Market Sizing:
Data-Driven and Compelling

Objective

This article describes a data-driven market sizing methodology for entrepreneurs seeking venture capital financing and executives who need a single version of market size to evaluate product manager requests for internal funding.

 

Crafting a compelling fundraising story requires a coherent approach to market sizing that clearly defines assumptions such as target customer, number of addressable customers, revenue model and product differentiation.

 

The article also explains how common market sizing jargon relates to this data-driven methodology.

 

Although examples illustrating the article’s concepts focus on healthcare to maintain consistency, these concepts apply to any industry.
 

 

Core Market Sizing Concepts

​

• Revenue equals volume times price. For market sizing, volume is the number of addressable customers and price is the average revenue per customer per year. For an individual company, volume is units sold per year and price is average revenue per unit.
   

• Many companies have both “direct” and “indirect” customers. For example, in healthcare direct customers could be institutions serving patients that benefit from your product, and indirect customers are patients.
   

• “Volume drivers” are situations or events that cause a customer to consider buying your product. For example, healthcare volume drivers include how often a patient needs a procedure or checkup with their doctor.
   

 

Data Sources

​

Trustworthy data sources for total customer numbers and volume drivers include government agencies, industry associations, analyst reports and interviews with relevant customers and industry experts. An ideal data source includes 3-5 years of historical data so you can estimate future volume and volume drivers using historical compound annual growth rates (CAGR). You need market size now, at product launch and for five years post-launch.

 

If your company has direct and indirect customers, focus first on indirect customer data because indirect customers are the volume driver for direct customers. Direct customer data, often sourced through customer interviews, is most important for determining sales model and for forecasting near-term revenue.

 

If you cannot find the specific number you need, derive it using related data. For example, if you have North American data but not European, estimate European data based on its relative population size since both regions are well-developed.
 

​

Number of Addressable Customers

​

To calculate a realistic number of addressable customers, segment your customers by their buying criteria and global region, and then eliminate segments and regions you will not serve. For example, if you are in healthcare and your indirect customers are patients diagnosed with a certain clinical indication, which type and stage of the clinical indication can your product treat? Which type and size of healthcare institution will your sales efforts target? In what global region(s) will you build a sales team or distribution channel?

 

If you plan to offer multiple products over time, analyze the market size for each product separately. The strategy to expand your products and addressable geographies over time is part of the fundraising story.
 

 

Average Revenue per Customer per Year

​

To calculate your average revenue per customer per year, multiply the number of times per year customers will purchase your product (your “algorithm”) by the average price per purchase.

 

Validating your algorithm and average price is important. Interviewing potential customers is always helpful. In addition:

• The Van Westendorp pricing method helps define a range of acceptable prices by asking customers four questions: at what price is a product (i) a bargain (ii) a bit expensive but still worth considering (iii) too expensive (iv) too cheap to consider because you question the quality.
   

• Estimate the value your product creates for direct customers and the portion you will capture. 10-30% is typical. For example, if you are in healthcare and your direct customers will treat your indirect customers for a total (reimbursed) cost of $500 per visit or procedure, your price to your direct customers could be $100 or 20% of $500.
   

• Research your competition’s pricing. Using existing products as a reference point is most important for products that are not revolutionary. To address the customer risk of using new products, many companies underprice new products which reduces their market size. Addressing customer risk directly is generally a better strategy.

 

Learn more about validating business case assumptions.

​

Eliminate from your market size calculation customer segments that cannot afford your price.

​

When seeking internal funding, consult with internal industry experts and salespeople about data sources, algorithms, price and customers willing to answer key questions.
 

 

Show Off your Work!

​

Document data sources and calculations via footnotes in your slides and business plan.

 

Key assumptions will change as you learn new information. Keep a record of changes and rationale.
 

 

Common Market Sizing Jargon

​

The data-driven market sizing method described above is known as “bottoms-up.” By contrast, “top-down” market sizing involves sourcing a broad market size number from an industry research report and multiplying it by a small (e.g., 1%) market share. The top-down method does not support a compelling story because it relies on a broad market size number that includes customers you will not serve and products you will not sell, and is not broken down by volume and price.

 

Other common market size terms are Potential Addressable Market (PAM), Total Addressable Market (TAM), Serviceable Addressable Market (SAM) and Serviceable Obtainable Market (SOM). For example, in healthcare PAM could include all people globally with the clinical indication you are targeting, regardless of whether diagnosed and clinical indication type/stage. TAM, a subset of PAM, could be all people globally diagnosed with the clinical indication type and stage relevant to your product. SAM, a subset of TAM, could be the regions in which you will sell and the portion of patients who can afford to purchase services from your direct customers. SOM is the subset of SAM you could realistically capture given the competition and your value proposition and sales execution.

 

The bottoms-up market sizing method described above results in TAM and SAM over time.

 

Applicable to Any Industry

​

Although the examples illustrating this article’s concepts focus on healthcare to maintain consistency, these concepts apply to any industry.
 

​​

About the Author

​

Daryl Michalik is a Principal at Michalik Enterprise Services.
 

​

Michalik Enterprise Services Can Help

​

As experts in product management and financial analysis, we have significant experience in crafting market sizing analyses that support justifiable revenue forecasts. We distill market sizing into simple assumptions and credible financial models by collaborating with stakeholders and efficiently sourcing relevant information about assumptions. We can undertake an entire project or a portion of one or provide feedback on an existing analysis.

​