One of the most important things to know before you even think about turning an idea into a product, is the size of the market you’re going to be targeting.
The most obvious reason is to make sure we have a large enough opportunity to turn our idea into a profitable business. We might have a brilliant solution, but if it’s solving a problem that’s shared only by a handful of people, it’s not going to be a commercial success.
Moreover, in the process of analyzing the size of the opportunity, we would also need to think through various aspects of how we’re going to bring our product to market. This can help us make important decisions about the features we’re going to include in the product and the places where we’ll offer it to customers. For example, if we find out that a large part of the market consists of enterprise customers, we’ll be aware that we need to consider hiring a sales force early in the lifecycle of our product.
There are various ways in which you can determine the size of a market. The two quickest and most common ways entrepreneurs use are the top-down and the bottom-up approaches.
In the top-down approach, you use a central source of data to gather intelligence on the total size of an industry and a mix of additional data, logic, and guesstimation to determine the size of the specific market that can be addressed by your product.
For example, if you’re planning on developing a SaaS tool for SEO agencies and consultancies, you should start by looking at the total size of the of the industry — $65 billion in 2016. Sounds great, but if you look more carefully at the report, you’ll notice it includes spending on buying email lists, etc., which is not part of what your tool will be doing (and, hence, cannot be included in your calculation of the addressable market).
Here’s a great example from VigLink, an ecommerce services provider, which shows how they’ve broken down a large industry into a specific segment, which they can attack with their product:
That way they’ve went from a huge number (~$670B) to a very specific “tiny” segment of $1.2B where they’re well-positioned to build a profitable business.
Sometimes finding reliable and detailed data on the size of an industry is not easy, so we have to resort to using a bottom-up approach where we infer the size of the addressable market based on how many customers we estimate it contains and how much they’re willing to spend on a solution similar to what we’re planning to build.
We’ll use another example to demonstrate how this works. Let’s assume we’re working on a CRM tool for freelancers. We know the total market for CRM in 2016 was a little over $26B and that it is dominated by a few large incumbents like Salesforce, SAP, Microsoft, and others that offer expensive solutions targeting large companies. However, we’re interested in capturing a specific niche, which isn’t necessarily using a CRM tool at the moment (i.e. we’re looking at expanding the market, not just capturing a slice of the existing pie).
In this case, we can gauge the market opportunity by predicting the number of paying customers we can generate within a specific time frame. We can quickly find out that there are over 57m freelancers in the US alone in 2017. If we can capture just 1% of those within 5 years, we would have close to 600k customers.
Coming up with a number of what they’d be willing to pay is just a bit more challenging. One way to do it is to look at the ARPU (or Average revenue per user) for services that target a similar demographic and adjust based on how similar our offering is and how painful we think the problem we’re solving is. (If you can’t find an ARPU number, just take the lowest plan available.)
We’ll assume a minimal $10/month or $120/year from which we get:
600,000 customers * $120 = $72 million in [ARR](https://baremetrics.com/academy/annual-run-rate-arr) (``*Annual Run Rate*``)
Of course, that a very rough (and probably a very inaccurate) estimate, but it gives us a reliable ballpark number which we can use to judge the opportunity.
Estimating the size of a potential market is the first step when you’re planning on starting a new business. These techniques can be used to quickly vet a potential product idea and/or convince an angel/VC investor that there’s a viable business model behind it.
If your estimation proves there’s a large enough opportunity, the next step is to start thinking about the channels that will help you generate customers for your new product.