Startup founders need to nail defining, estimating, and analyzing market size as part of their pitch deck – if they want their startup to actually grow and conquer checks from the best investors on the block, that is.
The good news: prestigious venture capital firms have a "large target market" at the top of their list. And since startup founders have discovered that's one of the ways to gain their interest, chats about market sizing have become more and more present and transparent.
Now the bad news: as an angel investor, I’ve learned that startup founders struggle with market sizing. Some calculations are commonly used in the ecosystem, yet often misunderstood.
And what's even worse: the standardization of the so-called "US$1B market opportunity“ has created an anchoring effect. Founders are subjected to the US$1B reference point and tempted to overweight confirming data points and rationalize out potential counterfactuals to somehow reach the stars.
Not on my watch. As a former management consultant, I’ve been involved in projects in 15+ countries around the globe in the last 13 years. Market sizing has been a loyal companion on my journey, debated on boards of companies no matter its size, industry, or maturity. So I’ll share below some actionable insights for founders to nail it.
Let's see why market size matters for startups, what's the definition of market size, how to estimate market size, and finally, what are the most common pitfalls when doing market sizing for startups.
There are two viewpoints to consider when considering market sizing for startups, and they explain why it is so important:
1. As a founder, you want to make sure that the market opportunity is large enough to create a big company to compensate for the hardships you embarked upon. The purpose of market sizing for a tech startup is to understand the potential customer base for the startup's product or service and to determine if the market is large enough to support the startup's growth and revenue goals.
2. If you aim to raise funding from a venture capitalist, you’ll need to be able to convince investors to be entrusted with their LPs' money. VCs need to be convinced that the market opportunity you are going after offers the potential to return their entire fund and that you are the person with the ability to make that happen.
The goal of market sizing is to showcase that you are aiming for a big market opportunity and that you deeply understand it. As a founder, it gives you the perfect opportunity to gain a competitive advantage and sets you apart in the race for funding.
Before you freak out, take a deep breath. A founder’s clarity of thought and perceived determination matter more than the market size numbers in the pitch deck. We all know market sizing isn't an exact science – and smart investors know it too.
So display your thought process behind the assumptions leading to your rough market size estimate as clearly as possible, and earn the chance of showcasing your determination in a subsequent interview with the VC.
Market sizing can also help with other areas inside your pitch deck. A founder with deeper knowledge about the target market can gain additional clarity on areas such as business model, competitor landscape, target customers, go-to-market, and use of proceeds (summary of how a startup is going to spend investors' money).
Market sizing is the process of estimating the potential size of a market that a company can target for its products or services. For a startup, market sizing involves analyzing the market for the startup's specific technology, product, or service.
A few points to remember when talking about market sizing: first, market sizing involves forecasting the future related to a specific product or service, and is therefore subjected to an array of biases – from previous forecasting to the various incentives of the parties involved.
Second, market sizing should be regularly reviewed, as the startup gains more customer insights along its journey to its target market.
A top-down approach starts with the overall size of the market and then estimates the size of the specific market segment that the startup is targeting. The top-down approach for market sizing is generally quicker and less resource-intensive but may be less accurate because it relies on assumptions about the size and growth rate of the market.
A simple example of market sizing with the top-down approach:
You are a founder of a procurement SaaS that targets SMBs in Latin America, with less than 100 full-time employees. You want to estimate its market size.
First, you’ll need to estimate the industry market size. By looking at industry reports for SaaS B2B in LatAm, you learn that it's estimated at US$10B for all SaaS B2B in LatAm.
Since you target SMBs of a specific magnitude, you’ll need to estimate the size of this market segment by reaching assumptions. You also need to take into consideration that you additionally are targeting procurement SaaS, which further reduces the target share.
For simplicity, let us assume that you settle for around 12% of the industry market as a proxy for your market share. This leaves you with a market size that is US$1.2B.
Make sure that the assumptions made are clearly displayed in your deck so the reader can follow your thought process.
Market size = industry market size multiplied by % target share of the market
Industry market size = US$10B for SaaS B2B LatAm
% target share of market = 12% relevant to our startup
Market size = US$10B x 12% = US$1.2B
A bottom-up approach estimates the size of the market segment by analyzing the number of potential customers and the amount of revenue that each customer could generate. The bottom-up approach is generally more accurate but can be more time-consuming and expensive.
A simple example of market sizing with the bottom-up approach:
Again, you are the founder of a procurement SaaS that targets SMBs in LatAM, with less than 100 full-time employees, and want to estimate its market size.
Since you are using bottom-up, the process is different. First, you’ll need to start with the notion of how many SMBs exist in LatAm. You find out that there are around 13M in total. Since you are targeting those with less than 100 full-time employees, the initial number needs to be reduced. You figure out that around 4% have more than 100 FTEs. This leaves you with around 12M.
Next, you need to estimate the average revenue per customer per year. Your customer base includes a large chunk of micro businesses (<10 FTEs), with less purchasing power. Hence, the average will be affected as the SMBs with more than 10 FTEs and higher purchasing power are fewer in numbers. For simplicity, let us assume that in the end, you settle for an average yearly SaaS subscription fee per customer of US$100.
This leaves you with a market size of US$1.2B. Once again, make sure that the assumptions made are clearly displayed in your deck so the reader can follow your thought process.
Market size = Average revenue per customer per year multiplied by # of customers
Average revenue per customer per year = SaaS subscription flat US$100
# of customers = 12M SMBs (<100 FTEs) in LatAm
Market size = US$100 x 12M = US$1.2B
I personally recommend a combination of both approaches. Bottom-up relies on assumptions that are directly linked to other areas of your pitch (e.g. target customer, pricing, go-to-market), which are easier for an investor to examine and validate. Top-down is useful to cross-check the bottom-up estimate.
It’s okay to keep it simple. As time progresses, you’ll have more insights that will feed back into your assumptions.
Most pitch decks include the infamous 3 concentric circles on a pretty slide, often without assumptions or context. I get it. We all are somehow afraid to be wrong, hence we tend to stay more opaque in our statements.
So, what do TAM, SAM, and SOM mean (besides reminding me of my favorite Thai dishes)?
In our example, we stopped at the SAM for simplicity. SOM estimations are often problematic as they tend to be too optimistic. Many post-IPO companies that have been operational for years have achieved less than 1% of their SAM. Let’s assume you will grow into that rockstar that everybody thinks you are and give you a 10% market share. This leaves you with a SOM of US$ 120M.
In case you are targeting a market where there is direct evidence of rapid growth, you should highlight this by adding these assumptions on growth rates and sources.
To recapitulate, here is what the step-by-step process of using the top-down approach to market sizing might look like:
Start by defining the specific market segment the startup is targeting. This could be based on demographics, geography, industry, or other factors, like technological innovations.
Use market research reports, industry publications, or government data to estimate the size of the TAM.
Estimate what percentage of the TAM is realistically serviceable by the startup. Consider factors such as competition, regulatory requirements, and the startup's ability to serve the market.
Estimate what percentage of the SAM the startup can realistically capture. This could be based on the startup's unique value proposition and competitive advantages, or just on market research.
Multiply the SAM by the target market share to estimate the size of the target market for the startup.
In general, there are probably more opinions and differing definitions of both approaches than there are yellow plastic chairs in Brazil. You'll always find a person that does not agree with the methodology used. And that's okay, as long as founders lay out the methodology used in their deck to limit misunderstandings.
For top-down, we started by estimating TAM first and moved to SAM and eventually SOM. Now, we will conceptually go in the other direction. We’ll start with SOM, move up the ladder to SAM, and end with the TAM.
Now, as time goes by, we will gather insights on customer buying behavior and finances with our Procurement SaaS. We envision developing a go-to-market edge that will allow us to expand our product offering, for example, to SMB lending via embedded finance. For simplicity, let us assume that our customer segment remains the same and we estimate our average revenue per customer per year to double from US$100 to US$200. That leads us to a TAM of US$2.4B.
As we moved up the ladder, we added customer segments (from the 20 biggest cities in LatAm to the whole continent) and products (from procurement only to procurement and lending products).
Once again, in case you are targeting a market where there is direct evidence of rapid growth, you should highlight this by adding these assumptions on growth rates and sources.
To recapitulate, here is what the step-by-step process of using the bottom-up approach to market sizing might look like:
Think about their characteristics, what problems you are solving for them, and factors such as geographic scope, industry, demographics, etc.
Think about factors such as your business model, pricing strategy, and expected sales volume.
Think about public data, such as government and industry reports or market research, and primary data, including direct insights from target customers.
Think of it like the base case market size for your initial product and initial target customers. See SAM.
Think of it like the first chunk of your initial target customers you can serve. It should be based on current abilities and resources, specific insights that make some customer segments better suited to begin with, their willingness to pay and differences in need, and the current competition. See SOM.
That's the best-case market size you envision in the long run. How can you translate your gained insights into a go-to-market edge in other product and or customer segments? Think big – but make the reader understand your reasoning. See TAM.
Determining the market size is, without a doubt, a challenging endeavor. You’ll need to make assumptions and face a substantial degree of uncertainty.
Let’s dive into some common pitfalls that you should be aware of as a startup founder doing market sizing:
So, will spending more time and effort on market sizing guarantee that you’ll get funded? No. But it offers an important opportunity to set you apart.
While others might rationalize the lack of a glass ball as an excuse for not putting in that extra work, you will have the chance to impress your investors with your clarity of thought - and turn the odds of receiving an invitation to present to your favor.