How to Size Up Your Market

One of the biggest questions that a startup needs to answer as it embarks on a new venture is how big their market is. Without understanding what the size of the market really is, a company has only a limited understanding of where it is headed. Think of market sizing like reading a map and knowing the fine details—I can tell you that your market is the United States, but that’s not nearly as helpful or as useful as knowing that your market is concentrated in the Pacific Northwest and has a size of 3 million potential customers who are really interested in your hiking shoes in the gray color.

Your investors will also want to know what your market is, and for you to show them that you’ve thought about and understand who your customers are and how you can reach them. Market sizing will help you define your customers more clearly and the activities that you will undertake.

Market size is usually expressed in terms of revenue, the amount that the customers would pay to suppliers for the product or service. In some cases, the market size may be expressed or augmented by a unit measure, such as number of individual users or installed base of devices. However, unit measures always need to come back to drive revenue, so for our purposes market size is expressed in dollars.

I think of determining market size using a combination of a top-down as well as a bottom-up approach. The top-down approach looks at the total addressable market (TAM), serviceable addressable market (SAM), and serviceable obtainable market (SOM). The bottom-up approach takes a more detailed look at how much in sales the company could generate based on its projected activities. Using both approaches will help you narrow down the market size and target market.

The top-down approach is based on the TAM, SAM, and SOM.

The TAM is the total demand for a product or service if it were available to everyone. It is the most extensive measure of potential revenue and includes all possible customers and all the ways a company can generate revenue from its product or service.

To find out how big the TAM is, there are several places you can consult, but there is seldom one place that will give you all the information you need. Analyst reports from companies like IDC, ABI Research, and Gartner are all good sources for technology-related products and services, but their reports will cost you. Some of the key headline figures from their research are frequently cited by news articles, which a quick Internet search can usually reveal.

Other good sources of information are the annual reports of publicly-traded companies in the same space that you are targeting—not only will these companies be potential competitors of yours, but their annual reports and quarterly earnings calls are likely to include discussion of the market and competition.

You should also talk to your potential customers to understand how they perceive the market and how they think of the competition. This can also provide valuable insights to help you focus and differentiate your product offering.

The SAM is the portion of the TAM that a company can target with its products or services. The SAM considers geographical, regulatory, and market-specific constraints that might limit access to the total market.

You would need to assess what your SAM is in the context of your product and your company’s operations, but you can also change these factors to enlarge the SAM. Your SAM could be constrained by the fact that as you are starting out, you may not be able to target companies in certain regions of the world. Or, there could be specific laws or business practices in certain countries that your product is not suitable for.

The SOM is the portion of the SAM that you expect the company to be able to capture, taking into account competition, company capabilities, and market conditions. It is the market share you can reasonably achieve within a specific timeframe.

To determine the SOM, I would look at the competition and their positioning to determine how much of the SAM the company could potentially attract. At this same time, this information would also feed back into the go-to-market approach. For example, if there were several entrenched competitors in an already relatively mature or established market, then it may be harder to take a larger SAM, but it may also direct me to focus on specific features and benefits that my competition doesn’t already provide.

Be careful of using data that is too out of date – industries change quickly. Also remember to always cite your sources in your decks and presentations.

Let’s use the car industry to illustrate the concept of TAM/SAM/SOM. Suppose you are General Motors. (For purposes of simplicity, we’ll use units instead of dollars here.)

• The TAM is the total worldwide passenger car and truck market, which was about 75.6 million units in 2023 (Source: ACEA Economic and Market Report, Global and EU auto industry: Full year 2023).
• The SAM is limited by the countries in which GM operates and the types of cars GM makes (mainly larger gas-powered cars and trucks, with only limited capacity to expand into battery-electric vehicles), which let’s say for argument’s sake is 22 million units worldwide. (In 2023, the total U.S. market was about 15.5 million units, and North America makes up over 80% of GM’s market. Since GM builds for the U.S. market, we can expect the SAM to be at least 15.5 million units, plus whatever else GM can build and sell internationally.)
• Finally, the SOM is that portion which GM is able to capture, taking into account the number of factories it has and how well its products can compete with other manufacturers. In 2023, GM sold about 6.2 million units worldwide (Source: GM).

The bottom-up approach is the opposite of the TAM/SAM/SOM model, and it builds up the company’s revenue based on its business plan. For example, suppose the company can manufacture n units of its product each year, and the company plans to deploy its product in this way with this much marketing or sales support, so that it will be able to reach x people and of those 10 percent will become customers, giving it y customers in its first year, which translates into $z of revenue.

One of the benefits of the bottom-up approach is that it factors in the constraints faced by the company. The company cannot perform beyond what its budget allows. On the other hand, the bottom-up approach also allows the company to model different scenarios, for example such as by being able to pinpoint how much it can generate in additional sales if it had an additional $10 million to spend today.

The market sizing exercise above is about more than just determining how much revenue you can potentially make—it’s also about understanding market segmentation, the competitive landscape, growth potential, customer acquisition cost, and scalability, and about determining how much to ask for in your funding round.

By understanding the different segments in the market, you can identify the most lucrative ones for your company, and focusing on them can be more effective than targeting the entire market. Segmentation can be based on demographics, geography, industry, customer behavior, and more.

Analyzing the competitive environment is key to understanding how market share is distributed and the potential barriers to entry. Knowing who the key players are and what share they hold can help in assessing the realistic SOM, as well as help you identify an effective go-to-market strategy where you can differentiate from the competition.

When analyzing the market size, you should also be considering the growth rate of the market. Even if the current market size is small, a high growth rate can make it attractive in the long term. Conversely, a low growth rate with several established and well-regarded players will be a more difficult market to enter.

Customer acquisition costs should be evaluated, along with their expected lifetime value (that is, how much you expect them to contribute to sales and profits over the period of time you expect them to be a customer). For every product, there is a sales and marketing process—this takes people (e.g. sales people, technical field personnel), dollars (e.g. sales commissions, marketing at trade shows, visits to potential customers), and time. For some products, the cost of acquisition may be too high compared to the revenue generated from customers. This is a larger concern when customers can churn frequently and switching costs are low, and when the price of the product itself is also low.

Finally, the scalability of your business model should also be assessed to determine if it can meet the potential demand. Not being able to scale up means leaving money on the table. On the flip side, scaling up too fast means that you’ll need to cut back later. Neither is desirable, but understanding the market size can help you size your company and operations, production, and delivery appropriately. 

Once you know all of the above factors, you can come up with a defendable and well-reasoned amount to ask for in your funding round, because you will be able to clearly articulate how you will spend the amounts you raised and how much revenue you expect to be able to derive from it.

As an investor, I would never expect a startup to calculate a precise number based on the bottom-up approach, but you should be able to determine a rough range and be able to compare it to the top-down SOM to see if it is realistic. For example, if you are an upstart and your bottom-up approach says you will get 90% of the TAM in a year, you’d better be able to back up how you’ll get that far that quickly, otherwise it’s an indication you haven’t done enough homework.

At a certain point, the market size is either big enough and/or growing fast enough that the precise size doesn’t matter for a VC investor; what is more important is how it informs your company’s strategy, how you would take your product to market, and how you explain how you will use funds raised from your investors.