What is Market Sizing?
Market Sizing is a top-down forecasting method for estimating a product’s total addressable market (TAM) and revenue opportunity.
The process of estimating the market size requires informed assumptions leveraging internal company data, industry reports, and customer analysis among various data sets to quantify the revenue opportunity that pertains to a particular market (or sub-market).
How to Perform Market Sizing
The total addressable market (TAM) represents the entire revenue opportunity present within a particular market, which is a function of customer demand and the pricing of a given product or service.
Upon establishing the revenue opportunity from selling a specific product or service, the company can then decide whether to enter a particular market.
In the absence of sufficient customer demand and revenue potential, most companies would be deterred from entering a given market.
While all market sizing exercises are “ballpark” estimate figures, the process of taking a high-level view of the market landscape and segmenting customers into unique profiles can still be very insightful.
Note that the size of a market can be estimated via the bottom-up approach as well. However, the top-down approach tends to be more common because of the ease of arriving at an approximate market size.
In particular, the top-down build is most applicable for early-stage to growth-stage companies, where the unit economics (or operating drivers) are not yet reliable enough for a bottom-up build to be applied.
The quality of a bottom-up build to size a market is contingent on the underlying assumptions that drive the pro forma forecast (i.e. “garbage in, garbage out”).
Therefore, the bottom-up method of market sizing is more appropriate for established, mature companies, whereas the top-down method can be used for companies across the entire lifecycle — from early-stage startups to late-stage, mature companies.
TAM vs. SAM vs. SOM: What is the Difference?
The total addressable market (TAM) can be further broken down into 1) the serviceable addressable market (SAM) and 2) the serviceable obtainable market (SOM).
- Total Addressable Market (TAM) ➝ The TAM is an all-inclusive, “birds-eye” view of the entire market (and representative of the total revenue potential).
- Serviceable Available Market (SAM) ➝ The SAM refers to the proportion of customers counted in a company’s TAM that actually need its products or services.
- Serviceable Obtainable Market (SOM) ➝ The SOM is the company’s current market share that accounts for the proportion of its SAM that can realistically be captured across the forecast period alongside the growth of the overall market. The implicit assumption here is that the company can retain its current market share percentage in the foreseeable future.
Therefore, the sequence of steps illustrates how we’ll start with the broadest potential revenue value (TAM) and subsequently reduce the potential revenue figure based on the company and customer profile before applying more granular market assumptions to arrive at the SOM.
Based on the market size data points, we can estimate the number of potential customers that could be acquired. Furthermore, the market value of a company is, in part, a function of the total number of existing and potential customers.
Why? The market value per share—or stock price of a company—is a forward-looking measure, so companies with more upside potential tend to fetch higher valuations in the public equities market (and the same applies to the private market).
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In order to calculate the total addressable market (TAM), the total number of potential customers is multiplied by a pricing metric.
For instance, the pricing metric could be the average order value (AOV), annual contract value (ACV), average selling price (ASP), or other similar metrics.
Further, the pricing terms are typically tier-based, so it is recommended to segment the customers by type, e.g. small and mid-sized enterprises (SMEs) vs. large enterprises.
In the SaaS industry, one formula for calculating market size is to multiply the total number of customers by the average contract value (ACV).
Where:
- Total Number of Customers ➝ Estimated Number of Customers (Potential + Existing Customers)
- Annual Contract Value (ACV) ➝ Normalized Total Contract Value (TCV) ÷ Contract Term (Length)
Market Sizing Calculator
We’ll now move to a modeling exercise, which you can access by filling out the form below.
1. SaaS Market Sizing Calculation Example
Suppose a B2B SaaS company is performing a market sizing analysis to determine its revenue potential in the near future.
Currently, the company serves two types of customers, which are segmented by size.
Total Addressable Customers
- Small and Mid-Sized Enterprise (SME) = 2,500 Customers
- Large Enterprise = 200 Customers
For the next five years, we’ll assume that the growth rate for SME customers will be 5% and the growth rate for large enterprises will be 2%.
From 2021 to 2026, the total number of addressable customers has increased from 2,700 to 3,412.
Regarding the pricing, the annual contract value (ACV) of SMEs is $50k, whereas the ACV of large enterprises is $400k per year.
- Small and Mid-Sized Enterprise (SME) = $50,000
- Large Enterprise (SME) = $400,000
2. Top-Down Market Sizing Build
In the next part of our TAM sizing training exercise, we can now calculate the TAM, SAM, and SOM, i.e. a “top-down” revenue build.
For the total TAM market sizing, we’ll multiply the total number of SMEs by the ACV and then repeat the process for large enterprises.
- SME, Total Addressable Market (TAM) = Number of SME × SME Average Contract Value (ACV)
- Large Enterprise, Total Addressable Market (TAM) = Number of Large Enterprise × Large Enterprise Average Contract Value (ACV)
From the TAM, we’ll work our way down to the SAM by making assumptions about what percentage of the TAM is serviceable.
- % Serviceable SME = 50%
- % Serviceable Large Enterprise = 25%
- SME Serviceable Attainable Market (SAM) = SME TAM × 50%
- Large Enterprise Serviceable Attainable Market (SAM) = Large Enterprise TAM × 25%
Using those assumptions, we’ll multiply those percentages by the TAM for the entire forecast.
3. TAM Market Sizing Analysis
In our final step, we’ll calculate our SOM by making assumptions about what percentage of the SAM is obtainable.
- % Obtainable SME = 20%
- % Obtainable Large Enterprise = 10%
Given those two assumptions, we’ll input them into our SOM formula.
- SME, Serviceable Obtainable Market (SOM) = SME SAM × 20%
- Large Enterprise, Serviceable Obtainable Market (SOM) = Large Enterprise SAM × 10%
In closing, we can observe how, from our initial period to the end of the five-year forecast, the total serviceable obtainable market (SOM) has expanded from $14.5 million to $20.9 million.
