This article explores multiple methodologies for how to calculate a market size, including top-down and bottom-up approaches.
In this article:
- How to Estimate Your Potential Market
- Bottom-Up Market Size Analysis
- Top-Down Market Size Analysis
How to Calculate a Market Size
How do you calculate a market size? Estimating market size empowers investors to know whether an opportunity merits investment. It allows decision-makers to quantify growth potential, identify market segments of interest, and set sales performance goals. Segmentation of a market can also refine a company’s strategies and goals by identifying promising geographies, customer types, and areas of application.
Unfortunately, the methods used by most companies to quantify market size are vague, confusing, or poorly described. For this reason, we describe below how market size estimations should be performed.
Given the importance of accurate market size estimations, it is critical that you understand how to estimate market size. Regardless of the approach you use, the steps to estimating a potential market remain the same.
The six steps to calculating a market size are:
- Identify your market
- Define what is included and excluded from your market
- Identify the major market leaders
- Determine the total number of market competitors
- Choose a market size determination approach (Bottom-up or Top-down)
- Calculate the market size
Bottom-Up Market Size Analysis
Although the steps are always the same, there are two different methodologies for market size determination, which are a “Bottom-Up” and a “Top-Down” approach.
At its core, a bottom-up approach to market size determination seeks to add up all market participants. There are three different techniques for executing a bottom-up analysis, and each of them must be considered in order to select the methodology best suited to assessing a specific market of interest.
For example, let’s say that we want to determine the size of the dental stem cell storage market. Baby teeth and molars contain a population of valuable stem cells, so several companies now store these teeth for a fee.
Using a bottom-up approach to market size determination, we would attempt to add up the revenue contributions from all market participants worldwide who sell dental stem cell storage services.
1. Roll-Up All Market Participant Sales
One way to perform a market size determination is to roll-up the total annual sales of all market participants. This is effective for small markets or slowly changing markets.
In this approach, all independent contributors to a market of interest are added together to determine a total market size figure.
For situations in which the sales of all industry participants are known and can be aggregated, this is considered an effective approach for market size determination. However, it typically does not work well when there are large numbers of industry participants or if a market is rapidly evolving.
For instance, to determine the market size for dental stem cell storage, we would add up the sales of all companies worldwide that provide the service.
For pure-play companies that specialize in dental stem cell storage, this would be a relatively easy calculation, because we could either contact company leaders to inquire about total revenue figures, or we could seek out these numbers online. However, for companies that offer multiple stem cell storage services, only the sales that they generate from dental stem cell storage services would be included.
It should be noted that we are using the market size for dental stem cell storage as an example because it is a relatively small market. You cannot use this approach effectively if a market is too large or rapidly evolving because the market value will already have changed by the time that you aggregate the data.
It is a “rookie” mistake to use this approach with high-tech, exponential growth markets.
Also, as a rule of thumb, it is relatively easy to find total revenue figures for a company, but substantially more difficult to find data about a company’s sales by product line. Keep this in mind when selecting this approach to market size determination.
2. Weighted Analysis of Industry Leaders
This method is effective for large or rapidly-evolving markets. Unfortunately, in large or rapidly-evolving markets with many small participants, it is often not possible to roll-up all competitor sales.
In these cases, the single best alternative is to estimate market size by determining sales of the largest players and then estimating the aggregate share of all other, smaller players.
This is generally an excellent approach for fast-growth markets, like the much larger umbilical cord blood storage industry which has 450+ market participants.
For example, if we need to determine the market size for cord blood storage services, we would add up the sales from 10-20 of the largest market participants, and then estimate the combined sales contributed by all of the other smaller market participants in order to calculate a total market figure.
This methodology is often an intelligent approach to market size determination because market leaders historically publish greater amounts of information about sales volumes and revenue figures. The reason is that market leaders often use sales figures to assert market share. Additionally, public companies are required by law to make certain sales metrics public in SEC filings and other public statements.
3. Survey Customers for How Much They Spend in the Market
Asking customers how much they spend within the market of interest can also be used to determine market size via a bottom-up approach.
For this approach, a population of customers is asked how much they spend each year on the products composing the market, and the results are extrapolated for the market at large.
Please note that this approach is always less accurate than the “Silver Standard,” because it relies on the accuracy of reporting by the surveyed participants (which cannot be confirmed) and adequate sample size.
However, it can be a moderately effective approach in situations that require it.
Top-Down Market Size Analysis
In comparison, a top-down analysis is a procedure in which a larger reference market is used and the percentage of that market that a company expects to capture is estimated. There are two different techniques for top-down analysis, as described below.
1. Using a Known Reference Market
In this method, the size of a known reference market is required and then the amount of that market that is contributed by a specific segment of interest is estimated.
For the example given, in which we want to determine the size of the market for dental stem cell storage services, we would have to know the size of a larger reference market, such as the size of the total stem cell storage market.
Then, we could estimate the percentage contributed by the market segment of interest, in this example, the size of the dental stem cell storage market. This can be an effective approach, but its limitation is that it requires a known metric as a starting point.
Therefore, BioInformant only relies on this approach for corroboration of findings determined via a bottom-up approach. It is not an ideal starting point for market size determination, because its accuracy relies on the accuracy of the reference number, which frequently cannot be confirmed.
However, in instances where a known reference market that has been carefully studied and quantified, it can be a valid approach for determining the size of a sub-segment of interest within that market.
2. Market Sizing Using Population Metrics
This can almost always result in misleading information. In this method, the size of a specific population is used and then a company estimates the percentage of that population that it can capture with its services.
Therefore, a common top-down analysis would look like this:
“Since there are approximately 320 million people in the U.S., even if we can only capture 1% market share per year with our dental stem cell storage service, we would be serving 3.2 million people. Because our product costs $750 per sale, that means we could make $2.4 billion in annual sales ($750 x 3.2 million people).”
Does this sound inaccurate? Does it sound way too optimistic? In our experience, it nearly always is.
We generally dislike this method of market size analysis, because it is rarely, if ever accurate. I would suggest that you be extremely hesitant to believe top-down market size estimations based on population metrics.
Calculating Market Size
In summary, there are several different market size methodologies that can be used, each of which varies in accuracy. Use the information in this post to empower yourself to calculate your own market size estimations.
If you have seen a market size figure that you would like us to cross-check for accuracy, feel free to send us an email at [email protected], and we will take a look. Go forth and be empowered!
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