Ignore that Pie in the Sky
A question often asked of entrepreneurs is ‘How big is your market?’ Whether you are trying to raise capital through equity investment, or building a business plan and sales strategy for an already established company, this question is one of the most important you can ask yourself – and the answer is one of the most difficult to base in reality.
There’s more to market analysis than picking up the latest Gartner or Forrester research report and cutting and pasting their sector estimates into your business plan. This is one area where you need to do your homework, as the answer to this question will impact your marketing plan, your investor pitch, and your entire business strategy.
There are no secret formulas, no subscription-only online reports providing all of the answers, and you don’t need an MBA to succeed. What you do need is a clear understanding of your product or service capabilities, and your competition.
Many entrepreneurs have a vision of the last great, untouched market – floating out there in front of them, ready to be conquered. But seriously, how big is that pie in the sky? And how big of a slice can you really expect to take?
Never say “We have created something totally unique – we have no competition” unless you never want to be taken seriously. Every idea has competition. If you can’t see it, you’re not looking hard enough. While it may be true that there are no companies offering the specific combination of tools and services you plan to offer, there are always replacement technologies. What do people use today to solve their problems while waiting for your idea to come to the market? That is your competition.
While there are no guaranteed formulas for determining your market potential, there are some fundamental questions you can answer that will help you build what I like to refer to as the “defendable swag.” Let’s put it into more familiar terms:
- How big is the pie?
- How big is my slice?
- How much of that slice can I actually eat?
- How much of that slice should I eat?
As you follow along, apply these questions to your own product or service:
How Big Is The Pie?
When determining the size of your overall market sector, those Gartner and Forrester reports actually do come in handy. If you are the creator of a new optical mouse, for example, there is much data available on the web and through the major analyst firms to help you outline the space. But you would be better served by not listing the total market for personal computers as your market opportunity. More suitable would be all PC mouse sales worldwide. This is sometimes referred to as your Total Available Market, or TAM.
The long and short of it is to not automatically assume that the number in your business plan should be in the trillions for an investor to be interested. Depending on the sector and on the viability of your product or service, a total market of $100 million could be acceptable – or $25 million, depending on your ability to penetrate that market. Venture capitalists will have different expectations than angel investors, and angels will have different expectations than institutional investors (corporate investors). Again, it all depends on your product or service.
The net-net here is that you need to show room for potential growth within the realistic boundaries of your product group.
How Big Is My Slice?
The next step is to further divide your market by identifying that portion which pertains directly to your product or service. In our optical mouse example, is your slice the entire market defined in your TAM, or a subset? In most cases (I’d say 99.99%), your opportunity is a slice of this number. In the case of our optical mouse product, let’s say you have 40% of the market interested in optical technology. You can always argue that your product could expand this percentage, but you are better off making that case in your sales and marketing strategy – not bucking the trends as researched by the analyst firms and set by the industry leaders. After all, isn’t it better to show a higher penetration rate in a defined sector rather than sell an investor on the need to build a new market?
Again, there are no hard and fast rules here. The key is to understand how your product or service will be positioned in the industry – how they will be viewed by customers relative to other offerings in your defined space, and what is spent by companies or individuals today on comparable products or services. Sometimes referred to as the Served Available Market, or SAM, this number more accurately reflects your actual market opportunity.
My recommendation is to use this number – not your TAM – in your business plan and investor pitch materials. You may want to include both numbers, but it is important to show that you understand the difference between total applicable market and served available market.
How Much Of That Slice Can I Actually Eat?
Now that you have your global market defined, what is your addressable market? Even though you’ve whittled down your numbers from a TAM of $10 billion in global mouse sales to a SAM of $4 billion in global optical mouse sales, what portion of that served available market are you really targeting?
Here you’ll need to rely on some of your sales and marketing planning efforts. For example, if you do not have key OEM relationships in place, you may find it difficult to justify market penetration predictions in the 75 to 80% range. What is the size of the market for individually purchased mice? Who are the leading vendors? What are the primary sales channels?
How you plan to market your wares will affect the size of your addressable market. You may realize that your best strategy, based on your current relationships and contacts, is to only market within the Continental US market, and then expand from there. If your initial distribution is the individual buyer via web sales, what is your actual addressable market? What portion of individual buyer sales are being done on the web today?
This is one of the most difficult steps for most entrepreneurs. The balance is between promoting the larger potential of your company and product, and setting realistic ands achievable goals for your team and for investors.
To continue with our example, maybe you have a relationship with one OEM, and decide to build your initial strategy around the US and Canadian markets – or 25% of your SAM, which is $1 billion. Still a healthy opportunity.
How Much Of That Slice Should I Eat?
Now we get into tactical planning. You are starting a business from scratch, with limited funds and a small team. What portion of that addressable market can you conceivably target given your size and budget over the next 3 to 5 years? Which relationships should you build first, which will provide the most bang for the buck in the shortest time? Within that $1 billion opportunity, where will you go first? How will you expand your sales team? What is your marketing strategy? What is your expected market penetration?
You should have answers for all of these questions, as they directly apply to your business plan, your marketing strategy, and the tactical plans you provide to your team to go out and accomplish.
Hopefully I’ve made my point that the easy answers are rarely the right answers. While it is true that investors recognize that any business plan contains numbers that are at best a swag, you must be able to defend your assertions, and have a credible strategy for making the numbers you present.
In an eWeek article, Peter Coffee berated “the ease with which we slide our assumptions toward the optimistic limits, inching good numbers up and bad numbers down until we get the result we want – failing to admit that the result is based on multiplying a series of less-than-even chances.” (3/22/04)
Dream big. Have high expectations. Seek to accomplish all of your goals. But recognize the realities of your chosen marketplace, and the limits of your resources – and build your business plan and strategy accordingly. It’s all about the “defendable swag.”
The fact is, you’ll find it much easier to eat a slice than to swallow the pie whole.
(Originally published on About.com in 2004)