All successful startups have something in common — their product or service solves a problem or fills a business or retail consumer need. Thus an important part of identifying your startup’s space in the economy is understanding the market that you are targeting.
This article is the first in a series examining how you can build a deeper understanding of your target market. From there, we’ll look at developing go-to-market strategies that will result in customer traction and ultimately drive the success of your startup.
Defining a Market
A market definition is a set of characteristics that identify the group of businesses or consumers who would use your product or service, and could reasonably be expected to purchase the product or service within a given timeframe.
The diagram below shows how your market definition is constructed of both internal and external factors. Broadly, internal factors relate to your startup’s ability to bring its product or service to bear on an opportunity, while external factors are those that impact whether or not your target market adopts your product or service.
Thinking About Market Size
Before we reach the point of building a model that calculates your potential market, it is important to understand how to approach sizing your market. Similar to the Russian Matryoshka dolls, any market can essentially be understood as a series of smaller nested sub-groups.
While you may think your product or service may be relevant to nearly everyone on earth, in truth there will be a series of limitations on the size of the market you can actually capture.
For example, while a new brand of sports/exercise compression gear could be targeted at the human population generally (on the basis that everyone can/should exercise!), you’ll likely need to adjust to take into account factors like:
- whether particular customer segments display more or less interest in sporting gear;
- purchasing habits of those same customers (e.g. time to purchase, replacement timing); and
- your ability to actually manufacture, produce and otherwise address the market demand for your product.
Estimating Market Size
There are two approaches that are typically taken to estimating market size: the ‘top down’ and ‘bottom up’ methods.
As the names suggest, these methods look at market size from opposite sides of the question. The top down approach is characterised by its simplicity, it essentially involves calculating the total market, then estimating your potential share of that market.
On the other hand, the bottom up approach involves estimating the potential sales you could make in a market in order to determine a total sales figure. As you may guess from the comments above in relation to thinking about market size, the bottom up estimating approach is generally preferred.
The preference for the bottom up approach is largely due to the series of hard questions that the method forces you to ask about your product and service, and potential customer.
Rather than the simple back of the envelop calculations under the top down method (“Well, the total market is USD 100 million, and we think we can capture 10%, so our sales will be USD 10 million.”), the bottom up method requires you to think deeply about:
- your product or service’s position in the market (“Is our product superior / more desirable / cheaper than competitors?”);
- your go-to-market approach and market addressability (“How will we sell our product?”); and
- market demand and growth (“While the overall market is growing at 5% per year, do we think we can capture market share from competitors and grow at 10%?”).
Of course, it is important to remember that any market model is ultimately based on the assumptions and inputs you feed in — as the saying goes “garbage in, garbage out”.
You may think that your product is world-beating and destined to sit on the counter of every home in the world, but it can be important to take a step back and consider the challenges (and opportunities!) that you will face before then when estimating the potential market for your product or service.
In the next article in our series, we’ll look at some more of the specifics that go into building a market model, including how to make reasonable assumptions and sourcing data for your models.
Lupercal Advisory is a consulting firm that specialises in advising startup and early stage companies on strategy, operations & finance, and data. Please contact us at enquiries@lupercalcapital.com if you would like to discuss your startup. Please also visit us at lupercaladvisory.com.