But all too often entrepreneurs that answer that first question positively get ahead of themselves and race to develop the business in a rush of excitement without asking the critical follow-up.
‘How big is the market for my product?’
Only once you have answered this question will you know whether the payoff from your new venture is worth the toil, sweat and tears.
A model for market sizing – TAM, SAM, SOM
Answering the all important question of market size is not easy. It generally takes a lot of research from a number of sources to even begin to make meaningful assumptions about how many people out there could want to buy your product. Industry-analyst reports, market research reports, competitors' press releases and general internet research are all useful. But how do you turn these disparate sources into a hypothesis of your market size?
Start big and segment your market down. A top-down approach.
First, calculate your Total Addressable Market – this is an estimate of the total number of people in the universe that your product might appeal to and might be prepared to pay for it.
However, you will have constraints on the number of those people you can reach, either in terms of logistics or marketing reach. Therefore, you need to build in assumptions to reduce the TAM down to estimate your Serviceable Addressable Market – this is the segment of the TAM targeted by your product which is within your reach.
But it is extremely unlikely you will ever be able to sell to 100% of this segment as other entrepreneurs and businesses will compete with you. Therefore, you need to plan for how much market share of the SAM it is realistic to expect to achieve. This is called your Serviceable Obtainable Market – the size of the market you can reasonably initially target.
To illustrate the methodology let’s look at a simplified example for Alfred’s new proposed business selling fairy cakes with a twist – they include local superfood watercress – from his shop in Winchester.