How to calculate market size

Learn how many customers your start up business is likely to reach by calculating market size, and the total addressable market.

Market research is a vital part of any new business process. Just as important as hiring the right staff or finding the best premises, market research allows you to learn more about your potential customers and gives your new business the best chance for success.

Central to any market research you conduct is calculating market size. Learning how to calculate market size is important: too small a market could mean there aren’t enough customers, and your business might not make enough money to be profitable. Calculating market size also helps you think about how much of that market you could capture – called market share – and how much of a market your business needs to prosper.

What is market size?

At the most basic level, market size is simply the number of potential customers that you could sell your product or service to. For example, it could be the number of people who visit a high street who could become customers of a new coffee shop, or it could be the number of dog owners in your local area that could use a dog grooming service.

There are two types of market size to calculate along with your business’ expected share:

  • Total addressable market – this is shorthand for checking if the potential market for your start up is big enough, and is usually the first type of market size to calculate. Shortened to TAM in business circles, it is the number of customers or amount of money you could earn if you were 100% successful and achieved 100% sales to every potential customer.
  • Target or available market – this is the market size that your start up business can realistically reach. It’s a subset of the total addressable market, and is sometimes referred to as the Segmented Addressable Market (SAM).
  • Expected share of market – this is a useful addition to the two market size calculations above. It’s an extra stage that helps you learn what share of the market you want to aim for, and what you expect your business to achieve. This is often referred to as the Expected Share of the Addressable Market (ESAM), or simply market share.

Watch this: Understanding markets can be complex, but in this video from Tutor2u Graham Prior explains the key concepts in calculating and interpreting market size, growth and market share:

What to look out for when calculating market size

Before starting to calculate, it’s worth understanding that calculating market size means being objective about the facts: it is not about interpreting market information to support your business case. If the market size data reveals problems, such as lack of local customers, it’s a red flag that means it may not be profitable to launch your business in that location, for example.

Markets aren’t static – they develop and change – and you’ll need to factor in market trends, such as new technologies or consumer buying habits. Calculating market size relies on assumptions but it will help you think about market trends and their impact on your new business.

Market trend example: The video tape rental business Blockbuster was once ubiquitous on high streets across the UK. Yet it failed to anticipate the technology trend of online movie streaming, which helped launch companies such as Netflix. The result is Blockbuster lost huge market share until it closed, as Netflix increasingly won movie-watching customers.

Make sure to monitor market trends and think about how they could impact your business, even once you’ve migrated from start up to an established business. Taking advantage of new market trends can give your business an edge over competitors.

How to calculate market size

Calculating market size means you should follow the process of calculating the addressable market, then the available or target market, and finally work out how much market share your business will generate. Here’s how to calculate market size for each stage:

1. How to calculate the total addressable market

The total addressable market is simply all the potential customers who could be in the market for the products or services your start up is offering. It’s very broad. For example, if your business specialised in online learning and tutoring for school students, your total addressable market would be all UK students who have access to the internet and have parents or guardians willing to pay for tutoring.

  • Define your customer – set a few characteristics about the customers in your market. In our example, this could be students or parents concerned about exams, willing to pay for tutoring, and have home internet. Use this to define the market.
  • Conduct desk research using the internet – look for available data from sources such as the Office of National Statistics (ONS), government whitepapers, company or industry reports, and online research. The aim is to gather facts about the size of the defined market, such as the number of students in the UK, how many homes with students have internet access, and any information about the percentage of students who have tutors.
  • Carry out some top down analysis – this puts some numbers into your market size calculation. For example, you might discover there are around 650,000 UK students who take GCSEs each year, and 95% have online access with 30% of those paying for tutoring. That would give you a total addressable market of 185,250 GCSE students who could buy an online tutoring service. While sketchy, you could then assume that if your business attracted 5% of students to your online tutoring business, you would have around 9,250 customers each year.

Calculating the total addressable market allows you to see if there are enough customers for your start up to be worthwhile.

Watch this: Get additional help with this video from Entrepreneur, which provides ten useful tips on how to get to know your target market better:

2. How to calculate the segmented addressable market

While calculating the total addressable market size is useful, you really need to zoom in on the number of customers your business can realistically reach. Target customers are the customers who might consider using your business, that your marketing can reach, and that other factors such as competitors can influence.

One way to calculate the segmented addressable market is by using bottom up analysis. This is about counting potential customers you can reach based on speaking to experts in the market, surveying customers, and refining the information you used to calculate the total addressable market. It looks at sales of competing products, how you’ll distribute them, and how many customers you could target. Let’s work through an example.

  1. Let’s assume you want to get a share of all 185,000 GCSE students who get private tutoring in the UK. The question is how to reach them, so let’s start with schools.
  2. You could develop a tutoring sample pack to be sent to schools, but how many will stock it? Carry out some research by surveying, say, 100 schools. If half say they will hand it out to students, then cut that in half again to be safe – meaning around 25% of schools would do as they have said pass out your sample pack.
  3. There are 3,268 secondary schools in the UK, so we can assume that 817 (25%) will pass out your sample pack. Each school has around 60 GCSE students paying for tutoring, so you could reach 49,000 potential student customers.
  4. Survey some potential students who fit your customer profile. How many would be interested in online tutoring? How much would parents be willing to pay? Let’s assume that around 10% would be interested in online tutoring for the right price. That means you have a target market of 4,900 students from this marketing approach.
  5. You might want to consider other marketing channels as well, such as using social media or advertising on websites used by students or parents looking for online tutoring. Estimate how many potential customers would see your online marketing, and use industry standard conversion assumptions to calculate how many will respond.

It’s worth being ruthless when calculating your target market size. Remove all the customers that you will never reach, such as those who are very rich or too poor to have disposable income to spend on your business, or who don’t use the internet if selling online.

Build in sensitivities as well. These are honest reflections on how well your marketing will realistically do, how long it would take you to contact customers, and how quickly new customers will respond to your marketing activity. Use these to refine your market size calculation.

3. How to calculate market share

Unless your start up business is entirely unique, chances are you’ll have competitors who are also chasing the same customers. Taken together, the total number of customers who buy from all competitors in the market is also a useful indicator of the target market size.

Market size example: You discover that there are already 20 online tutoring businesses operating in the UK. By researching them, you estimate that together these have 90,000 students paying for online tutoring each month. You can use this as your target market.

Look at the target market, then estimate a sensible market share. This should include looking at competitors, their offerings and routes to market. You should aim for around 1% to 5% as a realistic goal over the first few years as a start up, unless you’re first to market with a new product or there are few or no existing competitors in your market.

  • Investigate competitors – Find out who is supplying the market and their turnover. Visit Companies House online and look at annual returns, as well as trade press and any press releases about significant customer wins. You can also look at annual reports to estimate numbers of customers and how much spending. From this, build up a picture of the rough market share for each of your competitors.

Market share example: If there are 90,000 students paying for online tutoring between 20 companies, then each company would have around 5% share. Naturally, some companies may have more – say 10,000 students or 9% share of the market. Look at each competitor and decide if your product will be more attractive, and who you want to take market share from.

  • Be realistic – Most start ups won’t get 1% market share in the first year, and perhaps 2% in year two if fortunate. Many companies never achieve more than 10%-20% of target market share.
  • Plan your business – What market share do you need to break even and start making money? Do the maths, working out how much revenue you’ll likely make in each year.

Market share example: In year one of our example, your online tutoring business will aim for around 0.5% of market share, which is around 450 students. If the average monthly fee for online tutoring is £10, then your business would earn £4,500 per month or £54,000 in one year. If you aim to target 2% market share by the third year, your business would be generating £216,000 in revenue.

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