The importance of market size and how to calculating market size

Market size is a metric that gets discussed a lot in the world of business, but what is market size and what does it actually mean?

There are a lot of misconceptions and a lot of confusion around the real meaning of the term, which can result in people making the wrong decisions or failing to make the most of their strategy.

If you can accurately determine your market size, this gives you a big advantage from day one. It allows you to secure better investment, make more clear-headed plans, and avoid getting sucked into a strategy that simply has no future.

In this article, we’ll break down the basics of market size, and show you how to determine yours and differentiate it from some other concepts.

What is market size?

Essentially, market size refers to the total number of potential buyers for your product. The most common misunderstanding marketers and researchers have about market size is confusing it with the total population of a region or country. Choosing a market based on high population density can be misleading, and does not guarantee the success of your product’s launch. Just because a market has a lot of people residing in it does not necessarily mean that sales will be more than a smaller market with more matches to your target audience.

Alexa defines market size as “the number of individuals in a certain market segment who are potential buyers.”

More technically, it’s the total number of potential customers or sales in a given period (usually a year), or the total potential revenues you can reach in that time.

Why is market size important?

Understanding the size of an existing or potential new market is important for many reasons.

If sales growth is languishing or seems to have reached its peak, one explanation might be the size or potential of the market. The is no reason to keep investing in an existing market if your target audience in that market is not growing or declining.

If you are looking at entering a new market, whether that is locally or internationally, understanding the size of that market, in terms of how many potential buyers there are is an important consideration. Entering a market with a small pool of targets or personas could mean that your product or sales launch falls below expectations, or worse still fails to launch wasting both time and money.

Understanding market size is also important when determining a market’s potential. You may have the opportunity to launch your product in multiple markets. Strategically it makes the most sense to choose a market rich in potential customers. Understanding the potential of a new market also helps formulate pricing strategies, distribution channels and marketing strategies and campaigns.

When you understand the size of a potential market, launching your product or service becomes less of a risk and more of a calculated and strategic investment. If you do not know the size of a market with a high degree of certainty, you should not gamble launching in that market.

There are many reasons why you should be interested in your market size and how to accurately determine it. Here are some of the main reasons:

Gaining investment. Market size is an indicator of the potential for any new business, product or service. If you can show that you have a good chance of making money — and how much — it’ll be much easier to secure investment.
Develop a solid marketing and business strategy. Knowing who your market is, how big they are, and how much money they represent gives you a strong foundation for building a strategy and setting clear future goals.
Determine budget and hiring plans. Knowing your potential trajectory for growth helps you budget more accurately and hire the right team for the task ahead.
Use your Research and Development (R&D) budget wisely by better understanding who your customers are, what they want, and how you can deliver it.

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How to determine market size

So how do you actually figure out your market size? There are a number of ways to go about this:

Clearly identify the target market for your product or service
Carry out market research to assess the level of interest in what you’re offering — will people buy it?
Gather data on the number of potential customers and transactions per year. There are a number of secondary resources you can consult to help you do this.
Assess the total revenue generated in that segment of the economy in a given year

Is your market size too small?

So — you’ve calculated your market size, but what does that number mean? How do you know if your business is worth pursuing?

The answer depends very much on the market and the size of your business, but there are some good general guidelines. Usually, $100 million is on the lower end, and if your market size is smaller than this it may prove difficult to convince stakeholders or investors to get on board.

What is the serviceable obtainable market?

Determining your total market size is only the beginning, and this information alone isn’t worth much.

This is because you’ll never be able to reach literally every potential customer. There’s just no way. No business has the marketing tools, scale, and budget to reach every single person in their market.

And that’s without even mentioning competitors. You’ll never corner an entire market, and the most you can hope for is usually a small slice. According to Tx Zhuo of Karlin Ventures “If it’s 1 to 5 percent of the pie, you have a realistic plan.”

This is where we can turn to a useful metric called serviceable obtainable market (SOM). This refers to the potential customers (and potential revenue) you can realistically hope to reach with your marketing tools and budget.

So how can you calculate your SOM?

How to calculate the serviceable obtainable market

There are a number of ways to calculate your SOM. According to Jared Sleeper, an investor in early-stage companies, there are three main approaches you can take.

Top-down. This approach relies on the predictions, forecasts, and assumptions about your market from analysts like Gartner. It’s often based on conjecture and estimates to some extent. Think of statements like: “The wireless headset market is forecast to reach $2.5 billion by 2023”. It’s good for a general overview of the situation, but it’s a little vague and can be challenging to understand what proportion of the market you can realistically corner.

Bottom-up. This involves starting with your price and how many units you can realistically expect to sell. How many customers can you reach + how much is each sale = your SOM. It’s more tailored to your specific situation instead of just a broad assessment of the market as a whole, so in this sense, it’s a more reliable way to work out your SOM.

Value theory. This final strategy is a little less precise, but it still has some usefulness. It involves considering the value your product or service adds compared to alternatives and estimating how much customers would be prepared to pay for that extra value.

Sleeper recommends options 2 and 3 since they actually consider the specifics of your business and how you would interact with the market, as opposed to a general prediction. It may make sense to use a blend of all three approaches to gain the fullest picture of your SOM and provide as much insight as possible to your stakeholders or investors.

Calculating market size is an important step on the road to building a successful business or launching a new product or service. However, it’s only one step. The metric on its own isn’t worth a whole lot unless you can also show how much of that market you can reach and compete for.

Market research is a crucial part of determining your market size, SOM, and laying the foundations for a successful business. To find out how Kadence can help you with this, take a look at our market sizing services or get in touch with us today.