When choosing an online business idea to start running a market size calculation is an essential step. Today we’ll look at bottom up market sizing, top down market sizing and comparables as different methods of performing market size calculations.
Why run a market size calculation?
Why is it important to run market size calculations when deciding which business idea to pursue?
Let’s imagine you have two online business opportunities. One has a potential market size of £10 million whilst the other has a total market size of £100 million.
All things equal you should always pursue the £100 million opportunity.
This of course ignores competition in the marketplace as well as your ability to provide value to customers. These are additional factors that must also be considered when choosing an online business opportunity.
However, knowing the total potential market size remains a vitally important first step when weighing up your options.
Do you need a market size calculation?
You may be required to put together a market size calculation for a formal business plan which is to be submitted to a bank for financing or to investors for investment capital.
Full business plans are useful for these reasons but they’re not the focus of this particular article.
Instead we are talking specifically about how are you weigh up different online business opportunities and decide which to start.
Total Addressable Market
What are we are interested in is the TAM or “total addressable market”. We are not necessarily (indeed most of the time we will not!) be able to serve this whole market.
This does not mean that working out the total size of market is unimportant. We still need to know the size of the whole pie before we start cutting ourselves a slice. We want to make sure the pie isn’t too small!
One of my first online businesses was teaching Chinese to English speakers. The total addressable market size is only a few million customers. This limited the potential for the business to grow.
If I had flipped the direction of the business and instead taught English to Chinese speakers the total addressable market would’ve been many multitudes larger.
Last I checked there was somewhere near 400 million Chinese speakers actively learning English at any one time.
The total addressable market is therefore hundreds of times bigger than the Chinese language teaching market.
A large total addressable market means a large potential for growth. A smaller addressable market means a more limited potential for growth.
Again, all other things being equal we want a large total addressable market as it means more room to grow.
Now let’s chat about how how you can actually get your grubby mitts on market sizing.
Buy market size research
First up, you can purchase or gain access to pre-existing professional research which provides market size calculations. Emarketer and IBISWorld are two of my favourite sources for this sort of information. God, how sad is it that I have favourite market research destinations??
Sometimes you can find excepts available for free on Google. Just stick “niche + market size” , “niche + IBISWorld” or “niche + eMarketer” into Google and see what pops up. Often the excerpts give you the broad numbers – and that’s all you really need at this point!
If you do want to access the full research however the reports are extremely expensive: we’re talking hundreds or thousands per report. If you are simply weighing up different online business opportunities I cannot recommend purchasing a full report.
However, if you are currently enrolled in a university that has a good business school you may have access to this research through your school’s library. If not, some larger libraries (for instance in the UK the British library) also have paid subscriptions for the services which allow you to access the research for free. At the British Library you need to hit up the Business and IP Centre.
If you can find a market size calculation from one of these professional sources I recommend using this as they tend to be highly authoritative and well researched.
How to do market sizing calculations
Far more likely you’re going to have to perform your own market size calculation. I’m going to quickly discuss three different methods.
You can perform a top down market sizing, a bottom up market sizing and competitive comparables.
Ideally you combine all three methods to come up with a more accurate composite estimate.
Top-down market sizing
The basic idea with a top-down market sizing is to start with broad level data and refine it down to your total addressable market.
For example, let’s say that your business sells weight loss plans to women over the age of 40 in the UK.
In this case you would start with broad demographic data and work down. If you were based in a single country like the UK you would first find out how many people in the population are female and aged over 40.
This can be worked out simply using demographic data that is broadly available online via Google.
We would then further narrow down the sub-segment to include only those people who are categorised as obese. That’s 29% of women in the UK apparently. Again, Google will answer these questions for you.
Finally, we take this number and times it by the average value of our customer.
For instance let’s say that we found 5 million obese women over the age of 40 in the UK and we know that our average customer value is £100 per year.
Based on this the market sizing is 5 million x £100 . This gives us a total market sizing calculation of £500 million per year.
How to use top down market sizing
Obviously the accuracy of this method depends entirely on the steps we take and the assumptions that we make at each step.
It’s an extremely broad/method but it should get us at least into the right order of magnitude.
This is enough to compare online business opportunities. As long as you perform the same steps for each of the opportunities you are assessing then you’ll have a decent benchmark for gauging the relative market sizing.
For instance, if you run this exercise and found a different business opportunity only had a total addressable market of £50 million per year then the first market at £500 million is obviously superior.
There is greater room for growth as the market size itself is larger. Again this is ignoring competition and our own ability to address the market!
Your numbers might be wildly inaccurate but at least each of your calculations is equally inaccurate! This is sufficient for the purposes of relative analysis of different opportunities.
Bottom up market sizing
The second approach is the bottom-up market sizing method.
In this method we start with our business and work up.
Let’s use the same basic example as before. We already know that our average customer value is £100 per year.
Based on our research we believe our sales people can bring in 1000 new sales per week. 1000 sales per week is 52,000 sales per year.
52,000 times £100 is £5,200,000
There is obviously a gigantic gap between £500 million and £5,200,000. It’s nearly 100x less.
The total addressable market may sit at £500 million but based on your bottom-up estimates you may only be able to service £5,200,000 worth of this market – or just over 1% of the total.
These market sizes are vastly different. You’ll often find during analysis that this happens!
Using both top down and bottom up market sizing
Ideally we would find it I’ll pop down market sizing and a bottom-up market sizing meet nicely in the middle.
If they do then chances are you’re fudging the numbers! Life is never so neat I’m afraid.
Both top down market sizing and bottom up market sizing are rules of thumb.
Broadly speaking, top down market sizing starts large and uses division to work down towards your market.
On the flipside bottom-up starts from your business fundamentals and uses multiplication to work upwards towards your addressable market.
Both are rough gauges, just starting from different places and working in different directions.
In truth the total size of the market that your online business will be able to service will be somewhere between these two estimates. This is enough to give us a general range for where the market sizing actually sits.
Remember that we are again doing this in order to compare different online business ideas.
If you have one online business idea that has a potential market sizing between £5 million and £500 million and another business opportunity that has a market sizing between £1 million and £5 million then in terms of market sizing there is a clear winner! Go for the £5-£500 million opportunity.
Competitive comparables
A third and supplementary method of determining the market size is to use the size of your competitors as a yardstick. We call these comparables.
Once we have performed top down and bottom up market sizing calculations we can have a look at the size of our competitors, the number of customers they have, as well as estimate their average customer value to work out (roughly) the size of their addressable market.
We use this to confirm all our previous market sizing.
If we find that when we add up all our competitors in the market and their combined size is massively below our market sizing calculation then chances are we have messed up and in reality the market itself is much smaller.
On the flipside, if the competitors in the market have much larger businesses they could be supported within the ranges we just calculated then we have underestimated the size of the market.
Use comparable is as a sense check to make sure your estimates are not totally off the mark.
How do you check the size of your competitors? If they are large enough you can pull their publicly filed tax returns to at least get a gauge of their revenues and assets. Also check out company databases like Hoovers for detailed information if necessary.
What about competition?
Once you have worked out the addressable market sizing of different business opportunities you should have an idea of which you should go for. All else equal go for the larger market!
However, this is just the first step.
You also need to assess what the competition in the market is like as well as realistically determine how successful you and your online business can be within the space.
These assessments are beyond the scope of this particular blog article but are the natural next step.
However, before you can even get to these assessments you must at least have a rough market sizing in place for basic comparison!
You can use top down market sizing calculations, the bottom up method and then sense check using comparables is in order to find out the ranges for your considered business opportunities.
Then you can go to the next stage (competitive analysis) with a realistic sense of what you will actually be competing for!