Market Size Estimation

In order to prepare a business plan for investors you need to be able to estimate the size of your potential market.

A market size estimation is a useful exercise as it will allow you to determine whether the new business is a feasible proposition, and will provide you with some of the information needed to generate a sales forecast for the financial projection.

For a new start-up business without historical information a market size estimation exercise can be a difficult process with no obvious place to start. The starting point in this situation is usually market size research to try and obtain sales and population data from a number of publicly available sources of information including those listed below.

  • Government census information
  • Trade associations
  • Industry reports
  • Trade shows
  • Suppliers
  • Competitors
  • Demographic reports
  • Business acquisitions and sales
  • Traffic studies

Market Size Estimation Using Local Data

For the first of our market size estimation examples, lets assume that you plan to open a restaurant in your local area. If the local area is of sufficient size (say a major town or city), then the sources of information above may well provide the necessary information to estimate the market size.

Suppose that the published information shows that in the local area sales of 18,000,000 were generated by 125 local restaurants, then a simple calculation gives a market size estimation as follows:

Sales = 18,000,000
Number of restaurants = 125
Sales per restaurant  = 18,000,000/125 = 144,000

The local market size estimation is 18,000,000 with average sales of 144,000 per restaurant.

In the absence of any other information, and providing the business has the facilities and is capable of managing such sales, it is reasonable to assume that a new restaurant might eventually achieve this average sales figure.

It is important at this stage to point out that a bottom up sales forecast should also be carried out to ensure that the restaurant has the capacity to achieve such a sales forecast. Our revenue templates are available to help with the process of performing a bottom up sales forecast.

To be conservative and allow for the fact the business is a start-up and needs time to establish itself, it is best to discount the figure generated by the market size estimation by a percentage as follows:

Average sales per restaurant = 144,000
Discount percentage = 20%
Forecast sales for the start-up business = 144,000 x 80% = 115,200

Market Size Estimation when Local Data is not Available

The local area under consideration might be too small for information to be available. In these circumstances, an alternative approach can be adopted based on information for a larger region (for example information might be available for a state or county but not for individual towns).

Let’s assume that we plan to open a coffee shop business, and the information available is that the entire region has sales of 98,000,000 and the census shows that the population of the region is 1,050,000.

From this information we can calculate the average sales per head of population in the region.

Sales = 98,000,000
Population = 1,050,000
Sales per head of population  = 98,000,000/1,050,000 = 93.33

We now know that on average the spend in coffee shops is 93.33 for each member of the population.

Using this information, and knowing the local population in the area being considered is say 40,000, we can estimate the size of the local market.

Population = 40,000
Sales per head of population = 93.33
Sales in the local market = 40,000 x 93.33 = 3,733,333

The local market size estimation is 3,733,333 with average sales of 93.33 per head of population.

By using this figure and a target percentage the business aims to achieve, a sales forecast for the business can be obtained.

Sales in the local market = 3,733,333
Target percentage = 5%
Sales forecast = 3,733,333 x 5% = 186,667

The point of this method of estimating market size is that although local sales information might not be available, it is possible using national information to obtain an estimate of the average spend per head of population (93.33), and then using the local area population (however small) an estimate of the local market size can be obtained.

Calculating Market Size for a Business to Business Operation

For businesses which trade with other businesses where the population is not directly a relevant factor, a variation on the above method can be used to provide a market size estimation when local sales information is not available.

Lets assume that we plan to open a business operating in the business to business sector, the information available from market size by industry reports is that the entire sector has sales of 7,546,000,000 and that there are 350,000 businesses operating in this sector.

From this information we can calculate the average sales per business as follows.

Sales = 7,546,000,000
Businesses = 35,000
Sales per business  = 7,546,000,000/35,000 = 215,600

We now know that on average the sales for each business in the sector is 215,600.

Using this information and knowing how many businesses there are in the local area being considered (say 60), we can estimate the size of the local market.

Businesses = 60
Sales per business = 215,600
Sales in the local market = 60 x 215,600 = 12,936,000

The local market size estimation is 12,936,000 with average sales of 215,600 per business.

Again, by using this figure discounted by a percentage to allow for the fact that this is a start up business, an estimate of the initial sales forecast can be obtained

Average sales per business = 215,600
Discount percentage = 15%
Forecast sales for the start-up business = 215,600 x 85% = 183,260

Market Saturation Point

Starting a business on the assumption that the market place will get bigger to accommodate you is a dangerous game. More often than not, the market will stay the same and the business you get will be at the expense of competitors.

Having carried out your market size estimation, it is important to check that the local market is big enough for additional businesses to enter.

In our coffee shop business example above, suppose that there were 500 coffee shops in the region with the population as before of 1,050,000. The average population per coffee shop can be calculated as follows:

Population = 1,050,000
Number of coffee shops = 500
Average population per coffee shop = 1,050,000/500 = 2,100

We know from above that the local population is 40,000, so we can estimate based on the regional information that the number of coffee shops which can be supported by the local community is:

Local population = 40,000
Average population per coffee shop = 2,100
Number of coffee shops the local area can support = 40,000/2,100 = 19

By checking the number of coffee shops actually operating in the area to see whether it is anywhere near 19, it is now possible to see whether the market is saturated or whether there is room for another business.

For example, if there were already 15 coffee shops operating in the area, we could say there is room for another 4 to open, and that the local market is under-utilized by 4/19 x 100% = 21% of the businesses it can support.

Market Size Estimation and Break Even

An alternative method of deciding whether the market is suitable for a new business, is to calculate the break even sales of your business and see what percentage of the total population you would need to capture in order to break even.

Again using the coffee shop business as an example, suppose the fixed operating costs of the business were 95,000 and the gross margin percentage is 60%, then the break even sales are calculated as follows:

Operating costs = 95,000
Gross margin percentage = 60%
Break even sales = Operating expenses / Gross margin %
Break even sales = 95,000/60% = 158,333

But we already know from regional information that the average spend per head of population is 93.33, so the break even population is given by:

Break even sales = 158,333
Average sales per head of population = 98.33
Break even population = 158,333/98.33 = 1,696

We now know that the coffee shop needs a population of 1,696 or 4.2% (1,696/40,000 ) of the local population to break even. In addition, on the basis that we know from above that the average population per business is 2,100, this new business would need to achieve 81% (1,696/2,100) of the industry average just to break even.

However, we also know from our market saturation calculation, that the market is underutilized by 21%. The decision now based on this information, is whether or not you believe this is achievable.

Our market size calculator is available as a free Excel download to help carry out the market size estimation calculations.

Last modified February 19th, 2019 by Michael Brown

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.

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