Market size is a technical term, but you don’t need a degree in business to calculate it. Any entrepreneur can estimate their business’s market size, and use that data to make more informed marketing, pricing, sales and growth decisions. Knowing how many potential customers you have access to is helpful in many ways.
Whether you’re a first-time business owner or have been in business for years, this is something you should know, and use. Here’s how to calculate market size for your business with simple step-by-step methods. Use the size of the market in your business plan, informally when brainstorming, or anytime you’re thinking about potential opportunities.
What is market size?
Market size is an estimate of your business’s potential customers, and how much revenue might be generated from those customers. The goal isn’t calculating to the last person. It’s simply to arrive at a grounded and useful estimate.
Your estimate will be dependent upon the scope of your market size analysis. You might define the potential market size by geographic boundary, customer segment, time frame or category. It’s highly possible that you could arrive at a few different useful estimates by changing the scope.
For example, consider a local sheepskin retailer who sells high-end slippers in a shop. The owner should know the shop’s market size, which would be restricted by geographic boundary. Evaluating online retail opportunities would require a different market size analysis. Perhaps there would even be different analyses for different e-commerce platforms (i.e. digital boundaries).
Depending on your scope and purpose, size of market can be expressed as:
- Number of potential buyers
- Buyers’ total annual spend
- Resulting annual revenue potential
Market size definition
You can define market size without any technical jargon. Two simple questions capture the customer and revenue aspects:
- “How big is the group of people who might realistically buy this?”
- “How much money do they realistically spend on this type of solution?”
“Realistically” is the key word here. Market size isn’t about everyone who could theoretically use your product/service. It’s the people who actually may want to purchase.
Common misconceptions about market size
It’s also important to understand what market size is not. There are a few common misconceptions to avoid:
- “Everyone is my customer.” This is the most common pitfall. Even if you sell water, your market isn’t 8 billion people. Your market is the people you can actually reach. The question isn’t “how many people could benefit from my product?” but rather “how many people might buy?”
- Market size ≠ how much you personally want to earn. Market size calculations must be based on real-world data, not your goals or targets. Your potential revenue should be calculated based on size of market, not the other way around.
- Market size ≠ guaranteed demand for your business. A big market doesn’t automatically mean customers will pick you. You can have a massive market size, yet still not sell much if your marketing, pricing or other efforts are misguided.
Why accurate market sizing drives better business decisions
Understanding your business’s size of market is essential for making accurately informed decisions.
In fact, 42% of startups fail because they misread market demand, creating products nobody wants or needs, highlighting that a credible market size estimate isn’t just a planning nicety, it can mean the difference between success and failure.
This is one of the first things to calculate soon after you have an idea. Knowing the number of potential customers is necessary when validating a business idea. It’s also necessary when you’re setting revenue expectations, deciding how to price and position products (e.g. premium vs budget), or assessing a growth opportunity (e.g. new location or target segment).
Ultimately, accurate market size analysis helps you determine where time, funds and effort are best spent to grow your business.
(Note: Remember that accurate market size analysis doesn’t guarantee success. It grounds and guides your decisions, but virtually nothing can absolutely guarantee success in business.)
How to calculate market size
Market sizing is an estimate built on assumptions. As long as those are informed, reasonable and transparent, you should have a good basis for your analysis. Transparent is particularly important, as it shows where calculations came from and lets you adjust assumptions later if needed.
The goal of market size isn’t some perfectly accurate calculation for the ivory tower. It’s to arrive at a reasonable estimate that’s useful on Main Street, or wherever your business is located.
Step 1: Define what “your market” actually includes
Remember that your market isn’t everyone? The first step is to define who actually might be a customer/client. This is the “scope” of your market, and it’s determined by several boundaries:
- Category: Where your product fits among other options
- Customer Type: B2C (individual customers) or B2B (other businesses)
- Customer Segment: Demographic, industry, etc.
- Geography: City, county, state, region, online only, etc.
- Time Period: Monthly, annual, seasonal, etc.
You could have multiple scopes if conducting several market analysis for different purposes.
Quick check: are you sizing the market or your target customer segment?
While a whole market can be broad, your business’s potential market will be narrower. Everyone drinks water, but you aren’t going to sell every person a bottle of water.
Make sure you’re calculating the market size of your actual customer segment. This is what’s realistic for your business, and what’ll be most useful when making projections and decisions.
If you’re in doubt, start off with a narrower and more conservative scope. You can always expand it in the future.
Step 2: Choose the right approach for your business
You have two options when determining how to calculate market size for your business.
You can use a top-down approach that starts with existing market data, or you can use a bottom-up approach that starts with customer counts and pricing information. Both are valid regardless. Which works best for your business mostly depends on what information is available.
Rule of thumb
Local businesses often benefit most from a bottom-up sizing. The approach better captures their capacity to reach customers, and businesses already in operation have access to granular data.
New ideas can require a top-down approach if there aren’t already existing customers. Any top-down approach should be checked with firsthand market research.
Step 3: Gather your inputs (keep them simple)
The inputs, or assumptions, you use should be clear and simple. You don’t need to do multivariable calculus worthy of a doctoral degree. You need a clear estimate that’s useful tomorrow or next month when making decisions. Clear and simple are most useful.
Some good inputs for small businesses to use can include:
- Number of nearby businesses (for B2B)
- Area population (for B2C)
- Further customer segmentation
- Percent who’ll want the product/service
- Typical purchase frequency
- Average purchase price
- Average customer spend
You should be able to find fairly accurate population, business and segmentation data. The latter inputs are more based on your own assumptions.
Use ranges, not single-point guesses
When determining inputs, use ranges rather than single-point guesses. A threefold analysis that includes conservative, expected and best-case inputs is fairly standard and helpful.
Using ranges better prepares you for different scenarios that could unfold. It also lessens the risk of making a wrong assumption that throws the entire analysis off.
Step 4: Calculate market size (with a simple formula)
The formulas to actually calculate market size for your business can be incredibly simple. Here are some simple formulas for both volume- and revenue-based market size calculations.
Customer-count method
Annual purchases = potential customers x purchase frequency
Annual purchases = (broad customer base x percent who will purchase) x purchase frequency
This approach could use conservative, expected and best-case assumptions for both potential customers and purchase frequency.
Revenue method
Annual market revenue = potential customers x average annual spend
Annual purchases = (broad customer base x percent who will purchase) x average annual spend
Annual spend could be substituted with monthly, quarterly or seasonal spend for different time periods.
Simple example (service business)
For a real simple example, consider helping a kid with their lemonade stand. There are 50 houses on the block, with an average of 3 people per household. It’s a hot day, so maybe 20% of people will get a lemonade. Here are the calculations for the day:
- Customer-Count Method: 30 purchases
- (150 customer base x 20% purchase) x 1 purchase = 30 purchases
- Revenue Method: $30
- (150 customer base x 20% purchase) x $1 spent = $30 revenue
Notice how these assumptions were kept simple. We didn’t worry about the exact number of people per household, nor that there were two families on vacation. We also assumed customers would buy once at a price of $1. Figures are for the day rather than the year.
Step 5: Reality-check your result
After completing calculations, it’s good to ask “Does this make sense?” Ask yourself and a couple of other people. Their answer should be “yes,” or at least “it can,” without you having to convince them of each assumption.
Further check your analysis by double-checking individual assumptions, and your business’s constraints. You can finally compare figures against what you know about competitors.
Red flags your market size estimate is unrealistic
- Overly broad market definition
- Overly optimistic conversion assumptions
- Overly high pricing assumptions
If your reality checks show that any assumptions are too high, adjust them accordingly and recalculate.
Step 6: Turn market size into a usable plan
You’re now ready to turn that analysis into a usable plan. The final step of market size analysis is to determine the next step that you should do. You might decide to:
- Prioritize which customer segment(s) to focus on
- Set attainable goals for leads, customers or revenue
- Calculate informed revenue projections
- Note which assumptions still need future confirmation
The next step could also be to write this part of a business plan, discuss an opportunity with your partner, invest resources toward a specific opportunity, or any number of other actions.
Market sizing methods
Market sizing can be calculated via a number of different methods, and using a combination is often helpful. Most small businesses primarily rely on a top-down and/or bottom-up method. Other methods are useful in certain situations.
Top-down market sizing
Top-down market sizing uses published industry, nonprofit and government reports to understand the overall market. Assumptions then narrow down the market scope and datapoints.
A top-down approach is helpful for understanding context, but it doesn’t afford the level of precision that small businesses need. Think of this as the “bird’s eye view.” The only problem is that most business owners aren’t eagle-eyed to see local specifics.
Bottom-up market sizing
Bottom-up market sizing starts with your business, focusing specifically on who your business can reach. It draws upon realistic customer counts and more granular pricing data. Assumptions can then be made about your business’s total addressable market and potential revenue.
The challenge with bottom-up sizing is making accurate assumptions. Use existing data if you have any, such as existing customer counts and current prices. Continually review and revise these assumptions as you gain more information, though.
In many cases, bottom-up market sizing yields better insights for small businesses. Understanding the overall market is also important, though.
TAM, SAM, SOM
These other methods aren’t commonly used by small businesses. You may hear them referenced, though, and they can have a role in some situations.
- TAM (Total Addressable Market): Everyone who buys your product or service.
- SAM (Serviceable Addressable Market): The portion of TAM that you can actually reach.
- SOM (Serviceable Obtainable Market): The portion of SAM you can realistically capture in the next 1-3 years.
These become more useful as you work down the list. Progressing from TAM -> SAM -> SOM frequently requires making assumptions without much information, though. That’s why you’re likely better off with a bottom-up or top-down approach.
Market size analysis
Market size analysis isn’t just about calculating market size, but also analyzing to make decisions. This is where your acumen as a business owner truly comes into play.
Most importantly, don’t be overly enthralled by large markets or outright reject small markets. Small markets can actually be the perfect opportunities for small businesses.
Small markets often have less competition, so it’s easier to get established in them. You also might find that the market size is sufficient for your business goals, especially when margins are strong.
Large markets can be good, but they can be difficult to succeed in. You could very well struggle to gain a foothold, and margins may be much smaller. Be sure you have the capacity and acquisition channels necessary if you’re endeavoring to compete here.
In short, there’s nothing wrong with being a big fish in a little pond. Even small fish can do well in little ponds. Surviving in the ocean is a lot harder.
Market size in a business plan
Market size is a standard part of a business plan. It’s found within the Market Analysis or Opportunity section, and used to justify your business idea (and plan). You may use good market size analysis to justify your:
- Chosen customer focus
- Demand assumptions
- Pricing logic
- Growth expectations
Again, don’t use it to be overly optimistic. Inflating numbers based on abstract, unfounded or simply hopeful assumptions isn’t helpful to success. It just sounds good during a meeting or at a bar.
Getting prepared before doing market sizing
Market size analysis is just one of several steps you’ll go through when learning how to start your own business. Other important steps include:
- Define Your Business: Clearly state what your business offers and to whom. This will be further informed by market size analysis, but be as specific as possible from the get-go.
- Business Structure: Sole proprietorships, limited liability companies (LLCs) and corporations are all various structures small businesses use. You can set up your business structure at any time, and it’s easy to do if you use a formation service. Our LLC formation will guide you through the entire process of formally registering a business, no unknown assumptions needed.
- EIN (Employer Identification Number): An EIN functions like an SSN for your business. You’ll need it if starting an LLC or corporation, and have it as an option if a sole proprietor. You can register with the IRS yourself, or use a formation service to do this quickly.
- Separate Finances: Open a business checking account to keep business and personal finances separate. You may also want a business savings account or business credit card.
- Keep Records: Create an organized system for keeping records of your research, assumptions, plan and business growth. You’ll want to keep your market research accessible, since it provides the foundation for your market size calculations and future decision-making.
At Tailor Brands, we help small businesses with many of these steps, from filing formal documents to creating logos and staying organized. No one can guarantee success in business, but we can help you on the path forward.
Conclusion
Understanding market size analysis is important, but ultimately all that remains is to actually do market size analysis for your business. Start simpler, use ranges, and refine as you gain more data. So long as you’re able to explain assumptions and update conclusions, you’ll be well on your way to better understanding your business’s potential customers.