How to calculate market size and why it is important (2024)

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

There are many misconceptions about 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 significant advantage from day one. It allows you to secure better investments, make clear-headed plans, and avoid getting sucked into a strategy with 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 other concepts.

Market sizerefers to the total number of potential buyers for your product.Alexadefines 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.

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

Gaining investment.

Market size indicates 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.

Budget better.

Use your R&D budget wiselyby better understanding who your customers are, what they want, and how you can deliver it.

How do you actually figure out your market size? There are several ways to go about this:

• 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 many 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.

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 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.

Determining your total market size is only the beginning, and this information alone is only worth a little.

You’ll only be able to reach some potential customers. No business has the marketing tools, scale, and budget to capture the attention of every 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 toTx Zhuoof 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). SOM 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?

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

#1. Top-down.This approach relies on analysts’ predictions, forecasts, and assumptions about your market. It’s often based on conjecture and estimates to some extent. Consider statements like: “The wireless headset market is forecast to reach $2.5 billion by 2023”. It’s suitable 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.

#2. 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 a broad assessment of the whole market, so it’s a more reliable way to work out your SOM.

#3. Value theory.This final strategy is 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 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.