How does a company create a vision that is inspiring yet realistic? A good place to start begins with measuring the market opportunity.
Too often companies wait until the IPO process to measure their market opportunity thinking the TAM (Total Addressable Market) is a metric only interesting to investors. Until that time sales strategy, knowing their customers, and measuring sales activity were synonymous with measuring the market opportunity. Yet, broader market dynamics that shape the size of the market impact customers and ultimately drive sales. The market opportunity encompasses all of the underlying market forces impacting a business, its customers and their shared market dynamics.
In addition to revealing the overall size of the market opportunity, the exercise exposes which segments are growing fastest, slowing in growth or stagnating. Understanding the dynamics impacting each segment helps management teams prioritize product development, allocate resources and refine their strategies for long-term success. Both investors as well as management teams benefit from sizing the TAM to identify growth opportunities or gating factors.
The most common approaches to sizing a market are top-down, bottom-up and value theory.
- The top-down approach is based on industry research and reports. For example, “IDC estimates there were 21.03 million software developers in the world at the outset of 2017.” The top-down approach is most often used when speaking to potential investors, as it generally presents a larger market opportunity in support of a premium valuation. Approaching market size from the top-down relies on industry analysts observing the industry from the outside. Those analysts may obtain information from companies that self-report their share of market, pricing or other metrics that could be inflated or unreliable, particularly from privately-held companies. Sizing markets that have mixed pricing models are also difficult to accurately capture via the top-down approach.
- The bottom-up approach is based on unit price and volume of units purchased by segments of buyers. For example, “According to IDC’s Gaming Tracker, worldwide server shipments increased 10.8% year over year to 2.84 million units in 4Q17.” The bottom-up approach generally imagines a growing customer base whose adoption rates can be difficult to estimate, but unlike the top-down approach it includes tangible, relatable data on current pricing and product use. Market sizing using the bottom-up approach is more likely to be conservative given today’s pricing and volume levels but is often preferred by companies to determine realistic approach to developing their vision.
- The least common approach to sizing the market opportunity is value theory. Value theory is based on the increased amount of value a business is able to add to an existing market. For example, “Goldman Sachs estimates that the ride-hailing industry will be 4X the size of the taxi market and reach $485B by 2030.” Value theory is more theoretical and scientific than other approaches, as it reflects in-depth market knowledge of buyers and sellers and requires solid market, industry, pricing and population data that can be difficult to find, particularly in international markets.
Once the market opportunity is understood, management teams can create a vision that not only inspires support from investors but creates a basis for building a solid strategy. The TAM should become part of a corporate narrative that outlines a strong position in a developing marketplace that makes sense to prospective clients, partners and employees. Everyone wants to be part of a company that understands the market, has a clear vision for its future and the opportunity to be part of something bigger.
Hayflower has been actively involved in helping companies size their market opportunities in digital media, software and emerging technology. For more information, contact us at email@example.com.