment size, the decision on which investors to pursue – as well as getting to “yes” – is very difficult.
Market share size and realistic exit strategies
Once in business, it’s not only important to understand your market segment size for the reasons stated above. Because a key metric for evaluating any business is market share. You can’t calculate market share without knowing your market segment size. And market share can be a critical factor in deciding when to exit.
Now that I’ve discussed some common reasons to go through the trouble of conducting a market size analysis, how do you go about it? Unfortunately, there is no easy, standard answer to this question. Every situation is different, and the “right” answer is a function of available data, which varies wildly from case to case. Let’s look at a few of the more common methods to consider using when attempting to size a market opportunity:
Market sizing methodologies
Published secondary market size research studies
Most people are inherently lazy! I don’t really mean that in a “bad” way; most of us would prefer not to do any more work than we have to, on any particular task. So the most obvious thing to do first in any market sizing exercise is to see if anyone else has already done the work for you! Definitely do an Internet search for any already-published secondary research studies that may be available. Check out Gartner, IDC, Forrester as well as their less well-known competitors, who may publish research on smaller vertical markets. If you get REALLY lucky, they may have already done exactly what you’re looking for! But far more often, they’ve published a piece of research that you can use as a starting point for your market size analysis, adjusted to suit your needs. Going this route has the added benefit of adding CREDIBILITY to your analysis; this is particularly useful if your work will have an outside audience, such as potential investors.
Hire a market research firm or consultant to do primary research
Even if there is no secondary, already-published market report out there for your segment, there are plenty of market research companies that will be happy to build you just what you’re looking for via a primary research engagement. If you are part of a mature software business, already funded, or just independently wealthy, this can match closely with your needs. But this can be a very, very pricey option, out of reach for those who don’t fit into one of these flush-with-money categories.
Self-service primary research
A more financially modest option to hiring a market research firm to conduct a primary research study is to ‘do it yourself”. Another in the long line of beautiful things born out of the Internet is the ability to do widespread research relatively cheaply and efficiently. So you might consider using one of the affordable online market research SaaS products which are widely available. Check out SurveyMonkey and their many competitors.
Top down market size analysis
Lacking any primary or secondary research efforts due to lack of current funding or a possibly an acute need for that level of analysis, a common market sizing method is what’s knows as the “top down” approach. That means that you start with a typically larger, known market, usually one with good secondary research available. Then you start “cutting it down” based upon the specifics of your particular segment.
For example, you’re planning on entering the accounting SaaS market. You know that there is a published figure of $2B for the overall accounting SaaS market. But your product is aimed only at cost accountants, which make up 60% of all accountants. This gets you to $1.2M. And it’s aimed only at enterprises, not SMBs, which is 50% of the accounting SaaS market, getting you down to $600M. So $600M would be your total addressable market segment size. If your projection for your maximum possible market share due to heavy competition is 25%, then your internal forecast would top out at $150M. All the numbers above are fictional, intended only to illustrate the methodology. Get the picture?
Bottom up market size analysis
Finally, the last method of market sizing is the “bottom up” method. The bottom up method entails trying to count up the total number of all of your prospective customers and then multiply that number by your product price, annual subscription amount, or other similar price metric to come up with a market size estimate. This method is particularly useful for smaller or not-yet-existing market segments where there isn’t a good larger market size starting point for a top down analysis. For example, you’ve developed a completely new type of SaaS application aimed at large quick serve restaurants in the southern United States. You would find demographic data for the number of quick serve restaurants with more than 75 employees in the 16 states defined as “southern” in by the US Census Bureau. Then multiply that number by your annual SaaS subscription price of $7500 to get your total addressable ARR, or market size. Again, a totally fictional scenario, but hopefully this simple example illustrates the basic “bottoms up” methodology.
Bottom up market sizing is sort of the opposite of the top down method. because of that it’s the perfect complement to a top down analysis from a “sanity check” perspective. When you can’t find secondary research or don’t have the money or the time to do primary market research, doing both a top-down and bottom up analysis can add comfort and added trust in the results. If the top down and bottom up number converge reasonably closely on the same “order of magnitude”, then you can probably feel pretty good about your analysis. If not, it’s usually best to sharpen your pencil, check your assumptions, and take another look. Remember, don’t try to attach too much credibility to any one of these estimates, no matter how it was calculated. So when in doubt, I would always go with the methodology that provides the most conservative estimate.
Market sizing is difficult & imprecise, but important
Market sizing is often a difficult and highly imprecise exercise. This is particularly true for an early stage SaaS or mobile software business which is trying to create something completely new in the market. When there are few or no existing “direct competitors”, there may be little published research data out there to start the process. In these cases, the only thing to do is either bite the bullet and pay for a primary research study, or use a classic bottoms up approach: identifying the broad customer type and using demographic data and estimated pricing to “size the market” from the ground up.
There’s my introduction to software market sizing and analysis. It was intended only as an overview to point you in the right direction, subject to your own particular resources and market circumstances. I hope that you found it useful.
Have you done any marketing sizing activities for your mobile software or SaaS company? Use the comment field below to inform us of your own experiences.
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Gregory Olson says
Very helpful and tidy summary of how to approach this pricing/forecast/growth strategy/funding problem, Phil. Thank you for taking the time to create this.