… the market looks like this …
What is Market Size?
In this series we have covered the solution your business plan puts forward to solve the customers problem. This idea must now be tested to see whether there are any customers for it and to see how large the available market might be.
To the investor, the solution in itself has no value unless it can be realized in the market place. Ultimately, it will be the industry market size that decides the value of your business to an investor and, as a rule of thumb, the bigger the available market, the better.
How to Calculate Market Sizes
Before calculating market size we need to look at a couple of definitions. For a business plan, the available market is defined by two terms, total available market (TAM) and served available market (SAM).
TAM (Total Available Market) is the total market size (people, revenues, units etc.) who have the problem you are seeking to solve today.
SAM (Served Available Market) is the part of the TAM who are able to use your solution to the problem. This is your target market.
Available Market Size Estimation
As an example of how to determine market size (using made up data), suppose you are in the lawn care business. You have just started and have one operation but have plans to expand throughout the region into a chain of lawn care centers.
The total available market or TAM is based on the number of properties in the region which use lawn care treatments. Using a top down approach, Government statistics might show that there are six million properties with gardens and industry analysis reveals that 3% of properties use lawn care treatments, and spend an average of 150 per year. The TAM is calculated as follows:
TAM = 6 million x 3% X 150 = 27 million per year
This means that if your business operated throughout the entire region with no competition its revenues would be 27 million per year. TAM defines the maximum size for the market the business operates in.
However, at the moment not all of the TAM are able to use your lawn care service as you only have one lawn care outlet in one town in the region. The market which is able to use your solution is limited to the town, so the serviceable available market or SAM is based on the number of properties with gardens within the town. Again, Government statistics might show that there are one million properties with gardens in the region, so the SAM is given as follows:
SAM = 1 million x 3% x 150 = 4.5 million (16.7% of TAM)
If there was no competition within the town and you had the resources to provide the service, then the revenue from the business would be 4.5 million per year. The SAM represents 16.7% of the TAM.
Market Size and Growth
The investor will also want to know whether this is a growing or declining market. The market size section of the business plan should also give an indication of the potential for growth over the next five years. We might be able to find additional market size data which shows that the number of properties with gardens will grow to 20.5 million, and the number using lawn care treatments is expected to increase to 4%, with an average spend of 165. the TAM is calculated as follows:
TAM = 6.5 million x 4% x 165 = 42.9 million per year in five years time
Like wise for the town the number of properties with gardens might be expected to increase to 1.15 million, and the SAM is given as follows:
SAM = 1.15 million x 4% x 165 = 7.59 million (17.7% of TAM)
Market Size Presentation in the Business Plan
The business plan market size section can be presented in a number of formats, but a simple column format setting out the TAM and SAM now and in five years time, will allow the investor to quickly ascertain how big the market for the product could be and it prospects for growth over the duration of the business plan.
Market sizing is an important part of the business plan process. But this is planning not accounting. The market size section is an educated guess at how big the available market for the product is and aims to show that a successful launch and continued growth for the product is possible. It is based on available statistics and trade association data.
A few key points should be remembered when trying to determine market size
- Start from verifiable and accurate base data. In the above example, the starting point was a government statistic based on the number of properties with gardens.
- Double check any information with an alternative source if possible.
- Check the results make sense.
- Check the results using a bottom up calculation. For example, if you know a lawn care business in the region has revenue of 500,000 and estimated 2% of the market, then the TAM should be in the order of 500,000 / 2% = 25 million compared to the 27 million calculated above.
- Keep the industry definition narrow, in this case lawn care treatments.
- Be specific, don’t try and say for example, there are millions of properties in the world with gardens and if we can take a very small percentage of that our plan will work.
- The analysis will differ depending on whether you are dealing with an existing market or a completely new market. For an existing product there will be market and industry data available, for a new product you may need to carry out market size research with potential customers and work upwards from there.
This is part of the financial projections and Contents of a Business Plan Guide, a series of posts on what each section of a simple business plan should include. The next post in this series is about the analysis of the target market for the business plan product.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.